Icon8888 Gossips About Stocks
(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 Fernandes 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 Fernandes' 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 effortlessly grew its earnings by 23% in 1H FY2016.
(b) One thing that sets Asia Aviation Capital apart from other leasing companies is its relationship with Air Asia. Did you notice that Asia Aviation Capital's staff cost is zero whereas BOC Aviation incurred staff and marketing expenses of USD64 mil (that is approximately RM256 mil, dude), equivalent to 6% of its revenue ? That is because Asia Aviation Capital does not need to solicit for businesses. Air Asia's affiliated companies (Air Asia X, Air Asia Thai, Indonesia, Philippines, India and Japan) provide it with a ready supply of clientele. If the buyer is smart, he would request for first right of refusal to lease aricrafts to those companies in the future. Of course, our Tony Fernandes is not dumb either. He will leverage on that to extract even better pricing. Don't rule out the possibility of more than USD1 billion valuation (Tony Fernandes gave me the impression that he is shopping around for best deal).
(c) How do I feel about the proposed disposal ? Well, if Tony Fernandes really pulls off the deal and rewards me with a huge dividend, I will happily pocket it. However, if the proposed disposal falls through, I will not be unduly upset either. If my understanding is correct, Asia Aviation Capital is a very 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)
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Discussions
11 people like this. Showing 33 of 33 comments
sell AAC now, short term good, long term not good.
hold AAC now, short term we are not good, long term very very good. (^-^)
2016-09-21 08:53
Icon Sifu Thank you. I enjoy reading ur article and have a much understanding in AA
2016-09-21 10:00
Your assumptions for 'aircraft leased from other companies' Sep15 are wrong
2016-09-21 10:03
thx Icon, some extra info wish can help your analysis:
1. base on TA Report and info after investor roadshow, Airasia "might" target inject more aircraft to AAC from current 55 -68 units.
2. base on the Qtr report, AAC latest" total equity" is only 45.9m, With ttl assets 801m and total Debt 755m
3. New appointed CEO, Stéphane Daillencourt, with 30 years exp in GE, manage leasing arm 1700 aircraft portfolio.
base on above info, and the latest p&L and balance sheet, i believe the 1b is viable, how ever, to be realistic, there is 2 possibility:
1. buyer will take 755m debt out of airasia balance sheet with AAC, and paid extra usd 245m, in cash, which mean it will greatly reduce debt and boost AA BS to healthy zone.( jus like tony first bought AA at RM1 and take the 40m debt with it)
2. buyer pay 1b, and AA keep the 755m debt in AA balance sheet, with USD 1b cash, Tony will pay special dividend and cover the private placement of RM 1b.(which i thk with high possibility)
2016-09-21 10:26
Very well written. thank you Icon for the detailed analysis and comparison.
2016-09-21 10:29
sifu koohaiwuyah, I believe Asia Aviation Capital's net asset is USD45.9 mil + USD185 mil (amount owing to holding company) = USD230.9 mil
2016-09-21 10:39
Nice one Icon. Great analysis and straightforward presentation for a clueless layman like myself.
2016-09-21 10:40
feel even more confident with AA after reading Icon article, yesterday i sailang in Airasia, thanks Icon for this timely article.
2016-09-21 10:47
ya, icon sifu, i thk u r right, i overlook this part(amt due to holding company) =D
2016-09-21 12:05
Great post. We all are alway waiting for your post and learn from you on how to do a good analysis.
2016-09-21 12:41
Thanks for your great effort in preparing the analysis. It's data based and give opinion with well stated assumption.
2016-09-21 13:15
I'll add my compliments, Icon8888.
What's your view of a report I read that there won't be US$1.4 bil for distribution after sale of Asia Aviation Capital as it has huge borrowings?
Anyway, I'm in AirAsia for its operating profit, not AAC. That latter's just a bonus.
2016-09-21 16:01
I will be happy if Air Asia pay me 50 sen dividend. Anything more than that is a bonus.
2016-09-21 20:21
1. May i know what's pass-through revenue?
2. Why do you say lost earnings contribution is not significant? AAC contributed USD19m or RM80 last quarter (ignoring inter-company), Airasia made RM342m in 2Q, RM412m in 1Q excluding forex. but one-off cash boost also good and may bring down interest cost
3. I think technically net assets should still be RM45.9m. Amount owing to holding is debt, not equity. In disposals, this amount should be settled. other than amount owing to holding of RM185m, there's also an amount owing from related parties RM68. so net for AirAsia group AAC owe RM117m. but it's more likely than this amount would have been factored in the USD1b valuation (if it's true)
4. What do you think about its valuation right now? especially considering the new shares to be issued will dilute the eps
Thanks a lot for sharing
2016-09-22 11:17
Icon, just assume that Airasia sold the AAC. The item under revenue "Aircraft Operating Lease" (On June16 Qtr 328m), and the item under expenses "Aircraft Operating Lease" (On June16 Qtr -121m) both will disappear, right? That mean quarterly Airasia will lost net income on this item around 200m/qtr right? correct me if mistaken.
2016-09-22 20:09
dear Jay and Tee Tom, I think your questions are valid. My argument that disposal of AAC will not affect Air Asia profitability in a big way was based on AAC figures. However, upon taking a closer look at Air Asia's financial figures, the lease income and lease expense is much higher than that of AAC. One possibility is that only part of Air Asia's leasing activities are housed under AAC. Due to lack of information, I think it is best that I don't take a stance when come to this issue. I have added a paragraph in item (d) of Concluding Remarks to say that I no more comfortable with my original view.
2016-09-22 20:31
Icon, I have no mean to question on your hard effort piece of work. Haha, I think you spent a lot of time & effort to produce this top class analysis. Anyway, no discuss, no debate, it wont has spark. This is just a normal processes we are going. The more important is the ending, right? You are my top example I want to learn on; Your analysis ability, your fugures sensitivity, your top class sense of investing, and your ability to put your thought on the paper. I always enjoy your writing. Thank god you are always by our side. Thanks.
2016-09-22 21:49
Oh no offence taken. You guys gave your comments in a professional way, I have no complain
By the way, I finished that article at almost 1am at night. So the last few items were not as well thought out and written as I wish (sleepy...). So I welcome you guys comments to point out any inadequacy.
2016-09-22 22:02
Talk so much for what?
AirAsia sudah 100%, buy others, kesm, gkent, rcecap, bornoil,choobee,etc
2016-09-23 22:19
RCECap buy call by Maybank TP 1.60 , Airasia TP 3.33 Buy call by Maybank, TP
3.85 Buy call by HLG.
2016-09-23 23:03
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