AVAP - Avation - OB Idea #11
More to come from this Lessor, Avation?
Dear reader
Following a pullback to a 154.5p ask and with an exciting runway ahead, Avation (ticker AVAP) wasn’t an option I could take off my ideas for 2025.
AVAP is an aircraft lessor and suffered bad times back in 2021 & 2022 when the price appeared to assume humans would never fly again, thanks to an airborne virus. But as more and more travellers filed through the doors of airports as weeks and months passed and it became clearer that the assets were undervalued.
In the December AGM we learn YTD growth in 2024 is 7.1% and exceeded pre covid highs.
Post Period 2 aircraft have been sold.
Founded 2006, AVAP is a commercial passenger aircraft leasing group now managing a fleet of 32 aircraft. Avation leases aircraft to 15 airline customers spread across 13 countries in Europe and the Asia-Pacific region. Major customers include Vietjet Air, airBaltic, EVA Air and Philippine Airlines. The Group’s fleet includes 15 narrow-body jets, two twin-aisle jets and 17 ATR 72 twin-engine turboprop aircraft. Avation operates from its headquarters in Singapore where it benefits from the 8% tax rate Singapore Aircraft Leasing Scheme (“ALS”) tax incentive, and this has recently been extended to 2029.
It was announced in the AGM statement that AVAP believes the values of narrowbodies have increased by 5%.
This is evidenced by re-leasing an aircraft at a higher rate than previous (bear in mind it is now an older aircraft than it was previously too)
Trade Discount
Back in August AVAP sold two aircraft at a gain of $3.7m*, releasing $10m in net cash. which is a purchase (from new) and sale. Following this transaction, Avation has twelve ATR 72-600 aircraft on order for delivery from ATR between 2Q25 and 2Q28.
One of these it confirmed in November for contract to Japanese JCAS Airways under a long-term contract. It committed to this 1 year ahead of its delivery showing the strong demand for ATR aircraft.
AVAP then has purchase rights for a further 24 aircraft with an extended expiry date of June 2034. 36 aircraft in all.
These “rights” at 30/06/24 were worth $112.8m or $3.14m per aircraft. This value sits on the balance sheet so isn’t a hidden value, it’s part of that 256p per share. The point was that book value meant a guaranteed gain.
*$3.7m gain is the $10m cash gain less the $6.3m purchase rights - you don’t get to book the same gain twice!
Recent Loss (1H24)
The -$8.8m loss in the first half is lost in the profit of $19.7m for the full year. This was due to a loss on disposal and some impairments.
Considering that $4.27m overdue arrears existed at 30/06/24 it appears some previously written off arrears have been collected post period ($6.4m > $4.27m).
The AVAP P&L
Assessing profit
Zeus’ estimated a $41.4m move in profit. This was wide of the mark. Operating profit EBITDA for 2H24 is in excess of $65.7m. This is backed up by a full year $120m cash from operations.
The run rate of revenue is noticeable too. $47.7m in 2H24 is $95.4m annualised.
AVAP weren’t kidding about being ahead of expectations! $65.7m of operating profit in 2H24 is well ahead!
The larger gain on purchase rights explains the higher number.
Revenue in H2 was $95.4m which is $0.6m ahead of my prior estimate.
Debt is reduced by $67.7m which is well ahead of my $55.2m estimate. At a weighted and hedged rate of 6.4% that’s $4.3m a year cost reduced, and since focus is being made to repay unsecured debt costing 8.25%.
About ATR aircraft
AVAP’s Purchase Rights and asset of $112.8m in the balance sheet is based on future discounts on the ATR-72 600 (and EVO) aircaft.
The perception around propellor aircraft might be a negative one. If you don’t live in the Highlands/Islands of Scotland or in Ireland then you probably don’t encounter turbo prop aircraft when you travel.
It’s worth being aware turbo propellers are the most efficient engines burning twice less fuel than turbojets, because they have a different propulsion system from the turboprop: the energy created drives a propeller in return. Because of the large diameter propeller, they require less power, so less fuel to accelerate the air. The turboprop will burn up to 45% less fuel, and emit up to 45% less CO2. They can use 50% SAF and from next year probably grow that to 100% SAF (Sustainable Aviation Fuel). ATR is owned by Airbus and Leonardo, based in Toulouse.
ATR’s next gen aircraft, which is about 5 years away offers even more than today’s ATR. 20% further fuel efficiency (using battery/electric for take off), 20% further maintenance cost efficiency and loss further 20% CO2 reduction (or close to 100% with SAF). AVAP has purchase rights over these aircraft which could be in strong demand with airlines.
Valuation
The annual results to 30/06/24 back up my prior assessment of AVAP. Yet AVAP has dropped from recent highs of 178p to 157p today. The market remains asleep to the value.
At $1.27:£1 AVAP is £2.70/share estimated NAV at 30/06/24 so a 41.9% discount. But that excludes 1H25 progress which includes a sale of one of AVAP’s order book ATR-72-600’s straight from Toulouse.
If we look at what FY25 could deliver these numbers don’t seem unreasonable.
And if I’m right about the above then NAV today isn’t £2.70 it’s above £3.00 per share perhaps as much as £3.28. So by 31/12/2025 this idea for 2025 could be double it’s price today.
Valuation Drivers
Fully utilised fleet. IATA reported passenger air travel grew at 7.1% in the year to October 2024. International travel is showing particularly strong momentum with 18.9% year-on-year growth in revenue passenger kilometres.
5% increase in the resale value of 82% of aircraft could be a $32m fillip.
Buy Backs! £11.7m of shares bought back so 10.45% of the companies shares.
AVAP’s relationship and purchase agreement with ATR is a source of current and future value. The ATR-72 and EVO are the only credible plane in this segment with troubled Boeing having no presence in this segment and others like Embraer exiting the market and DeHaviland/Bombardier being more expensive alternatives. “Cheap and Cheerful” both to buy and to run, with decent reliability seems a decent strategy and AVAP gets to benefit from that through higher margins and higher residual values (a real worry in the airline leasing business).
Debt - more expensive unsecured (8.25%) debt is being actively paid down as well as debt coming due and the perceived risk of financing aircraft a very proposition to when AVAP last raised funds (during Covid). This was a $3.8m saving in 2H24 alone.
Refinancing could also play a part. AVAP would save ~$3m a year moving expensive 8.25% debt to a termed facility of around 5%. This is being looked at it was announced last month.
Expansion - intrguingly AVAP is at a cross roads.
Rather than aggressively paying down debt and selling up its aircraft what if it embraces debt and looks to profit from leverage? Canaccord Genuity identify this as a key inflection where free cash flow is used to reinvest into and to grow the fleet. New ATR-72s appear to be priced at around $16m each based on the Aircraft Fleet and Note 12 PP&E. (Net $12.6m to AVAP less its purchase right). Annual depreciation is around $0.56m (pro rating depreciation 75% jets and 25% turboprops and the resulting $5.68m for 1H24/20 aircraft).
Rental is around $1.18m (25% of $94.8m run rate and divide by 20).
On these numbers it is barely profitable to expand the fleet, and that’s based on using around $3m of equity per aircraft (and $9m of debt) at an assumed 5% interest rate (which is higher than prior bond issues).
But there’s a number of qualifications I’d make to my numbers:
a. They don’t include the $3.4m per aircraft purchase right gain.
b. They assume rental at $1.18m which is a historic pro rated assumption based on a split based on depreciation. Newer aircraft with lower costs of operation would presumably attract higher prices than older ones with higher costs.
c. It assumes depreciation at historic rates. This may or may not be reasonable going forwards. AVAP’s current policy is 15% residual and 25 years straight line which is a slightly lower $0.54m than my $0.56 estimate.
d. Assumes debt being 75% of PP&E and at a 5% rate.
Once we re-run the numbers to assume a 25% higher rental, a lower depreciation, include the purchase gain (amortised over 20 years) and factor in 20 years on income and 34 aircraft we arrive at a $343.4m net gain.
An approximate to its NPV if you are happy to accept that rentals (and the value of the discount against the future purchase price of ATR aircraft) will rise roughly in line with the cost of capital.
But this also assumes a business leasing 34 aircraft has the same costs as a business leasing 68 aircraft. It doesn’t. Apart from being able to “sweat” fixed costs more efficiently, a stronger credit rating, and higher FCF and profits lead to better access to cheaper debt. Perhaps too it can negotiate higher rentals as a larger player in the market. Perhaps negotiate a larger discount from future purchases of ATR aircraft too.
The model also doesn’t capture the residual value. Assuming 15% residual after 25 years that’s $81.6m on 34 aircraft. But eagle-eyed readers will notice my P&L model is 20 years so that adds back a further $91.8m to the residuals after only 20 years.
So a potential future (34 x $0.51) = $17m PBT net monthly income so $204m a year and perhaps $180m post tax. Even if we assume just a 1/4 of this ($45m) and apply a P/E of 6 is a $270m post tax valuation or £3 additional future value per share.
Risk
Obviously another Covid outbreak, or other reason for international air travel to cease or drop would knock these numbers sideways. As happened in 2020-2021. My numbers also assume 100% utilisation of aircraft which is now the case with robust travel demand and limited supply, but post covid that wasn’t the case.
Changes in technology might also transform AVAP’s fortunes. If the world invents teleportation or Tesla’s boring tunnel travel, or something to replace aircraft or if Boeing or another manufacturer perhaps from China, Brazil or India released a superior aircraft. But aircraft purchases are pretty conservative affairs and step-change SciFi technology at least for the foreseeable might just possibly be fanciful impossibilities.
It is also apparent that AVAP is a smaller scale operator than competitors and a larger scale would reduce risk. Its customers operate in an industry which is notoriously boom and bust and the loss on a repossessed aircraft in India is an example of risk.
Conclusion
Certainly AVAP looks cheap relative to its prospects and its assets. CG point out its cheap relative to Aercap, Air Lease Corp and BOC Aviation AVAP is cheaper by about 2.5X (on a P/E and Price to Book basis).
Whilst people could incorrectly (as I did I before examining this stock again today) see the debt pay downs and aircraft disposals as a potential way to “asset strip” and wait for debt to be paid down and assets to be realised to get a net gain…. but it appears the opposite strategy is in motion.
In other words I’ve done a double take and realised this is a growth stock disguised as a value stock!
That growth strategy given the attractiveness of ATR aircraft and of the desirability of air travel, along with remaining in keeping with moves towards Net Zero, make this an intriguing and lower risk way rather than owning shares in an airline, but rather to invest in the growth of CO2-friendlier air travel in a net zero world.
Take Off the LSE? Take Over Target?
Besides this idea might get bought out and not survive to 31/12/2025 if the rumours are true….
Regards
The Oak Bloke
Disclaimers:
This is not advice
Micro cap and Nano cap holdings might have a higher risk and higher volatility than companies that are traditionally defined as "blue chip"
The fact that Rangeley and Raper are on this as well gives additional comfort. Chris and Jeremy are smart guys.
On 18 December, AVAP announced it bought back 10.45% of shares in issue at 150p/share, and hinted at further such transactions in the future.
This does not inspire a lot of confidence:
– Rangeley/Raper sold almost half of their position in AVAP – potential pressure on management by these guys was one of the key parts of the investment thesis. Also, they clearly do not think risk/return is favorable at 150p/share to maintain the full position.
– It kind of seems that the whole buyback was done to cash out either insiders or large shareholders. Unclear which one, as there were two days with 8m+ trading volume – insiders were likely selling on Nov 28, and Rangeley on Dec 17.