The directors of aircraft leasing company Avation (AVAP:132.5p) held a reassuring investor conference call this week to highlight the initiatives put in place to help both their airline customers and the company to successfully navigate through the Covid-19 crisis. Their commentary inspired a great deal of confidence and adds significant weight to my buy recommendation (‘Deep value buying opportunities’, 8 April 2020).
To date, all bar four of the 19 airline clients who lease Avation’s fleet of 48 aircraft across Europe, Asia Pacific and Australia have taken up the offer of deferring some of their lease payments, generally for upto six months, with repayment terms of six to nine months. All airlines continue to pay maintenance reserves and cash rent. The sums deferred equates to only 7 per cent of pro-forma annual revenues of $133m.
Although Virgin Australia entered voluntary administration on 21 April, Avation is not overexposed. That’s because the debt of $45.9m (£37m) associated with 13 aircraft leased to Virgin Australia represents a small sum in relationship to the $159m book value of the planes. Moreover, Avation holds security deposits and maintenance reserves of $8.2m. The objective of Virgin Australia’s administrator is to sell the airline as a going concern and it has a 15 May deadline for first bids from interested parties. The airline is still flying around 64 routes.
In addition, Virgin Australia’s administrator has indicated that it will pay the final purchase option to buy out two Fokker F100’s (book value of $1.9m), and may retain five ATR72-600s (book value of $78.5m). Avation has already repositioned three of the remaining six ATR72-500s aircraft (book value of $79m) to another airline, and has an offer in place to transition the other three planes, too. The exposure to Virgin Australia equates to only 6 per cent of Avation’s contracted unearned future revenue. Also, there is a real possibility of a financially sound bidder emerging for the Australian airline at a time when the proposed Australia/New Zealand Trans-Tasman travel bubble will reassure passengers in the respective countries, both of which have had low levels of Covid-19 infections and deaths.
Other airline clients are flying again, too. Vietjet, an airline accounting for 25 per cent of Avation’s contracted future revenue, flew more than 1,000 flights last week after Vietnam came out of lockdown, and it’s business as normal at Fiji Airways. Interestingly, chairman Jeff Chatfield says the company was approached this week by “a sophisticated US investor looking to buy Vietjet aircraft”. That’s well worth noting, as is the fact that Air Baltic recommences flights on 15 May when it plans to operate a Latvian, Estonian and Lithuanian travel bubble, having secured €250m (£222m) investment from the Latvian government. The airline accounts for 22 per cent of Avation’s contracted future revenue.
Importantly, Avation has a high level of liquidity – the company held total cash of $130m at the end of April and owns unencumbered aircraft worth $53.9m; is compliant with all senior bank loan covenants; and has the support of its senior lenders, who have adjusted their loan amortisation schedules to realign them with the lower short-term cash rent receipts. Indeed, chief financial officer Iain Cawte revealed that having reduced annualised administration costs by 25 per cent to $8.5m, and after taking account of the agreements in place with airline clients and lenders, the company should be cashflow neutral over the next 12 months.
Avation’s liquidity position and the fact that its airline clients are either flag carriers with access to state aid, or Asian regional players in locations that have been least impacted by the Covid-19 crisis, reinforces my belief that investors are overly cautious in valuing the shares on a 62 per cent discount to book value of 352p. The shares are also rated on a miserly five times Avation’s net profit in a normal operating environment. For good measure, there is positive divergence on the chart as the 14-day relative strength indicator (RSI) made a significantly higher low on the retest of April’s share price low, a bullish signal. This suggests to me that a major bottom is now in place and a rally back towards my initial target of 270p is on the cards. Strong buy.
Trinity cash flow seriously undervalued
I had a lengthy results call with the management of Trinity Exploration & Production (TRIN:6.05p), an independent oil and gas explorer and producer focused on Trinidad and Tobago, and one that left me convinced that they are pursuing the right strategy in the current challenging oil price environment.
Operating break-even was cut by 9 per cent to US$26.40 a barrel on 5 per cent higher average production of 3,007 barrels of oil per day (bopd) in 2019, well below the average realised oil price of US$58.10. True, US benchmark West Texas Intermediate (WTI) has fallen 59 per cent to US$25.50 a barrel since the start of this year, but with the benefit of hedging arrangements now in place (worth US$6 a barrel when WTI averages below US$50 a barrel), Trinity is targeting 2020 operating break-even of US$20.50 a barrel. At the current oil price the company still generates cash flow of around US$1.10 a barrel.
Moreover, even without further drilling, guidance is for average output to rise to 3,100 to 3,300 bopd this year. Capital expenditure has sensibly been reined back and finance director Jeremy Bridglalsingh estimates total maintenance spend of US$1.5m for the second to fourth quarters, mainly low-cost work overs and recompletions of wells. So, after accounting for US$2.2m of capital spend in the first quarter, net cash should still rise from US$13.8m to US$15.1m (£12.4m) based on an average oil price of US$25 a barrel, according to analyst James McCormack at Cenkos Securities. At an average oil price of US$20, Trinity would end the year with net cash of US$10.6m.
To put these sums into perspective, the company only has a market capitalisation of £23.2m. This means that even if you attribute nil value to Trinity’s 20.1m barrels of 2C (contingent) resources, its 2P (proven) reserves of 20.94m barrels are effectively in the price for a bargain basement 63c a barrel even though a third of 2P reserves are located onshore (operating break-even of US$12.30 a barrel pre-hedging arrangements) and a further 50 per cent are on the east coast (operating break-even of US$17.30 a barrel pre-hedging arrangements).
Trinity is not only one of the lowest cost producers in the sector, but importantly is cash generative even at the current depressed oil price. It is certainly not distressed. Furthermore, you’re getting a free option on the company scaling up production in a more benign oil price environment to exploit the value embedded in its valuable acreage.
Trinity’s share price is up 10 per cent since I rated the shares a hold and advised holding your nerve (‘Targeting value plays’, 16 March 2020). However, a chart base formation now seems to be in place, and this looks like a decent opportunity to buy in close to the low. My initial target price of 12p offers 100 per cent share price upside, but still only equates to a third of Cenkos’ core net asset value of 36p a share. Buy.
Duke’s discount to book value unwarranted
Duke Royalty (DUKE:23.5p), an Aim-traded company that makes its money by providing capital to companies in exchange for rights to a small percentage of their future revenues over a typical term of 25-40 years, is being priced a hefty 38 per cent below proforma book value of £90.3m (37.7p a share) after factoring in last October’s £17.45m equity raise, at 44p a share. It’s a value opportunity worth exploiting.
Firstly, although some of Duke’s 12 royalty partners have been hit by the Covid-19 economic downturn, the company still received cash royalty payments in excess of £600,000 in April, albeit below the £1m record receipts in March. The directors have adopted a sensible approach to help royalty partners navigate through the crisis, electing to either accrue, capitalise or equitise its monthly cash payments in the short term with the intention of alleviating the negative cashflow impact on their businesses. I would stress that these royalty payments have not been lost, simply deferred.
Secondly, guidance is for Duke’s cash receipts to be maintained at the current run rate through the first quarter to 30 June 2020. So, having cut annual operating costs by 20 per cent to £1.8m, the company is effectively generating annual net operating free cash flow of £5.4m (2.25p a share) prior to interest and tax payments, thus highlighting the cash-generative nature of the business even under the stress of an unprecedented pandemic.
Thirdly, Duke has a robust balance sheet which includes cash of £3m, royalty investments worth £93m and modest borrowings of £16m. The company also has access to £18m of additional capital through its loan facility with Honeycomb Investment Trust.
Fourthly, having paid out total cash dividends of 2.95p a share in the financial year to 31 March 2020, the board intends to pay a scrip quarterly dividend in June and will revert back to paying cash dividends when a more normalised trading environment returns.
Effectively, this is an opportunity to lock into a high dividend yield, benefit from the economic rebound when lockdowns are lifted, as is now happening, and capitalise on a likely improvement in investor sentiment, which should drive a marked narrowing of the share price discount to book value. For good measure, there is positive divergence on the charts as the 14-day RSI was significantly higher on the May re-test of the March share price low (‘Targeting value plays’, 16 March 2020), a bullish signal and one highlighting seller exhaustion. My target price is 40p. Strong buy.
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