Geared for an airline industry recovery

Aircraft leasing company Avation (AVAP:102p) has endured its most challenging year since listing its shares on London’s junior market. As has been widely reported, the Covid-19 pandemic put the airline industry into a tailspin as operators’ cash flow dried up overnight, one of the many challenges faced by aircraft leasing companies.

The financial cost to Avation has been an $87.4m (£63.7m) impairment charge on its fleet of 44 aircraft which are leased to 19 airlines across 15 countries. The group also booked a $25.4m charge for expected credit losses on receivables in the 12 months to 30 June 2021. The $162m decline in fleet assets to $1.08bn reflects the sale of aircraft during the financial year, too.

Part of the impairment charge relates to a Boeing 777 aircraft leased to Philippine Airlines. The carrier entered Chapter 11 of the US Bankruptcy Code last month and is currently undergoing a restructuring with creditors. A successful outcome is predicted, which will enable the group to start collecting cash rent on the aircraft for the first time since mid-2020, as well as payments relating to utilisation since September 2020 (on a power by the hour basis), and rent outstanding prior to September 2020 (through a promissory note). The lease will then continue to its original scheduled termination, and revert to current market rate fixed rents and maintenance reserves following an initial period on a power by the hour basis.

Avation has also had success in repurposing 13 aircraft that had previously been leased to Virgin Australia before the airline entered administration on 21 April 2020. Two Fokker 100 aircraft held on finance leases were transferred to the lessee in September 2020, four of the 11 ATR-72s were re-leased at market rates, and one has been sold. Of the remaining six ATR-72 aircraft, Avation has entered a letter of intent to sell three of them for cash to another European airline. The transaction is expected to complete before the year-end.

In addition, Avation has a A$101.4m (£54m) creditor claim outstanding with the administrator of Virgin Australia. A payout of 9.5¢ to 13¢ on the dollar is predicted for unsecured creditors. However, Avation’s management believe that 45 per cent of the A$101.4m claim should take priority over unsecured creditors and is preparing to commence litigation for its priority claims to be recognised.

Fleet generating positive operating cash flow

Aircraft disposals raised $20m in the financial year, which combined with $62.2m of net cash flow from operating activities – 13 airline customers were paying normal market rents at 30 June 2021 – helped drive down group net debt to $922m.

Importantly, Avation is well funded, having extended US$342m of senior loan notes until October 2026 (‘Small-cap bargain hunt’, 14 February 2021). Around 91 per cent of debt is fixed or hedged, the weighted average cost of debt is 5.4 per cent, and loan durations typically match the lease maturities. Avation has total unearned contract revenue of $668m due on the unexpired leases, which have a weighted average term of 6.4 years, so should continue to generate healthy operating cash flows. In terms the geographic split, two-thirds of unearned contract revenue is derived from Latvia (airBaltic), Vietnam (Vietjet) and Taiwan (Eva Air), countries that have fared relatively well during the pandemic.

Strengthening balance sheet for airline recovery

Proceeds from aircraft sales, and creditor payments from Virgin Australia’s administrator, will increase liquidity and enable borrowings to be further paid down, thus strengthening the group’s balance sheet.

That’s important because airlines will require significant numbers of leased aircraft following the pandemic due to the large number of older aircraft that have been retired. However, the impact of the pandemic on airline balance sheets has reduced their ability to purchase aircraft directly. This is supportive of demand for leased aircraft. Indeed, Avation has just entered a letter of intent with another European airline to transition an Airbus 320 from Air France when its current lease expires this month.

In addition, Avation is mainly focused on higher-growth regional markets through its fleet of sub-100 seat turboprop and narrow-body aircraft, with a strong bias towards Asia. Retaining purchase rights on 28 new ATR 72-600 aircraft and with orders on a further two, the group is well placed for the post Covid-19 pandemic recovery.

There is also the possibility that some of the impairment charges will reverse in due course. That’s because a return of air travel to pre-pandemic levels, coupled with a reduced global airline fleet, will put upward pricing pressure on the value of existing aircraft. Avation’s relatively new fleet will benefit more than most as it has a weighted average age of only 4.8 years.

Potential for upgrades

Analyst John Cummins at house broker WH Ireland expects pre-tax losses to narrow from $70.2m to $4.8m on 8.5 per cent lower revenue of $107m in the 12 months to 30 June 2022, and notes “potential for these numbers to move higher as liquidity increases and is redeployed into the acquisition of further aircraft”. 

Priced on a 39 per cent discount to net asset value of $157m (164p a share), Avation’s shares are a geared play on the airline industry's recovery. Buy.

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