Interims H1/25Avation issued their
interims earlier this week. The interims were...complicated.
Retail investors probably struggle to understand the business on two levels; firstly the actual business of aircraft leasing is unique in the UK because Avation is the only pure aircraft leasing company out there and hence nothing to compare the company against; unlike practically any other company listed on the LSE which have comparable competing companies.
Secondly the basic premise of why an airline with a much lower cost of borrowing would prefer to lease an aircraft against outright purchase is a conundrum. Understanding Operational Lease, Finance Lease or Wet Lease principles is not appreciated let alone, Base Value, Market Value, Lease-Encumbered Value etc., and when it comes to finance options then there are more acronyms than you can shake a stick at. Then there is the mechanics of actually buying aircraft, maintenance, re-locating aircraft etc.
Years ago when Richard Wolanski did the Investor Relations for Avation he simplified it down to being akin to taking an a mortgage on your house. That explanation worked well until COVID happened and Avation ordered a whole bunch of ATR's for future delivery which introduced the 'problem' of Purchase Rights valuation. Richard's explanation of the business of aircraft leasing became too simplistic but investors want to see some basic things which essentially boils down to growing profits and margins. This is where Avation's numbers fall down...or do they?
Avation reported a Pre-Tax Loss of $9.8m. This was turned into a post tax profit of $0.87m following the use of tax credits. Not good, at first reading.
The primary issue is that the 24 Purchase Rights are valued using risk free interest rates, inflation, time to expiry and ATR purchase costs via the Black-Scholes model and this has historically lead to very large fluctuations in the value of those Rights which directly impacts the reported profitability of the company. Investors may query the use of the Black-Scholes model, seeing it as some sort of investment trick.
For the interims those Purchase Rights value decreased by $15.4m (non-cash). They are currently worth $100.5m. Excluding the valuation change in the Purchase Rights would have resulted in a pre-tax profit of $5.6m.
To address the confusion caused by the Purchase Rights, Avation is now looking for a financial partner to invest in a joint venture for the purchase rights to reduce the volatility in reported profits. It will be interesting to see how that evolves and hopefully will not lead to an adverse one-off exceptional charge.
Furthermore there is the Amortisation of IFRS 9 gain on debt modification regarding the unsecured notes of $7.4m (another non-cash item). Taking that into account the 'adjusted' pre-tax profit would be a loss of $1.8m.
Looking ahead, the unsecured notes (8.25%/9.0%) totalling $331.6m will be refinanced probably late 2025/ early 2026 (can't be done before October 2025 as there is a 4% penalty for early redemption). This will undoubtably be refinanced at a significantly lower rate reducing repayments by perhaps $11m/year or more. That effectively drops through to profit.
Additionally, Avation have improved revenue (and they really should be highlighting the continuing collection from COVID forbearance and they are now saying they could pick up around a further $11m in cash), improved EBITDA and operating profit, continued to reduce leverage which now stands at an industry standard poultry 56% net debt to total assets.
However, as I've mentioned before I prefer to measure Price to Fleet Book Value which is nearly at 0.9 or 154p/share That's uncomfortably high for an aircraft lessor on a traditional basis. However at a corporate level the current NAV stands at a reported 294p per share up from last years 285p per share. With a current share price of 137p that's a P/NAV of 0.48.
Today Avation
announced300,000 share buyback at 138p/share against the 294p NAV. It appears that someone sold 335,435 shares to facilitate this. Market makers or Rangely Capital perhaps?
Lease yield is a metric often ignored yet it is a financial measure of Profitability. A higher lease yield indicates a more profitable lease agreement. Currently it sits at 11.4%, up from 10.7% This is a reflection of now having the entire fleet leased out at attractive returns.
Net spread is a key profitability metric used by aircraft lessors to measure the difference between the lease yield earned on the fleet and the cost of financing that fleet. It represents the lessor’s effective margin on leased assets.
Net Spread=Lease Yield−Cost of Debt
where:
Lease Yield = (Annual Lease Rental ÷ Aircraft Purchase Price) × 100
Cost of Debt = Interest expense on debt used to finance the aircraft
So this gives a net spread of (11.4% - 6.6%) = 4.8%
In terms of lease revenue, this is now stable at $89m (plus a couple more million from the recent Etihad lease) and similarly depreciation remains effectively a constant value. So going forward both revenue and depreciation will remain 'as is' subject to aircraft trades. So that leaves Avation with two primary levers to play with namely debt reduction and lower debt costs against a backdrop of increasing market aircraft valuations and higher lease rates for new aircraft coming into the fleet.
Perhaps the complexities of Avation's business if behind the reasoning of moving to the LSE's ESCC category. This category was established in July 2024, consolidating the previous premium and standard listing segments into a single, streamlined framework; Would increase visibility and access to capital markets, potentially benefiting shareholders through greater liquidity and investor interest (apparently).
The interims also show that Avation paid $15.682m for the last ATR that was immediately sold for $19.790m, yet they report a profit of $1.7m (not $4.108m) I do note that elsewhere it states it was sold for $19.077m (maybe something to with Pre-Purchase Payments being made outside the period????) We should be seeing $5m profit on those aircraft??
Operationally there is a lot going on which is best read for yourselves in the Interims. Essentially, all future aircraft are sold for 2025, all 2025 future transistion aircraft already have new homes to go to and the company have taken over the lease from ORIX Aviation of an 11.5 year old A321-200 A6-EIU (MSN5821) on lease with Etihad. That aircraft maybe worth $20m and bring in an income of $2.2m/year. Am not keen on that sort of deal with an old aircraft but Avation say the economics are good and it will help with credit ratings in the future.
So what are the catalysts going forward?
Debt Refinancing at much lower rates
New customers in Japan, Korea, and Etihad provides credit quality improvements.
Organic ATR growth
Ongoing debt reduction
Potential Credit Rating upgrade
Market valuation upside
Aircraft sales
Continued interest rate cuts
Potential M&A
Jeremy RaperJeremy Raper (The 'activist' shareholder with a 16% holding with Rangeley Capital) posted a good analysis on his
Twitter feed. which covers the results in far more detail than I. Accepting he has a vested interest as a result of his shareholding it nevertheless demonstrates how a sophisticated investor can view the business. Well worth a read.
His initial comment is that Finance theory suggests you should pay above (tangible) book value if return on equity > cost of equity. The problem is calculating it!
Cost of Equity (Re) = Risk-Free Rate (Rf) + Beta (β) * (Expected Market Return (Rm) - Risk-Free Rate (Rf))
Lets assume Rf is 4.5% (Based on US 10 Year Rate), β is 1.8, Rm is 9.2% That gives a CoE of around 12%
Return of Equity = (Net Income / Shareholders' Equity) * 100 Based on the interims lets just say its an awful number of less than 1% but if you take it over a number of years then averages out around 9%
So in fact Avation should indeed be trading below book value. However, there are so many assumptions that have to be made that I find it impossible to calculate a convincing/justifyable number as to be near irrelevant. Risk-free rate is less contentious, β is dependent on which time period and index is used, Rm is essentially 'pick a number' and add it to the Rf.
The rest of his long tweet is worth a read but as with all of us, it hinges on what assumptions you make. I would point out though his assumption of 125bps refinancing benefit on the bonds is very much on the low side in my opinion. Those bonds were modified in March 2021 to help navigate the financial impact of the pandemic and against the backdrop of high interest rates. I would expect a much better refinance rate; at least 250bps.
TLDR SummaryA simple glance at headline profit/loss figures is misleading. To gain a true picture, the components of revenue, expenses, and one-off items analysis is needed to uncover the underlying business performance with complex accounting like aircraft leasing. The statutory figures can be highly misleading. Operationally, the company has 'turned a corner' and is being completely ignored by investors enabling astute investors to acquire shares at very attractive prices given a 2-3 year timeframe.
Miscellaneous StuffThe RNS was delayed by the LSE/RNS because the original RNS contained a controversial word that they had to remove.
The reason why Avation used the LSEG platform for the presentation was as an experiment where they expected an additional 20 investors to watch, compared to the usual 200 that tune in to the Investormeet platform
Jeff is presenting this week at the 2025
Cirium Finance Briefing I thought it was interesting that practically all of the numerous questions were of high level; an indicator perhaps that the most fickle investors having departed the shareholder register?
