HOW TO DOUBLE YOUR MONEY EVERY 3 YEAR
Avation is an aircraft lease company. The model is easy to understand, and has been very effective in recent years: Purchase new aircraft, which offer a lease yield of 13%, with asset depreciation of about 5% per year. Apply 75% debt financing, at an interest rate of around 5%. Total other cash costs net off to around 1%.
So to illustrate how this all adds up, on an investment of $100m, the first year’s net cash yield is around $8m ( = 13% * $100m, minus interest of 5% * $75m, minus admin etc. of $1m). Leveraging this $8m with 75% debt, the company can add $32m to gross assets. Netting off the 5% depreciation gives final gross assets of $127m after one year. This gets us to a doubling of assets (gross and net) every 3 years.
The table below shows that this is indeed how things have played out in recent years, with variances from year to year due to phasing of asset purchases. We believe conditions remain in place for very strong growth to continue into the future.
THE STOCK MARKET ONLY VALUES AVATION ON PRICE/BOOK OF 0.8x
There are 10 listed independent aircraft lease groups globally – of which 3 in Hong Kong which trade on 1.2x book value, and 6 in the US which trade on 0.9x. We believe that Avation is under-valued due to being the only UK-listed name, and due its relatively small market cap at only £112m.
WHAT WILL DRIVE RE-RATING?
In addition to continue growth in the asset base, investors stand to gain from an expansion in the price/book multiple from its current 0.8x. We believe this is inevitable for a number of reasons. Firstly, as the company’s market cap increases (now above £100m), we expect the small-cap discount to be eliminated. Secondly, the company could crystalise some of its asset value via disposals (an unsolicited bid for 22 aircraft is currently being evaluated). Finally, if the share price remains at a big discount to its peers, we believe there is a likelihood that a bigger lease company could bid for Avation as a cheap (below book value) route to acquiring fleet. We conclude that there is scope for shareholder gains both from re-rating, and from continued fleet expansion.
These four charts provide further illustration of the growth characteristics of Avation (above) as well as some of the downside protection measures built into the group’s strategy.
GROWTH
The first chart shows Avation’s fleet growth over the last 6 years. This represents a doubling of the asset base every 3 years, and has been achieved by recycling and leveraging the lease cashflows generated by the fleet.
The second chart shows the group’s cash return on equity. This has averaged 31% over the last 6 years, and after taking into account depreciation of around 5%, this explains how the company’s growth rate has been sustained at above 25% average run-rate.
RISK MITIGATION
The charts below show the average age of Avation’s fleet of aircraft, and the average remaining lease term on the fleet. The fleet age, at 4.1 years as of June 2016, is low. Aircraft have a typical working life of 25 years, and the big flag-carrier airlines typically have average fleet age of over 10 years (e.g. British Airways, Air France, Delta).
The second chart shows the average remaining lease term. This has been steadily around 6 years, giving Avation good visibility for future cashflows.
Both of these measures are useful risk mitigation for Avation. The most liquid market for aircraft is at the low age end of the market, and aircraft are also generally easier to sell if they are under lease. Having a liquid asset base gives Avation the ability to adapt to any potential future changes of circumstance in the market. We conclude that the company has the ability to continue its very strong growth trajectory, but is also taking a prudent approach to managing risks for shareholders.