Avation PLC (AVAP) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the Avation PLC Financial Half Year 2020 Investor Update Conference Call. My name is Stuart, and I will be your conference moderator for today. I will now turn the conference over to Duncan Scott, Avation Group General Counsel. Please go ahead.

Thank you, Stuart. Today, on 28th of February, Avation published its unaudited financial results for the year -- for the financial half year 2020. A copy of our earnings release is available on our website at www.avation.net. This conference call is being webcast and recorded, and the webcast will be available for replay on our website. As you may be aware, Avation is currently conducting a strategic review and formal sales process and is in an offer period as defined by the City Code on Takeovers and Mergers. We are, therefore, limited in what information we can provide or questions we can answer regarding this process. More information will be disclosed via public announcement and on our website as and when appropriate. Please note that certain statements in this conference call, including answers to your questions, are forward-looking statements, including, without limitation, statements regarding our future operations, performance, revenues, operating expenses, other income and expense items. These statements and any projection as to the company's future performance represent management's estimates of future results and speak only as of today, 28th of February 2020. These estimates involve risks and uncertainties that could cause actual results to differ materially from expectations. Further information on the factors and risks that may affect Avation's business are included in Avation's regulatory announcements from time to time, including its annual report and half year results announcements. Avation assumes no obligation to update any forward-looking statements or information in light of new information or future events. Unauthorized recording of this conference call is not permitted. I will now hand over to Executive Chairman, Jeff Chatfield.

Thank you for joining us for a report on the company for the 6-month period to 31st of December 2019. I'm pleased to advise that Avation delivered record lease rental revenue and total assets for the period ended 31 December 2019. The company finished the period with 49 aircraft in the fleet, serving 18 different customers in 15 countries. The fleet of twin-aisle, narrow-body and turboprop aircraft is split by value, 18%, 46% and 36%, respectively. At the end of the period, the average fleet had a 3.7-year weighted average age and a 7.2-year weighted average remaining lease term. Total assets grew by 7% over the past 6 months or a record $1.5 billion, of which $1.3 billion are aircraft fleet assets. Avation has just over $925 million in contracted unearned revenue from the existing leases. Avation has acquired 3 ATR aircraft since the 1st of July, and we expect to deliver a minimum of further 4 aircraft during the current financial year, leaving Avation sold-out of ATR aircraft until the end of calendar year 2020. Avation has also been successful in signing a lease for the first engine available for lease and has also acquired a new customer in the process. Avation's strategy is to target growth and diversification by adding new airline customers while maintaining low average aircraft age and long lease term durations. Avation focuses on new and relatively new commercial passenger aircraft and then will source aircraft through its order book for ATR aircraft go through acquisition of aircraft in the market. Avation now has the largest fleet, most diversified set of aircraft and customer revenue distribution than at any time in its history. Slide 4. Slide 4 is a snapshot of the historical performance and expansion of the company over the 6 -- last 6.5 years. Avation has consistently delivered strong growth in the fleet. Investment in new or young aircraft has seen the average age reduce and the average lease term increase to rank among the best in the leasing industry. Total assets and revenues have more than tripled over this period. Avation commenced its calendar year 2020 with record monthly lease rental collections, contracted fleet growth and long-term visibility of revenue and cash flow. During the financial period, Avation generated revenue of $67.6 million, up 15% year-on-year, with lease revenue -- lease rental revenue of $65 million, up 12%. Profit before tax was up 218% at $45.2 million, with the increase driven by both the increase in lease rental revenue and the unrealized gain through the recognition of purchase rights for ATR72 aircraft, which added $37 million in assets in financial statement and, importantly, recognize the growth opportunity to convert another 25 ATR purchase offers -- purchases into future aircraft in the fleet. Total profit after tax is $38.2 million, which is up 180% year-on-year. Growth during -- delivered during the year saw fleet assets increased by 22% to $1.3 billion. Avation was also able to lower the weighted average cost of debt from 4.62% to 4.56% since the 30th of June. This was achieved through new lower-cost facilities on recent aircraft acquisitions. Over the same period, the weighted average cost of secured debt decreased from 3.74% to 3.69%. Earnings per share were up 178% to USD 0.60 per share. Given the robust trading conditions, the company declared and paid an interim dividend of $0.021 per share in January -- paid in January 2020, which was up 5% from the same period a year ago. The company also confirms it's going to maintain its progressive dividend policy and also aims to provide continued growth for investors. I'd like to thank the executive team at Avation for their effort in achieving those results. This past year has delivered strong record results, strong growth in new airline customers. Turning to operation. Following the liquidation of Thomas Cook on the 23rd of September last year, Avation repossessed 2 Airbus A321 aircraft and successfully transitioned the aircraft to a new lessee. Avation acquired 3 aircraft during the period and disposed the 2 end-of-life Fokker 100 aircraft upon completion of finance leases to the lessee airline. Avation has been an active trader in aircraft, and we look to sell when possible due to prevailing market conditions, risk concentration, age and seek to redeploy capital to newer assets. Leases were signed for 5 ATR aircraft to Braathens, and delivery of these aircraft commenced. With the addition of Braathens, Avation increased the number of airline customers to 18 at period end. Avation also initiated the purchase of Pratt & Whitney aircraft engine, which has since been leased to a new customer. This acquisition represents Avation's first investment in an individual engine for leasing. In October 2019, Standard & Poor's Global Ratings advised company's issuer default rating and issue rating for the $350 million senior notes due 2021 issued under the company's global medium-term note program had been upgraded to BB- with a stable outlook. Avation also funded the acquisition of a fuel-efficient ATR with a green loan, which is understood to be the first commercial passenger aircraft green loan and was awarded the Deal of the Year for Innovation in respect of the fundings. On January -- 6th of January 2020, the company announced a comprehensive review of strategic options that could include the potential sale of the company and/or certain assets through a formal sales process. Since the date of the announcement, a number of parties expressed an interest -- and have expressed an interest in the company and certain portfolios of aircraft. The strategic review and formal sales processes is now undertaken in response to an unsolicited approach to purchase the company. Purpose of the review is to establish what path would represent the best value to shareholders. The Board believes that Avation's value is above the net asset value of the company. Such value drivers, which are not included in the balance sheet include: realizable value of the fleet could exceed book value; the value of the leasing platform and experienced employees; the tax domicile of the company and the Aircraft Leasing Scheme; the scale and diversification benefits to existing industry players; the positive rating trajectory and potential savings a larger entity may unlock through refinancing existing debt with lower-cost debt; and a control premium. The strategic review and formal sales process is ongoing, and further announcements will be made as the process continues. Slide 8. Global passenger traffic has doubled every 15 years. The company is aware of the impact of pandemics, including the COVID-19 virus, which is currently affecting the global travel industry. Such pandemics can have a material impact. However, historically, financial impacts of these events have been relatively short term. ICAO last week forecasted air travel is set to decline for the first time since 2009. Their view is the virus will have a V-shaped impact on demand as occurred during the 2003 SARS outbreak, which was marked by a 6-month decline and an equally quick recovery. The forecast short-term negativity in passenger traffic is mitigated by a sharp fall in the price of oil and also on the grounding of the Boeing 737 MAX, which has resulted in the limiting abilities to -- of airlines to grow capacity, which would have likely remained unutilized in the short-term due to the impacts of the virus on travel. The full impact of COVID-19 on travel is as yet unknown, but it remains a serious business risk moving forward to both the leasing business and the strategic view and the formal sales process being conducted and the industry overall. Avation will remain vigilant in the monitoring of lessee customers and their financial performance. Avation's recent diversification is designed to mitigate the reliance on any one particular lessee customer for revenue. Slide 9. Avation's fleet has grown to 49 aircraft, and it's the most diverse in the company's history. The company has built an aircraft leasing platform, including marketing, legal, finance and technical teams able to support all types of aircraft and now has added aircraft engines to the fleet. Growth in the jet fleet, which now represent close to 2/3 of the fleet by value, has been generated through new aircraft acquisitions, sale and leaseback transactions or acquisition of secondhand aircraft in the market. The company has no speculative forward order book for jet aircraft, no exposure to Mainland China, no exposure to Boeing MAX -- 737 MAX aircraft. Avation believes that it has sufficient liquidity to fund further fleet growth and is actively looking to grow the fleet. Avation's order book comprises 8 ATR aircraft for delivery prior to 2022, with 4 of these aircraft expected to deliver -- to be delivered prior to 3rd of June 2020, and long-term purchase rights for further 25 ATR72 turboprop aircraft. These purchase rights for 25 ATR72-600 aircraft represent a material source of growth for Avation and value to shareholders. In recognition of this, the company recognized the purchase rights at fair value through the P&L in the financial statements for the period ended 31st December, 2019. The average age of the fleet was 3.7 years, and the average lease duration was 7.2 years. These metrics are among the best in the industry and result from Avation's continued investment in new or young aircraft. Avation believes newer assets are a lower risk due to lower cost of obsolescence and the long-term cash flow provided through long leases. Slide 10, the next slide shows airline customers. As of 31 December 2019, Avation serves 18 customers in 15 countries, including a number of flag carriers. With the lease of the engine announced this week, we've added our 19th customer. Let me hand back to -- let me now hand to Richard Wolanski, who'll provide more detail on the financial result and key ratios.

Thanks, Jeff. I'll start on Slide 11. This slide shows the improvement in revenue, scale and distribution over the past 4.5 years. Revenue has more than doubled with the distribution of revenue increasing from 6 customers to 18 customers. The slide describes the derisking of the portfolio of fleet assets through growth and diversification. The same period represents the evolution of the credit rating from B- in 2015 to BB- that it is today. The company now has lower revenue concentration with any single airline than at any time in its operating history with concentration with the largest customer dropping from 66% in 2015, down to 19% as at 31 December 2019. Diversification improves the quality of the earning stream by lowering concentration risk. Scale and diversification are 2 key drivers of the credit rating of Avation. This trend is set to continue in 2020 calendar year with further growth already announced and new customers expected to be added. Slide 12 shows the fleet asset that continued to grow during the period. The slide charts Avation's track record of growth in the past 9.5 years and shows that Avation has added $1.1 billion in fleet and grown by a factor of 8x during the period from $165 million in fleet assets in 2011 to the current level of $1.3 billion at period end. We've also provided a summary of the profit and loss on Slide 13. Our financial results showed the revenue increased by 15% to $67.6 million for the year -- for the period compared to $58.7 million a year ago. These are record levels for the company. Lease rental revenue represents $65 million of the total. Depreciation increased by 22% to $24.2 million, in line with fleet asset growth. Administrative expenses increased to $6.1 million, increasing by 8% compared to the revenue increase of 15%. We have provided an analysis of the leasing business operating profit before tax, excluding unrealized gains on the ATR purchase rights, gains on disposal of aircraft and the impairment of aircraft. And the reason we've done this is to highlight to investors that the recurring [ pool ] leasing business of the company continues to grow. To this end, the leasing business operating profit before those factors increased by 8% to $36 million from $33.4 million last year. Finance expenses net of income increased 7% to a total of $27.5 million for the period compared to $25.7 million a year ago, which is far lower than the growth in the fleet over the respective period. This shows the core long-term leasing business grew on a profit before tax basis by 10% to $8.5 million from $7.7 million a year ago. If we look beyond that for ongoing leasing business to the more nonrecurring items that impacted the financial statements, in December 2019, the company changed its business model for the purchase rights by recognizing that it holds excess purchase rights over and above the company's requirements to acquire additional ATR aircraft for its fleet. The company will seek to dispose of excess purchase rights from time to time when the market conditions are favorable. In recognition of this change in business model, the company recognized the purchase rights at fair value through the profit and loss in the financial statements for the 6 months ended 31 December 2019. Purchase rights for the 25 ATR-600 aircraft at fair values were determined by the company based on an independent third-party valuation of the aircraft delivery positions. The recognition of this asset on the balance sheet has generated an unrealized gain of $37 million. Gains on sold aircraft totaled $2.2 million compared to the large gains that were made in the corresponding period last year. Avation also prudently recognized an impairment in the value of the aircraft that we will repossess from Thomas Cook in the amount of $2.5 million that was combined for the 2 aircraft as a result of the amended lease terms negotiated with the new lessee. Profit before tax increased 218% year-on-year to $45.2 million versus $14.2 million in the prior year. And to the bottom line, total profit after tax increased 180% year-on-year to $38.2 million from $13.6 million a year ago to deliver $0.60 EPS, up 178% from last year. Moving to Slide 14. Avation had a credit rating upgrade by S&P in October 2019 and by the Japanese credit rating agency in December 2019. Net indebtedness has increased to $1.04 billion from $1.02 billion in the past 6 months. There was a reduction in the weighted average cost of the group's secured debt facilities to 3.69%, down from 3.74% as at December 31, 2019, through funding of recent aircraft acquisitions with lower-cost senior debt. This resulted in a weighted average cost of debt for the company as a whole being lowered to 4.56% from 4.62% as at 30 June 2019. At 31 December 2019, 90.8% of total debt was at fixed or hedged interest rates, meaning that the current fleet has very low exposure to any interest rate increases. Avation's net debt-to-asset ratio was 69.8%, which was reduced from the 30 June figure of 73%. The chart at the bottom of the page shows the evolution of the group's cost of debt over the past 7 years and shows the decline in cost of both unsecured, secured debt and the total cost of debt. On to Slide 15, we provided a key range of -- a range of key ratios on a comparative basis. The net asset value per share increased by 10% and -- since the end of the financial year and is at GBP 3.25 compared to GBP 2.95 as at 30 June 2019. Total dividend for the first half financial period increased by 5% to $0.021 versus $0.02 in the corresponding period last year. Administrative expenses as a percentage of total income decreased slightly to 9.1%. Debt to EBITDA decreased to 5.6x from 8.8. Operating cash flows remained strong. Funds from operations to debt and EBITDA as a function of interest expense improved during the period as a result of impact of the recognition of the purchase rights for ATR aircraft in the financial statements. And finally, onto the last slide before Q&A, Avation has delivered a record lease rental revenue and total assets as its core business continues to grow. Avation will continue to deliver further aircraft and add new customers while the strategic review and formal sale process is ongoing, and further announcements will be made as that process continues. The purpose of the review is to establish what path would represent best overall value for shareholders. While airline industry fundamentals are strong, COVID-19 is having a negative impact on airlines, passenger traffic and the industry outlook. Avation is constantly monitoring the situation. Avation has industry-leading fleet metrics. Diversification of aircraft type and airline customers has lowered risk, delivered credit enhancement that has resulted in improved credit ratings, allowed the evolution of the capital structure, delivered balance sheet flexibility, which supports the future growth and a lowered cost of debt that we delivered. Avation differentiates itself from the aircraft leasing sector through a number of factors that management believes lowers the business' exposure to risk. These include the vast majority of debt being at fixed or hedged interest rates, no exposure to China, lower exposure to emerging markets, no speculative orders for jet aircraft, no exposure to the Boeing 73 MAX (sic) [ Boeing 737 MAX ] and the opportunity for further credit enhancement through scale and diversification. Avation will continue to focus on growing the fleet and adding new airline customers for the remainder of the financial year. This concludes management's remarks. [Operator Instructions] Now I'd like to hand the call back to the operator.

[Operator Instructions] Your first telephone question comes from the line of Gert Zonneveld from Canaccord.

I just had a question on the overall market. I mean given the ongoing uncertainty regarding the 737 MAXs and the coronavirus more recently, how do you see the market for trading secondhand aircraft developing in the near term? In other words, I mean, do you expect opportunities to invest in the coming weeks or months? Or do you think that the uncertainties are simply too great at this stage to confidently acquire assets?

It's Jeff here. I believe the answer to that question is there is a lot -- there's always a lot of secondary trading goes on in the market. Clearly, there will be lessors who seek to diversify their portfolio and may potentially raise cash and/or seek opportunistically assets. And so as with most markets, there could be quite a bit of activity. I think the -- in a few days or weeks when the coronavirus situation is more clear, then the people in our industry will be very active and look for opportunities.

Okay. And just a follow-up, if that's okay. So you -- I guess that you are tracking the sort of the performance -- the financial performance and operational performance of your customers and the impact the virus is having. I know it's early days, but still, if there is no V-shaped recovery that you sort of referred to and that we have seen historically, and this sort of academic -- or pandemic continues throughout the summer, maybe even throughout the autumn. I mean, how likely is it that one or more of your customers might struggle to remain solvent?

Well, we have quite a diversified customer base, and we tend to have customers that genuinely need the aircraft. So we are probably -- and I mean I can't general -- I can't speak about any specific customer. I don't know their individual situations. But most of our customers are well placed. So they might be government-owned, or they might be flag carriers and/or in a monopoly or duopoly situation. We don't have exposure to anyone in Mainland China, we don't have too much, if you like, leisure travel clients. So look, I think given the diversification and the quality of the clients, so I think we're relatively well placed. I -- there are -- we did -- we checked today on certain deliveries that we have planned for this year, and there's no -- they're still on track. So I mean, it's early days yet. But at this point, things look okay.

Next question is from the line of Ross Harvey from Davy.

Jeff, Richard, the whole team, congrats on the half year. Two questions from me. First is on the engine leasing business. I'm just wondering how big you think it can be and what sort of capital you would commit into the area? The PW127M, as far as I can make out, is used on ATR aircraft. So I'm wondering as well, do you think new engine lessees can open up commercial opportunities for the core aircraft-facing business and vice versa? And second, like, in relation to the 25 purchase rights, I'm just wondering how many of these are being considered to be accessed, as the statement alluded to? And does the figure on the balance sheet cover all 25 or just the figure that's accessed?

Thanks, Ross. I'll answer the first part of that. The engine leasing, we saw strategically the engine leasing business is a sort of an excuse -- or the ATR part of it as an excuse to visit all the ATR operators in the world. So consequently, it's good to have dialogue with your customers and find out if they need engines as well as potentially aircraft. So we were quite, sort of, in a way, surprised how easy it was to lease the engine. In the current market that's weaker, the problem with that industry is acquiring engines. The engines for jet aircraft are in short supply. So it's not a business that you can scale up dramatically overnight and deploy lots of capital in because you can't get engines. So it is a -- it's a small business. We wouldn't -- we probably wouldn't deploy material amounts of capital. It is an interesting business in that -- in the sense that the customers -- for the same customers for sort of aircraft, and consequently, you want to talk to them anyway. In respect to the second question, we want to have a balance and diversification in our fleet. And as you know, we've got a variety of aircraft types at the moment. The majority by value of our aircraft are narrow-body jets. And clearly, were we to -- obviously, if we were to add another 25 ATRs, so the -- from the order book to the fleet, that would be too much. We'd have too much ATR exposure. So clearly, we want to have the flexibility in terms of either selling aircraft -- existing leased aircraft and/or effectively new-to-be-delivered aircraft. So hence, the willingness to contemplate the future delivery of aircraft to be for sale and/or the ones that we own now, if I've answered your question correctly.

Yes. That's perfect. And just while I'm on the line, I might just ask. In relation to the engines themselves, can you give us a sense of how much do they cost to buy versus what the ATR72-600 would be just to give us a sense of the quantum of money involved?