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Hi lootgaloot,
Sure, i like what if scenarios and it doesn't take a brain surgeon to realise that airline leasing companies will struggle in high interest rate environments. That point is undeniable. The article, written in 2018 when interest rates were expected to begin creeping up higher outlines the headwinds faced in such scenarios, but also outlines other options in play for such companies. In all, high interest rates does not necessarily mean the death of airline leasing companies, they just have to adapt. AVAP have continued to grow and thrive since 2014 with a slowly rising interest rate background. The scenario you suggest i presume is based on the mother of all inflation spikes where interest rates climb back towards the historical mean of 5 or 6%? There are many arguments as to why this probably will never happen (or rather, couldn't happen again) in developed countries, but lets not get into that here. I have never spoken to anyone who feels so upbeat about future interest rates. You should load up on bank stocks in that case.
I'm not saying that if your scenario played out, what you are saying is wrong. But you have to ask yourself the probability of interest rates becoming problematic for AVAP even when taking into consideration credit downgrades (which would reverse once sector finally begins to recover) in the near-mid future. I dont know anyone who thinks interest rates are going to be anything but rock bottom for the next 5-10 years, forgetting about inflation overshoots in which the FED have already indicated that they will be sluggish to react.
If i based my decisions to invest on every possible scenario no matter how unlikely and ruled them out based on this, please find me a single company i could invest in. What i am saying is, the probability that AVAP will be above the current SP when the aviation sector really starts to recover is significantly higher than a spike in interest rates before the aviation sector recovers that will capitulate the company. After all, this is just a game of probability.
Or more importantly, in what order will these events occur? The likelihood is, i wont be around here long enough for interest rates to have an impact on AVAP, but will be for the sector recovery. I'm here purely for the aviation recovery play where deep value can still be found.
lootgaloot - You almost make it sound that the worst is yet to come. Surely the worst is now over.
SHORT TERM - i.e. existing fleet + receivables + payables.
AVAP currently have a fleet leased out, and they have a number of aircrafts available for leasing (non-contracted).
Focusing on the short term, it would be:
- minimise cash outlay,
- lease out available aircrafts (which is very likely within the next 12 months once demand ramps up (unless you disagree that demand will ramp up)
- maximise cash receipts - collect lease receivables - current and arrears outstanding.
Once some semblance of profit is restored, assuming demand for international travel returns (yes I appreciate impact of zoom on business travel but still we all need to travel), AVAP's credit status should improve.
Does increases in interest rate have an impact in the short term on AVAP? I am not sure it does. Even if it does, it is probably hedged so exposure is minimised.
MEDIUM TERM - future plans
NEW DEBT FINANCING
Once the business model is restored on existing contracts, AVAP may look for further debt financing to finance additional aircrafts to facilitate further leasing to "new" clients or existing clients seeking for additional aircrafts.
Will there be demand for leasing from airlines? IMO yes.
Will higher interest rate charges have an impact on AVAP?
At this time, yes. Fully agree, interest rates for debt financing are likely to be higher, but then again, so would expected lease receivables from new contracts.
So how would airlines finance these higher interest rate charges to pay AVAP? Higher prices for tickets.
Once again, let's return to the interest rate, over the period of last 40 years, the current interest rate + future expected interest rate is still expected to be very very low and manageable. So whilst, interest rate for AVAP's medium term plans is important, they are expected to be manageable.
EXISTING DEBT RE-FINANCING
These are expected to be at a higher interest rate charge, which I'd imagine AVAP will seek to pass on to the lessee.
HIGHLY LEVERAGED
My understanding which could be incorrect is that, if AVAP default on payment to bondholders, then bondholders may under certain T and C grab the aircrafts and then seek to sell/lend them out themselves to raise proceeds. That sounds screwed to me because I do not think any bondholders want to go through this process. I.e. Sell at firesale prices is even worse. So I beg to differ that AVAP's situation is "perilous". The bondholders for the May 21 tranche has already been resolved - done deal.
So overall, this is my take on the situation.
@triumph, you point out that interest rates are still lower than pre-covid and ask why I think interest rates will continue to rise. It’s a fair point; I’m making certain assumptions. However, I believe it’s justified to ask the ‘what if’ questions and I’m hardly alone in raising the topic. In fact, the article you linked to is evidence of the nervousness around the airline leasing business model. I'd go as far as saying it is now the consensus view that interest rates will rise significantly in the future.
AVAP’s position is particularly perilous; they not only carry high levels of debt but rely on debt to fund ongoing operations. Add in the fact that bondholders were recently forced to accept 65% of loan note value and AVAP credit status will be at junk levels when they need to raise further funds. That's not a recipe for success in a high interest rate world.
You said I could say the same for any company but this is simply not true. There are many companies with low levels of debt who fund their operations from cash flow. Even within the airline industry, many large carriers still have investment grade credit ratings. So it is not true that all airlines credit ratings are junk; you mention IAG and Easyjet – downgraded in 2020 but not junk.
The later part of your post is irrelevant. You revert to a ‘once things return to normal’ argument whereas I am asking the ‘what if’ question regarding interest rates. You are entitled to ignore my scenario but I’d say that’s very unwise. Everything you say in the latter part of your post falls apart if AVAP cannot raise funds at a competitive rate.
Lootagoot, regarding interest rate environments, you can say that about any company. The buy to let analogy is fair despite AVAP having a buyout option, but unless the company want to expand their fleet it is not an immediate worry. High interest rates do create other downward pressures such as aircraft value, but this cost as you say would be absorbed largely by these smaller carriers with little access to debt that would pass costs onto customers. Will this stop people flying regional? I highly doubt it. Obviously interest rates would be hedged on any floating rate loans (see note 15 in last RNS). What makes you think interest rates will shoot up any higher than what they were before covid in which AVAP thrived? There may be a temporary overshoot, but whacking up interest rates would be akin to pulling the lever on the trapdoor for many companies. I agree high interest rates would be bad for their business model of operating with newer planes where the depreciation curve is steepest, but least they could buy back their debt sub par like they already have been at about 70c on the dollar. There are other options for aircraft leasing companies in high interest rate environments such as using older planes ect. Here is a good article on the matter.
https://www.ocorian.com/article/if-interest-rates-continue-rise-where-next-aircraft-leasing
Re leasing model, many of your assumptions are based on the past. All airline balance sheets longhaul or regional have been decimated, all airline credit has been downgraded to junk or as good as. In fact, i would go as far to say that i would much rather invest in a small regional than a large longhaul as these will recover much faster, and in particular Asia have fared well. And your statistics re current leasing are irrelevant as most airlines are nowhere near 50% capacity let alone pre covid so it is far too early to determine how landscape has changed as they are not operating. More time is required to see how the landscape has truly changed in terms of leasing a opposed to buying and this can only happen when we are close to 2019 air mile figures, but my money is on leasing increasing from pre covid. Regionals are AVAP's main customer base and are faring much much better than major longhaul carriers who will no doubt see consolidation. Its these small regional asian carriers that are currently outperforming which is why the company are still churning a profit if you take away write downs. I think demand for leasing planes in this category will increase as well as longhaul players increasing the level of leasing to free up cash in balance sheets, and although consolidation is inevitable, i dont think it will happen quite to the extent you think, particularly in asia.
The stock still trades significantly below NAV and has an excellent track record of delivering decent returns. This has to be a much better recovery buy at these levels than an airline such as IAG or Easyjet. I wouldn't write off AVAP jus
Thanks for that lootgaloot. I like your take on it - the "inversion" perspective - i.e. "what if it does not ...scenarios". Many of the "what if" cases your laid out are not unreasonable.
My guess is that the big boys are / have been in the process cost rationalisation and survival more than a focus on gobbling up more market share. Thus, right now, they are more focused on their own patch rather than the next door neighbours.
6 / 12 months on - who knows? But by then Avation, SP should reflect a more positive market sentiment to AVAP assuming international flights resume. LTHs of AVAP may have an more extensive view than possibly both of us.
It's not "rosy" for AVAP - agreed. Then again, it never is for recovery plays. GL
@Scoobydoo; it’s not really a case of picking my brains because I don’t know much about AVAP or the industry. However, what I do know is, to get nervous when people start to see things as a one way bet. 25 years of investing has taught me this is never the case.
AVAP has been on my watchlist for about 6 months for exactly the reason you state; ‘I see a simple equation for AVAP, if international travel back = AVAP is back.’ I have stocks on my watchlist for months (sometimes years) before buying. It gives me time to challenge my initial view of the stock and indeed to imagine scenarios that may never happen, but could.
Going back to my original post; my concern is with the business model of AVAP rather than with the specifics of current lending terms. Like you, I assume current borrowing is on ‘fixed’ terms that were sustainable before the lockdown and may even be sustainable IF business returns to pre-covid levels. But, as I have said, current borrowing is not my concern.
It’s the business model itself that looks shaky to me in a high interest rate environment. Of course AVAP are going to talk up their own business model in their presentation. I haven’t seen it and I’m not particularly interested in seeing it but I did have a laugh when you said that AVAP referred to the ‘burnt balance sheets’ of its customers. A phrase about throwing stones in glass houses springs to mind.
AVAP would like to present a scenario in which it continues to make sense for carriers to lease rather than buy. But let’s look at some facts; even in our current low interest rate environment only 4 out of every ten aircraft are leased. What type of carrier lease and which choose to buy? Ryanair lease only 33 of their 383 aircraft while over 70% of LOT and Wizz Air fleet are leased. Generally speaking, small, start-up airlines are much more likely to lease. Established firms with good credit histories will buy.
Now, your guess is as good as mine. If you believe we are about to enter a golden age for small carriers with poor credit ratings looking to expand their routes then maybe AVAP are a good bet. However, if you believe we are entering a period of consolidation where the big players snap up the airport slots of struggling regional carriers then I’d suggest you steer clear of AVAP.
Even if, as you suggest, AVAP can pass on their borrowing costs to these small regional carriers; this only shifts the burden onto the very customers that AVAP depend on. Higher interest rates mean higher costs for that part of the market and shifting the cost from leasor to leasee isn’t going to help. The big boys will also be affected by higher interest rates but they will survive and even grow. They may have to extend the service life of their aircraft by a few years and with a bit of inflation their fleet may actually increase in value.
I can’t predict the future of this industry any more than the next person. I can simply state the reasons why AVAP are no longer on my
lootgaloot - Great points you mentioned, I'm not a leasing expert. Would love to pick your brains.
U said, "Bond yields in US are rising fast and that will increase interest rates globally. "
Are AVAP's interest payable to bondholders based on a variable or fixed basis ?
If fixed basis. Why should they be concerned on increasing interest rates?
If variable, would they not have T + C with their airline customers citing that payments would be additional if the IR is X% above Y? (I am speculating but surely they can not be stupid to be left overly exposed). Or does AVAP hedge / lock in the IR payable ?
U said, "Can AVAP generate enough cash to pay interest on loans going forward."
Surely this goes back to what I said, provided international travel returns = bums on seat = revenue coming into airlines customers = money payable to AVAP for obligations both current and in arrears?
U said, At what point does it make more sense for carriers to invest in their own fleet.
During the presentation today 26th Feb, the management alluded that airlines with their burnt balance sheet are very unlikely to use precious capital to buy their own carriers outright. Instead, they would choose to use companies like AVAP. It'll require airlines too much capital and from my limited memory of finance/operating leases and impact on the P & L would not be entirely advantageous for them (ie.. on a Return on Capital Employed basis, hence "off balance sheet financing via lease appears to have advantages).
U said, "Just like buy-to-let housing, the business model only makes sense in a low interest rate environment."
So if the environment has higher interest rate, why can't AVAP not pass this on to the airlines (provided they are agreeable)?
If airlines are not agreeable, they will have to do a capital raise to buy airlines outright
or
sell bonds themselves at similar high interest rates to fund purchase (on balance sheet which with my limited knowledge does not appear optimal for airlines)
or
bank financing - at similar interest rates
Any sense in what I say or have I just made them up as I go along? Probably the missing piece could be the interest rate coz I am useless with bonds / yield etc. Currently, I see a simple equation for AVAP, if international travel back = AVAP is back. Simple as that at least for the next 12 months. If so, SP should recover significantly. Look forward to your reply. Thanks
Business model is a sound one, and one of the best recovery shares about at this very low price IMO!
LOL Lootgaloot you just made me buy more :)
At it's heart this company is essentially a buy-to-let operation. It borrows money to buy aircraft which are then leased out. For this reason, I don't think it's as simple as saying everything is OK once we return to international travel. The fortunes of this company will depend a lot on the future interest rate environment. Bond yields in US are rising fast and that will increase interest rates globally. Can AVAP generate enough cash to pay interest on loans going forward. At what point does it make more sense for carriers to invest in their own fleet. Just like buy-to-let housing, the business model only makes sense in a low interest rate environment.
Bit perplexed as to the recent flurry out of the door by PIs ..then realised - it's show time tomorrow 25/2/21 ! H1 results + Investor Update.
Surely the worst is over with the agreement with the May 21 bondholders.
The rest - well, we all know that it's going to be a bit ...off - hence the low SP
Get the popcorn out guys and let's enjoy the webcast!
Priced at half its intrinsic value .... I will take some of that!