AIRASIA (5099) - (Icon) Air Asia (11) - Asia Aviation Capital : Sale Or No Sale, Air Asia Is The Winner
1. Introduction
Air Asia stock price has performed well. Since early 2016, it has gone up from approximately RM1.70 to as high as RM3.30 few weeks ago.
I believed many investors were tempted to take profit. However, Tony Fernandez pursuaded shareholders to hold on to their stocks. According to him, Air Asia is in the process of disposing its aircraft leasing unit, Asia Aviation Capital Limited, for closed to USD1 billion, and there is possibility of huge dividend payout.
While excited about the potential windfall, I am sure deep in our heart many of us are quietly asking whether he is exaggerating the potential upside. Is Asia Aviation Capital really worth that much ? How has it been perfoming ? What is it doing ? Why are potential buyers willing to pay so much for it ?
To answer the above questions, I decided to do a little bit of research. The findings turn out to be quite interesting. Please read on.
2. BOC Aviation Limited
Asia Aviation Capital is a relatively new entity (incorporated in 2014). There is not much information available from public sources. To better understand the business of aircraft leasing, I decided to take a look at BOC Aviation.
BOC Aviation was listed in Hong Kong Stock Exchange in mid 2016. It is majority owned by Bank of China and is the largest aircraft leasing company in Asia.
Same as Asia Aviation Capital, BOC Aviation's business model is as follows :-
(a) Buys and owns aircrafts (through appropriate use of debt funding);
(b) Leases the aircrafts to airlines for rental income. Typically, lease period lasts for 5 to 7 years; and
(c) When opportunities arise, disposes aircrafts to lock in capital gain.
The following financial information is extracted from BOC Aviation's IPO Prospectus dated 19 May 2016. If you are interested, you can download it through the following link.
https://www.bocaviation.com/en/Investors/Prospectus.aspx
Key observations :-
(a) The business of aircraft leasing is surprisingly easy to understand. Basically, you let somebody make use of your aircrafts, and they pay you rental regularly. After deducting depreciation charges, interest expenses, staff cost, tax payment, etc, whatever left behind is your profit. Very straight forward.
(b) The bulk of BOC Aviation's FY2015 PAT of USD344 mil was operating profit. Exceptional items were very small at USD26 mil, being the difference between gain on disposal of USD70 mil and aircraft impairment of USD44 mil.
(c) Depreciation charges accounted for 35% of revenue. (Note : this piece of information will be useful in subsequent section for Asia Aviation Capital's financial modelling)
(d) Very high profit margin - net margin of 32%.
For comparison purpose, Public Bank, Gamuda, KLK, Tenaga (representing various industries in Malaysia) has net margin of 27%, 30%, 7% and 14% respectively.
(e) Based on average net assets of USD2.3 billion, FY2015 ROE was approximately 15%.
Air Asia stock price has performed well. Since early 2016, it has gone up from approximately RM1.70 to as high as RM3.30 few weeks ago.
I believed many investors were tempted to take profit. However, Tony Fernandez pursuaded shareholders to hold on to their stocks. According to him, Air Asia is in the process of disposing its aircraft leasing unit, Asia Aviation Capital Limited, for closed to USD1 billion, and there is possibility of huge dividend payout.
While excited about the potential windfall, I am sure deep in our heart many of us are quietly asking whether he is exaggerating the potential upside. Is Asia Aviation Capital really worth that much ? How has it been perfoming ? What is it doing ? Why are potential buyers willing to pay so much for it ?
To answer the above questions, I decided to do a little bit of research. The findings turn out to be quite interesting. Please read on.
2. BOC Aviation Limited
Asia Aviation Capital is a relatively new entity (incorporated in 2014). There is not much information available from public sources. To better understand the business of aircraft leasing, I decided to take a look at BOC Aviation.
BOC Aviation was listed in Hong Kong Stock Exchange in mid 2016. It is majority owned by Bank of China and is the largest aircraft leasing company in Asia.
Same as Asia Aviation Capital, BOC Aviation's business model is as follows :-
(a) Buys and owns aircrafts (through appropriate use of debt funding);
(b) Leases the aircrafts to airlines for rental income. Typically, lease period lasts for 5 to 7 years; and
(c) When opportunities arise, disposes aircrafts to lock in capital gain.
The following financial information is extracted from BOC Aviation's IPO Prospectus dated 19 May 2016. If you are interested, you can download it through the following link.
https://www.bocaviation.com/en/Investors/Prospectus.aspx
Key observations :-
(a) The business of aircraft leasing is surprisingly easy to understand. Basically, you let somebody make use of your aircrafts, and they pay you rental regularly. After deducting depreciation charges, interest expenses, staff cost, tax payment, etc, whatever left behind is your profit. Very straight forward.
(b) The bulk of BOC Aviation's FY2015 PAT of USD344 mil was operating profit. Exceptional items were very small at USD26 mil, being the difference between gain on disposal of USD70 mil and aircraft impairment of USD44 mil.
(c) Depreciation charges accounted for 35% of revenue. (Note : this piece of information will be useful in subsequent section for Asia Aviation Capital's financial modelling)
(d) Very high profit margin - net margin of 32%.
For comparison purpose, Public Bank, Gamuda, KLK, Tenaga (representing various industries in Malaysia) has net margin of 27%, 30%, 7% and 14% respectively.
(e) Based on average net assets of USD2.3 billion, FY2015 ROE was approximately 15%.
For
comparison purpose, Public Bank, Gamuda, KLK, Tenaga (representing
various industries in Malaysia) has ROE of 16%, 11%, 9% and 13%
respectively.
(f)
Based on 227 aircrafts, BOC Aviation generated PBT of USD402 mil. This
translates into PBT of USD1.8 mil (RM7.2 mil) per aircraft in FY2015.
Note
: BOC Aviation continued to do well post IPO. The company reccently
announced 1H FY2016 net profit of USD212 mil, 23% higher than FY2015.
Please refer to Appendix 1 for further details.
Summary Conclusion
The
dramatic decline in oil prices recently has benefited many airline
companies. Not only their profitability has increased, growth prospects
has also improved as better affordability increases the appeal of air
travelling.
Pursuant
to this positive development, aircraft leasing business has also
benefited substantially. Not only demand for aircrafts had increased
(resulting in robust leasing rates), there is also substantial decline
in credit risk.
My brief study
of BOC Aviation shows that the industry is enjoying healthy economics.
Both net profit margin and ROE is above average, an indication of strong
profitability.
3. Asia Aviation Capital Limited
Asia
Aviation Capital's financial information was obtained from Air Asia's
quarterly reports. Air Asia sometime is sloppy when come to disclosure.
Most quarterly reports contain information about Asia Aviation Capital. However, in December 2015 and March 2016 quarter, those information was missing.
Anyway, I have put whatever information I can get in the table below :-
Key observations :-
(a)
Asia Aviation Capital has been leasing out aircrafts to Air Asia's
affiliated companies since 2014 ("Affiliated Companies Leases").
However, back then, those aircrafts were apparently obtained by it
through Operating Lease from leasing companies. It did not make much
profit from the Affiliated Companies Leases.
For
example, in September 2015 quarter, Asia Aviation Capital generated
revenue of USD25 mil. However, it also incurred operating lease expense
of USD21 mil. After deducting other expenses, it reported net profit of
USD2 mil only, a very insignificant amount.
My guess is that those affiliated companies did not have the balance sheet strength to secure operating lease on their own. Asia Aviation Capital was thus set up by Air Asia to provide assistance to them.
(b) In June 2016 quarter, it seemed that there was a change in Asia Aviation Capital's business model.
During
that quarter, Asia Aviation Capital generated net profit of USD19 mil.
Based on exchange rate of let's say, 4.1, that amounted to RM78 mil per
quarter. If annualised, we are looking at net profit of RM312 mil. This
is not a small amount. Let's take a closer look at the figures.
(c)
First of all, we need to establish how much of the revenue and profit
was due to pass through mechanism (leased from external leasing
companies and subsequently on lease to affiliated companies) and how
much was actual leasing.
In
the June 2016 quarter, Asia Aviation Capital generated revenue of USD67
mil. My guess is that USD25 mil was Pass Through Revenue (closely
matching Operating Lease Expense of USD25 mil). This means that actual
leasing revenue was USD67 mil less USD25 mil = USD42 mil.
(d)
If that is the case, it means that Asia Aviation Capital generated net
profit of USD19 mil based on revenue of USD42 mil. Is that reasonable ?
One way to find out is to make comparison with BOC Aviation.
First
of all, the depreciation figure does not look right. BOC Aviation's
depreciation charges is approximately 35% of its revenue. In Asia
Aviation Capital's case, it is 26% (being USD11 mil divided by USD42
mil). By bringing it in line with BOC Aviation, the adjusted depreciation charges should be USD15 mil.
(e)
Secondly, there was an item called "other income" amounted to USD4 mil.
BOC Aviation also has "other income", comprises of fee income from
managing aircrafts leasing on behalf of third parties. I don't think
Asia Aviation Capital has such expertise. As such, it is likely a one
off item. We should exclude the USD4 mil from the financial model.
(f)
After making the above adjustments, we arrived at adjusted net profit
of USD11 mil (instead of USD19 mil). Please refer below :-
(g) Is the above figure reasonable ? Let's cross check by once again making comparison with BOC Aviation.
BOC
Aviation generated PBT of USD402 mil based on 227 aircrafts. This
translates into PBT per aircraft of USD1.8 mil. How about Asia Aviation
Capital ?
First
of all, we need to establish how many aircrafts are owned by Asia
Aviation Capital. In September 2015 quarter, Asia Aviation Capital
incurred USD21 mil Operating Lease Expense for 28 aircrafts leased from
third parties. In June 2016 quarter, Operating Lease Expense has
increased to USD25 mil.
Based on these information, my guess is that aircrafts leased from third parties was 25 / 21 x 28 = 33 units. This means that aircrafts owned by Asia Aviation Capital in June 2016 quarter was 55 - 33 = 22 units.
Based
on 22 aircrafts and annualised PBT of USD44 mil (being USD11 mil x 4),
it seemed that Asia Aviation Capital generated PBT of USD2 mil per
aircraft. This figure is closed to BOC Aviation's USD1.8 mil per
aircraft. In this regard, the financial model seemed to pass the test.
Summary Conclusion
First
of all, I would like to apologise for overwhelming you with figures. I
believe at this stage, most of my readers are lost and have no idea what
to feel about Asia Aviation Capital. Well, the following are the
salient points :-
(i)
In the past, Asia Aviation Capital was used as a vehicle by Air Asia to
facilitate leasing of aircrafts by affiliated companies. It did not
generate much profit.
(ii)
However, in June 2016 quarter, Asia Aviation Capital started generating
huge profit. My guess is that this happened because it started taking
delivery of new aircrafts, which allowed it to operate as an actual
Leasing Company.
(iii)
Asia Aviation Capital generated net profit of USD19 mil in June 2016
quarter. However, my calculation showed that that level of profitability
might not be sustainable. After making various adjustments, I arrived
at a more conservative figure of USD11 mil per quarter (USD44 mil per
annum).
That works out to be PBT of USD2 mil per aircraft per annum, closed to BOC Aviation's USD1.8 mil per aircraft.
(iv)
The figure of USD2 mil PBT per aircraft per annum is useful because by
simply multiplying it with the number of aircrafts to be owned, you can
arrive at an estimate of Asia Aviation Capital's future net profit (up to you to assume whether zero tax or 25%).
4. Concluding Remarks
(a)
My study showed that at current low oil price environment, aircraft
leasing has become a high quality business. It commands high profit
margin and strong ROE. As most of the leases typically last for several
years, Lessor Companies also enjoy strong earning visibility from
recurrent income. Bad debt risk is minimal - the moment the clients stop
paying rental, you can pull back the planes and deploy them else where.
There are plenty of demand for aircrafts nowadays.
After
taking into consideration the abovementioned factors, it seemed that
Tony Fernandez's claim of USD1 billion valuation is not that far fetched
afterall. Based on assumption of net profit of USD44 mil (we have been
through this in Section 3 above) and exchange rate of 4.1, Asia Aviation
Capital can potentially generate net profit of RM180 mil in FY2016/17. A
RM4.1 billion (USD1 billion) valuation translates into PE multiple of
22 times, not an unreasonable figure when come to take over.
The
valuation looked even more undemanding if you factor in the growth
potential. Asia Aviation Capital has justed started its operation. With
its backlog of aircrafts pending delivery, the group is well positioned
to grow its profit by leaps and bounds (just look at how BOC Aviation
grew its earnings by 23% effortlessly in 1H FY2016). No wonder the
buyers are so keen.
(b)
When come to Asia Aviation Capital, one very interesting point that
warrants discussion is whether it is making profit at the expense of Air
Asia's affiliated companies. This is an accusation levied against Air
Asia by Hong Kong based accounting firm GMT back in 2015, which caused
Air Asia share price to tank.
Did
what GMT say hold water ? Or was that merely a conspiracy to talk down
Air Asia share price to benefit short sellers ? I might not be able to
answer that question back in 2015. But now that I have studied and
understood Asia Aviation Capital, I will say that most likely those
allegations were not true. There is no need to go into great technical
details, let's just talk about simple facts - as mentioned in Section 3
above, before June 2016 quarter, Asia Aviation Capital hardly made any
profit leasing aircrafts to affiliated companies. Its role was to pass
over leasing cost from Lessor to those companies, and did it with
minimal mark up.
(c)
So far so good. But how about now ? In item (a) above, I have just
enthused about how much profit Asia Aviation Capital is about to make by
leasing newly acquired aircrafts to those affiliated companies. Has
GMT's accusation become a prophecy ? Is Asia Aviation Capital finally
playing the role GMT accused it of doing back in 2015 ? If Asia Aviation
Capital is not extracting value out of those companies, where do the
profit come from ?
The
answer is very simple - Asia Aviation Capital is benifiting at the
expense of other leasing companies. Before Asia Aviation Capital has its
own aircrafts, the affiliated companies were forced to lease aircrafts
from external leasing companies, resulted in huge earning leakage. Now
instead of paying external parties, they pay Asia Aviation Capital. In business school terms, this is called Vertical Integration.
(d)
Another point that warrants discussion is whether the planned disposal
of Asia Aviation Capital (to be followed by huge dividend payout) is a
futile corporate exercise that does not create value. I am aware of at
least one analyst that holds such a view. Basically, what the analyst
said was that the proposed disposal will result in huge drop in earning,
causing market cap to decline, thereby negating whatever gain arising
from the dividend payout.
Is
that true ? I don't really agree with that view. I believe Air Asia's
existing market cap reflects only its airline earning. Asia Aviation
Capital's contribution is not in the picture yet (if I am not wrong,
Icon8888 is the first one in the market to discuss Asia Aviation
Capital's earning potential). The proposed disposal will not cause Air
Asia's net profit to drop substantially. It will only cause it to grow less dramatically in the future.
(e)
Last but not least, I would like to point out that if Tony Fernandez
really pulls off the proposed disposal and reward me with a huge
dividend, I will be more than happy to take it. However, if the deal
falls through, I will not be unduly upset either. If my understanding is
correct, Asia Aviation Capital is a very attractive and valuable asset.
It has the potential to add significant value to Air Asia by delivering
huge earning growth. I am more than happy to see it remains in the
group.
Appendix 1 - BOC Aviation Latest Half Year Results
Appendix 2 - Billionaire Li Ka Shing Ventured Into Aircraft Leasing
(Source : Bloomberg, 5 November 2014)
AIRASIA (5099) - (Icon) Air Asia (11) - Asia Aviation Capital : Sale Or No Sale, Air Asia Is The Winner
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