Aircraft leasing company Avation (AVAP:270p) is bang on course to deliver record revenue, profit and operating cash flow after the directors guided shareholders to expect a 20 per cent hike in revenues to $117.7m (£93.9m) in the 12 months to the end of June 2019.
I last updated the investment case after the company almost doubled its pre-tax profits and EPS to $14.2m and 21.6¢, respectively, in the six months to the end of December 2018, a result that included a $5.2m gain on the $52.9m disposal of one of its narrowbody Airbus A321-200 aircraft ('Avation flying high', 21 Feb 2019). Avation subsequently realised an additional undisclosed gain from aircraft trading, selling off a 16-year old Airbus A320 aircraft in order to maintain a low average fleet age of around four years. Importantly, the sale was concluded at a premium to book value.
It makes sense to do so as the company expands its fleet, up from 38 to 48 aircraft in the 2018/19 financial year, diversifies its revenue stream to mitigate customer concentration risk – Avation now has 17 airline customers in 13 countries, the latest acquisition being a Boeing 737-800 NG aircraft on lease to Garuda Indonesia – and improves visibility of future contracted revenue by maintaining a stable average remaining lease length of around 7.5 years in order to optimise future cash flows.
This strategy clearly appeals to bond investors as Avation reduced its weighted average cost of debt from 5.0 to 4.6 per cent in the financial year just ended. The fleet growth is mainly funded by senior secured debt. It also appeals to shareholders, who can expect the company’s progressive dividend policy to continue after the board guided them to expect an increase on last year’s 7.25¢ (5.8p) annual payout. It’s justified too given that Avation’s pre-tax profits are set to rise from $18.9m to $22.2m, according to analyst John Cummins at brokerage WH Ireland, to produce earnings per share (EPS) of 31.7¢ (25.4p). On that basis, the shares are rated on a modest 11 times earnings and offer a prospective dividend yield of around 2.4 per cent, assuming a 10 per cent hike in the payout.
There is hidden value in the balance sheet, too. That’s because Avation has ordered a further eight ATR 72-600 aircraft for delivery by 2022, and has options on an additional 25 of these turboprop aircraft that are held on the balance sheet at nil cost. Each option could be worth £1m on the open market given their scarcity value – ATR only manufactures 85 planes a year and demand from China, India and Iran is tightening the regional aviation market for these fuel-efficient aircraft.
In addition, the aforementioned sale of one of its narrowbody Airbus A321-200 aircraft highlights a conservative approach to valuing these planes, too. Avation owns a further seven Airbus A321-200s, the implication being that there could be $50m (£40m) of hidden value in the balance sheet once you mark the A321-200 aircraft fleet to open market value, a hefty sum in relation to Avation’s market capitalisation of £174m. It’s also a significant sum in relation to the company’s last reported net asset value of $236m.
Avation's shares have posted a total return of 82 per cent, including dividends banked, since I first advised buying at 159p ('Get on board for blue-sky gains', 11 Sep 2014) and look primed to make new all-time highs north of 300p when the company reports a bumper set of annual results on 5 September. Trading on a discount to my 303p estimate of spot net asset value per share, which excludes the hidden balance sheet valuation gains I have outlined above, and rated on a modest earnings multiple, the shares are worth buying.
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