The directors of aircraft leasing company Avation (AVAP:256p) have delivered yet more good news to shareholders at its annual meeting as I had anticipated they would a couple of months ago ('Poised for take-off', 8 Oct 2018).
The board is guiding investors to expect a 39 per cent increase in aircraft lease rental values in the six months to the end of December 2018, an outcome that will deliver a record half-year profit and a run rate in line with Canaccord Genuity’s full-year revenue forecast of $119m (£93m). The update is supportive of expectations that Avation can lift full-year underlying pre-tax profit from $18.9m to $23.8m and deliver EPS of 35¢ (27.5p) for the 12 months to the the end of June 2019. The board has declared a first half-year dividend a share of 2¢, underpinning analysts’ full-year expectations of an 8¢ (6.2p) payout.
The directors have also revealed the extent to which the fleet is undervalued. The conditional disposal of one of Avation’s eight Airbus A321-200 aircraft to an Asian buyer has been agreed at a price that will exceed its book value of $48.7m (£37.5m) by “more than 10 per cent”, a significant sum in relation to the profits expected from the company’s leasing activities. They also flagged up that narrow-body aircraft now comprise “half of the $1bn fleet value”, the clear implication being that Avation’s last reported net asset value (NAV) of $231m (£180m), or 280p a share at current exchange rates, is far too conservative. Please note that I have adjusted the last reported NAV to take into account the exercise of share options post the June 2018 financial year-end.
Furthermore, after accounting for the delivery of two ATR72-600 aircraft by the end of this month, the company still retains options and purchase rights over 25 of these aircraft for delivery up to December 2023, all of which are held in the account at nil cost. To put the value of these aircraft options into perspective, Canaccord has a target price of 335p, representing a 20 per cent premium to Avation’s last reported NAV, which is "justified by the company’s attractive growth prospects and [the premium] largely underwritten by the value of its ATR options".
In other words, the 25 ATR-72 aircraft options could easily be worth $45m (£35m) on the open market, a significant sum in relation to Avation’s market capitalisation of £164m. Add to that a potential $50m (£39m) plus undervaluation of the narrow-bodied fleet and there is potentially $95m of hidden value not embedded in Avation’s reported NAV of $231m. Furthermore, my financial models suggest that Avation could boost its reported NAV to $257m, or 399¢ (312p) a share, by June 2019 after taking into account only the realised $5m-plus profit on the aforementioned Airbus A321-200 aircraft sale and retained profits in the 12-month trading period. However, mark Avation’s fleet of 41 aircraft to their open market value, and factor in a realistic valuation of the 25 ATR-72 options, which have increasing scarcity value – ATR only manufactures 85 planes a year and demand from China, India and Iran is tightening the market – and the company’s break-up value is realistically far closer to 400p a share.
Trading on a forward PE ratio of nine, offering a 2.4 per cent prospective dividend yield, and with substantial hidden value in the accounts, I continue to see value in Avation's shares, which have posted a total return of 72 per cent since I first advised buying at 159p ('Get on board for blue-sky gains', 11 Sep 2014). Strong buy.
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