Avation PLC (AVAP) Earnings Call Transcript & Summary

Ladies and gentlemen, welcome to the Avation PLC Interim half year results for 6 months ended 31st of December 2020 Investor Update Conference Call. My name is Emma, and I will be your conference moderator for today. I would now like to turn the conference over to Duncan Scott, Avation Group General Counsel. Please go ahead.

Thank you, Emma. Today, on 26th of February, Avation published its unaudited interim financial results for the 6-month period ended 31 December 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. 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 and 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, 26th of February 2021. 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, Duncan. Thank you for joining us for report on the company and its interim financial results for the 6 months ended 31st December 2020. The half year ended 31 December 2020, represents a complex period for the airline industry and Avation. Avation has been working diligently and with the success -- with success on its COVID-19 strategy implemented early in the crisis to preserve liquidity. The pandemic-related disruption to the airline industry has impacted aircraft valuation, and Avation has impaired the value of its fleet and provided for credit losses on receivables. These provisions are due to airline customers, who have all been subject to restructuring processes. There was a negative adjustment in the value of purchase rights held for ATR aircraft. These impairment losses dominates the financial result. Assuming that Avation's airline customers survive and meet their contractual obligations to pay rents and arrears, the company believes that it's unlikely there will be further large impairments to asset values in the future. We believe that airlines who have survived for the past year should make it out of the other side of this crisis. We believe that this is a pivotal period for the company by prudently recognizing impairments and losses. And with the recently announced agreement to extend the maturity of its unsecured bonds by over 5 years until October 26, the company has positioned itself for a cautious return through opportunities to aircraft trading and deliveries from its order book in a post-pandemic environment. So we positioned ourselves for growth. The presentation is set on 3 sections, including accompanying overview, COVID-19 strategy update and the financial results. I'll start with the company overview. So Slide 4 shows a snapshot of Avation. The company had 46 aircraft in the fleet, serving 19 customers in 15 countries. Avation owns, manages and leases regional narrowbody, twin-aisle aircraft to the airline industry. The fleet of twin-aisle, narrowbody and turboprop aircraft is split 16%, 49% and 35% by value, respectively. At the end of the period, the aircraft fleet had a 4.6-year weighted average age and a 6.5 year weighted average remaining lease term. The financial period saw fleet assets totaled $1.16 billion. Avation has $809 million in unearned contracted revenue from existing leases. More than half of our customers are now flying at above 50% and of pre-COVID levels. And in what is a promising sign, these customers make up more than 60% of the unearned contracted revenue. Slide 5 is a snapshot of the historical performance and expansion of the company over the last 6.5 years. Pre-pandemic Avation has shown that it can deliver consistent fleet growth. Investment in new or young aircraft have seen the average age and average lease term maintained to run amongst the best in the leasing industry. It is this diversified fleet base and proven aircraft transaction capability, even during the crisis, that is helping Avation navigate the pandemic. Avation's diversified fleet is now at 46 aircraft with a focus leaning towards regional and narrowbody aircraft. It is in these sectors that we are seeing the fastest return to service. The company has retained a full complement of commercial, legal, financial and technical personnel to ensure it has the skill set needed to manage the lessor platform successfully in the post COVID-19 recovery phase. Since the beginning of this pandemic, Avation has successfully completed 13 aircraft transaction, including lease extensions, aircraft sales and new lease transactions. In addition to an order book for 8 aircraft, Avation holds purchase rights for 25 ATR72-600 aircraft, representing material source of potential growth for Avation and value for shareholders. Avation believes that newer aircraft carries lower risk of obsolescence, has greater potential for long-term cash flow and have greater opportunity to service debt associated with financing through long-term leases. Slide 7. The next slide shows airline customers. As at 31 December 2020, Avation served 19 customers in 15 countries. Avation's customers include 7 flag carriers. While flag carriers were not excluded from the impacts of the virus and associated restriction, these airlines are most likely to receive government support due to the national importance of -- to carrier. The airlines are also likely to have a higher proportion of domestic routes. As countries move beyond the peak of the pandemic, domestic travel is recovering faster than international routes. It's important to note Avation's geographical spread of customers of the pandemic is at different stages around the world. Around 2/3 of Avation's customers by revenue are located in Asia, including airlines based in countries that had a less severe impact from the virus such as Taiwan and Vietnam. We've also been fortunate in Europe, where our largest customer, airBaltic, has been performing well and has received a government equity injection. I'll now move on to an update on the company's COVID-19 strategy, Slide 9. Avation's COVID-19 strategy focused on maintaining liquidity and cash flow. Avation took a pragmatic approach to focusing on preserving cash flow as airline customers suffered from major disruption. Avation was a first move in working with airline customers to help them through this difficult period. Support involved allowing deferment a proportion of the rent. This has done a rent decrease or holiday, airlines will need to repay the deferred proportion of the rent. The balance of this reduction in cash flow, Avation has implemented 3 key strategies. The first was to adjust the amortization of senior loans associated with the fleet and key lending banks. The second has been to reduce administration expenses while we are targeting broad lowering of costs, specific actions, including elimination of employee cash bonuses while pandemic persists. The third step has been to reduce capital outgoings. This includes moratory on capital expenditure that are seeing no new deliveries of aircraft into the fleet and a temporary suspension of dividends. By carefully managing cash flows, Avation is confident it will navigate through the COVID-19 to position itself for opportunities post-pandemic. Slide 10. The next slide provides a summary of what Avation has successfully implemented with its customers and lenders to deal with the COVID-19 pandemic. We made agreements with 14 of our 19 customers. Typically, Avation provided a 3- to 6-month rent deferral from a proportion of the rents with a 6- to 9-month repayment period. Avation airlines are required to continue to pay maintenance reserves as part of the deferral agreement. The total rent deferred by airlines is $25.9 million. Avation has successfully mitigated the impact of lower rents and cash flow by agreeing to reschedule $31 million in loan amortization. During the period, Avation initiated process to extend the date of maturity of its -- of the $342.6 million outstanding under the Avation Capital 6.5% senior notes due May 21 to October 2026. The company recently announced a reached agreement with sufficient bondholders to implement extension, and a consent solicitation exercise was launched on the 23rd of February 2021. The company expects the extension will be completed on the 16th of March 2021. In the company's opinion, this extension agreement constitutes an important capital structure stabilization measure. The directors believe that extension will provide sufficient financial flexibility to support the continued development of the business through and post the COVID-19 pandemic. The extension is for more than 5 years, and the company retains the option to refinance the notes at any time. Shareholders should -- stakeholders should note that the impact of the virus continues around the world today. Avation remains cautious and note that there may be further work in cooperation needed before we come out of the pandemic. Slide 11. On the next slide, we provide information on our customers. 12 of our 19 customers are being charged normal rents. This includes 3 of the top 5 customers. Airlines that represent over 60% of Avation's $809 million in future contracted revenues are now flying at over 50% of pre-COVID levels. We noted earlier that certain countries were some of our largest customers located have had less severe impact from the virus, including Vietnam, Taiwan and Latvia. Three of our airline customers then entered into restructuring processes as a result of pandemic. Two customers, Virgin Australia and Braathens, entered into administration. Avation had 13 aircraft with Virgin and thus far has transitioned 6 aircraft. Furthermore, we're very fortunate the leases to Virgin will mature with only 1 to 3 years remaining on each lease. The unearned contracted revenue associated with Virgin Australia represented less than 6% of Avation's total unearned contracted lease revenue across all customers as of the date of the entry into administration. The relatively low levels of debt associated with the returned aircraft will be further reduced by the expected payment to Virgin Australia's creditors, which we expect to receive in the coming months. Avation had 2 ATR72 aircraft on lease to Braathens when it entered administration. The airline has now exited administration and restarted operations. Avation has agreed to new lease terms with the airline, excluding extensions in lease duration from 10 to 12 years. The company has also negotiated adjustments to the amortization profiles of related loans to reflect the revised lease terms. The third airline is Philippine Airlines, which is currently preparing for an entry into restructuring. Avation understands that the airline tends to retain the use of Boeing 777-300ER, which is on lease from Avation, albeit at a reduced lease rate, and this results in an impairment loss in the financial results for the period. The majority of the impairment and expected credit losses that dominate the profit and loss for the period are related to Philippine Airlines. Having the aircraft by the airline is, in our opinion, the optimal outcome. The 3 airlines that have been through restructuring make up virtually all of the impairment and credit losses are recognized in the profit and loss. Let me now hand the call to Richard Wolanski, who will provide detail on the financial results and key ratios.

Thanks, Jeff. On to Slide 13. During the financial period, Avation generated total income of $63.3 million, which is down 6% year-on-year, with lease revenue making up $61.3 million of this amount, down 9%. There was an operating loss of $34.5 million, and this was impacted, as Jeff mentioned, dominated by a negative adjustment to the value of purchase rights for ATR72 aircraft of $7.9 million and through fleet impairment of $46.6 million and $12.9 million in expected credit losses on receivables and accrued revenue. Avation's loss after tax was $61.3 million. Following impairment, fleet assets were down 6% to $1.16 billion. At the onset of the pandemic, the company elected to suspend capital expenditure to preserve liquidity, and this will continue until the crisis abates. Avation's weighted average cost of total debt rose slightly to 4.6% from 4.5% since -- from 30 June 2020. A loss of USD 0.979 per share was recorded for the period. On to Slide 14, an analysis of the profit and loss. In the stock exchange released earlier today, we provided a breakdown of the P&L of the leasing business operating profit before tax, excluding adjustments to the ATR purchase rights and the impairment of aircraft and the expected credit losses on receivables and accrued revenue that I just mentioned to highlight to investors that the core leasing business remains profitable. Our financial results show that revenue decreased by 9% to $61.3 million for the year compared to $67.6 million a year ago. Depreciation decreased by 2%, $23.7 million. Administrative expenses decreased by 10% through cost-saving measures that we implemented to $5.5 million. And this resulted in the core leasing business generating an operating profit of $33 million versus $36.1 million in the previous half year period, which was down 8%. And they -- and that primary difference is due to the Virgin ATR aircraft that are yet to be repositioned, impacting on lower income during the period. Finance expense, net of finance income decreased 6% to $26 million versus $27.5 million in the previous period. This results in a profit before tax from the leasing business, $7.1 million, which is down from $8.6 million in the previous period. This illustrates the profitability of the core leasing business and the opportunity to generate shareholder returns once we are able to navigate our way through the pandemic. The impairments and provisions, as discussed in the previous slide, resulted in a loss before tax of $60.5 million, and at the bottom line, there was a loss after tax of $61.3 million. On to Slide 15. This show a summary of the debt of the company. Net indebtedness remains flat at $1.04 billion. There was a slight increase in the weighted average cost of the group's secured debt facilities to 3.7%, up from 3.6%. This resulted also in the weighted average cost of debt for the company also slightly at 4.6% from 4.5% as at 30 June 2020. At year-end, 90.7% of total debt was at fixed or hedged interest rates. Avation's debt to assets ratio was 77%, which increased from the 30 June 2020 figure of 73.2%. The chart shows the evolution of the group's cost of debt over the past 7 years and shows a steady decline in cost of both unsecured and secured debt. On to Slide 16. We provided some ratios on a comparative basis. The net asset value per share declined to GBP 1.74 compared to GBP 2.86 as at 30 June 2020. Administrative expenses as a percentage of total income decreased to 8.7%. Debt-to-EBITDA has increased to 11.6x from 8.4x. Funds from operations to debt declined during the period as with EBITDA as a function of interest expense. This is a function of the provision for expected losses on receivables and accrued revenue that lowered the EBITDA. Just on to the final slide and concluding remarks. Avation continues to navigate its way through the most challenging period in the history of aircraft leasing. The fundamentals of the business and the business model remain intact, and there are some optimistic signs that point to an end of the pandemic. Avation has adopted a pragmatic approach to preserve cash flow and liquidity, and we'll continue to work to preserve the business and deal with each of the numerous issues that have arisen. Avation has shown that it can transition aircraft in these tough times that intends to place the remaining 7x Virgin Australia ATR72 aircraft or potentially sell them. The company believes that airlines will require a significant number of leased aircraft in a post-pandemic phase due to the vast number of older aircraft that have been retired and the impact of the pandemic on airline balance sheets, reducing their ability to purchase aircraft directly. This supports the company's strategy of focusing on relatively new and popular commercial-type aircraft types. Future aircraft are likely to be delivered in a low interest rate environment where -- and where the main cash expense of lessor spaces from interest expense from borrowing, borrowing costs for new aircraft purchases may decline post-pandemic, which could enhance the bottom line of that source. As a result of the pandemic-related financial turmoil, there are likely to be opportunities to buy aircraft from airlines and other lessors looking to adjust or reduce their portfolios. Avation is optimistic about the long-term opportunity for airline travel, particularly with the turboprop and narrowbody aircraft sectors that are servicing the domestic group, which is rebounding around the world in the last couple of months. This concludes management's remarks. For the question-and-answer session, each participant will be allowed one question and one follow-up. And I'd like to hand the call back over to the operator.

[Operator Instructions] Your first telephone question today is from the line of Ross Harvey with Davy.

I have -- my main question is on the possible sources of cash over the next 6 months, and I'm thinking of the Virgin claim, the release of the restricted cash, finance and unencumbered aircraft and various other streams of potential cash inflows that you mentioned in the statement recently. Can you just give us a sense of their size, what the likelihood of each would be and maybe the timing of them?

Well, the -- thank you, Ross. I mean, I'll address that. We're a listed company. And so we have a variety of opportunities to raise cash. In reality, we linked about $30 million to the airline. So clearly, we need to get that back to maintain our maintain to tread water and survive as it were in this difficult environment. The process going forward, the cheapest form of finance we have seen is secured debt provided by banks, and it's still available, which is quite remarkable. We still -- we get offers for stuff. Indeed, we got offers today from an finance here that may or may not work, but the banks are still in the business, and that's the cheapest form of finance. We won't rule out equity issuance. Clearly, as a public company, you need to be willing to deal in the markets from time to time. That's what the stock markets for. We also have a few aircraft for sale. And quite interestingly, the market for what is perceived to be good credits is quite buoyant. What's driving aircraft trading, in my opinion, at the moment, and I'm very close to this right now, is credit quality of the airline. So it's not -- normally, we have a lot of discussions around aircraft type, age, maintenance condition and so on. But the key driver of decision-makers who are buying aircraft or investing in aircraft is around credit quality of the operating airline. So you'll see us look at everything. I mean, clearly, we're somewhat reluctant to sell good -- what we perceive to be good credits because, clearly, what that does is it shrinks our revenue base. We are willing to -- we have been. I mean we've dealt in -- we're dealing in the X Virgin aircraft because they either need to be placed or sold. We've got a couple of A320s that we're marketing at the moment. We're marketing an ATR at the moment. So there's a lot of trading activity that we're contemplating. But we're in business. We've got all the full management team. We're constantly dealing with banks, the share market and an aircraft. In terms of your question around timing, there's no real answer to that, we'll crack off crack on with things as quickly as we can because in these times of crisis, you've got to be nimble and move very quickly. Thank you, I hope that answered your questions.

It has, it has. The other question I had was on the growth guide, and I know it might be a little bit further down the line. But when you mentioned the opportunity that might be there, what sort of areas of the market would you be looking at? Would you be focused on a particular type of geography? Would you be looking for a particular type of airline credits or aircraft type? And how would you go about financing that if there was to be something significant interest to what's be a portfolio on offer?

Well, clearly, I mean, the industry, travel -- air travel. Some sectors of air travel diminish 90%. So clearly, it's been a torrid time, but the survivors, the airlines that have survived through that, clearly, a good credit. Like a lot of them have been reliant on government debt or other forms of debt. So therefore, they will need lease finance. And presumably, as the market recovers, they'll need a lot of aircraft because a lot of aircraft have been retired and left the industry permanently. So there will be an upswing. I've read analysis around the uplift in terms of credit filters. The ministry participants that have survived this crisis will probably survive a long time because they've had a big text, so it won't be difficult to work out what are good credits or not. I think that answers your question.

Yes. That's good. I might chance a third, if that's all right, if you will allow me. It's a shorter one maybe for Richard and Iain. I noticed one of your larger peers have moved recently from IFRS to U.S. GAAP on the basis that the impairment reviews obviously are less onerous, and maybe they don't require the discount in the future cash flows. Would you consider this type of move? And do you know what difference it would have made on your 2020 results?

Well, Iain for now. I mean, our opinion on that is, if you're going to have -- we've had a bad year, it is what it is. Selectively changing accounting standard to make your valuations look better is probably not a sustainable business tactic. We are fairly transparent. We are IFRS. We do have to look at a plane by plane. We deal in these assets. And in our view, some of our peers might be a little bit aggressive in not impairing stuff that obviously should be impaired, but we certainly wouldn't jurisdiction hop to try and make -- fluff up our results. That's not something we would do. But Iain, you can jump in here because he's an expert on this stuff.

Yes sure. I mean, I think -- I'm not quite sure which company you're referring to, but there might be other reasons why they want to switch U.S. GAAP, and the obvious one would be somebody contemplating labor money in the U.S., perhaps we'll have our next issue. I do know that the exercise of switching from one set of standard to another is a huge task because it's not just a case of recasting your balance sheet, you have to go back through your historical financials and get everything re-audited. So it's a huge task. It's expensive. And okay, yes, there are different accounting treatments, in particular, for impairment. I think U.S. get -- allows you to group assets for the impairment test, whether that would make a big difference to our accounts. So I've got no idea, frankly. I don't think it's something that we're contemplating at the moment.

No, we're not contemplating.

The next question comes from the line of John Cummins with WH Ireland.

A couple of questions, if I may. The first one, could you just give a bit more detail around the aircraft impairments and the expected credit loss? Just in -- Jeff, you mentioned Philippines being majority, but I just wonder whether you could give a bit more detail around how that was split by the customers?

Iain would love to help you with that, John.

Yes, sure. No problem. So the -- as was explained in the call earlier, most of these names and credit losses relate to the 3 airlines that have either gone into administration or are restructuring. So on the impairment side, 90% of the total relates to those 3 customers. And on the credit losses, it's actually 97%. So if you expect that, it's down for those airlines that have gone into administration on restructuring.

Okay. And just following on, Jeff, you touched on it both. It was -- just as far as the aircraft, what you're seeing out in the market. I mean, you mentioned that, actually, credit quality was very much driving that. But I mean, I was just wondering whether there were any aircraft type at this point that you're seeing has been particularly attractively valued or whether it really is just that credit quality point.

What we are seeing is different to normal. What we're seeing is credit qualities of the airline that's driving decision-making. Narrowbody valuations have held up extremely well. There's a lot of interested buyers of narrowbody -- modern narrowbody commercial aircraft. And probably the reason for that is there had been a bit of an undersupply going into COVID. The MAX hadn't delivered, so there was -- and there's a lot of backlog. And airlines, the survivors, may be thinking that coming out of COVID, they'll need lots of capacity. So I'd say the most popular type is modern narrowbody commercial aircraft and the -- what's the driver is the credit quality of the airlines.

The next question comes from the line of Gert Zonneveld with Canaccord Genuity.

I just wanted to go back to the statement you put out on the 9th of Feb, and talk about your existing leases, if I may. And you noted in that statement that between March and September, you extended several leases, which together represented about 10% of the monthly revenue run rate at rates, which are sitting between 5% and 19% below those prior year -- prior contracts. Can you give us a little bit more detail about that? For example, I mean, how many leases were extended or which aircraft types did it involve or which customers? And the second part of that question is, do you have any leases coming up for renewal over the next, say, 12 to 18 months? And should we assume further pressure on renewed lease rates compared with prior existing rates in the near term?

We don't have many expiries, if any, in the next 12 or so months. But Rod would like to answer the question on the extensions that we've negotiated over the last period of time. So Rod, why don't you jump in?

Yes. Am I allowed to go into names of airlines?

I think Gert's probably happy with the generalized comments.

Correct.

Yes. Okay. Well, we extended one 737 for 4 years. We extended some ATRs. We extended ATRs with 3 airlines, one for a period of 2 years, and one for a period of 4 years and another airline just for a period of several months. So those are the bulk of the extensions that I -- that come to mind.

Okay. And if I can just squeeze in sort of one final question. You currently have -- I think it's 7x Virgin Australia ATRs off lease, which you're in the process of either selling or leasing subject to various maintenance things that still need to be done. Can you talk a little bit about sort of the current demand and supply balance in the market for regional turboprops? And realistically, how long can I take you to find a new home for these aircraft, be it sort of buyers or lessees with a decent credit quality?