Broadly speaking we like leasing businesses. They are easy to understand and contain very few moving parts. Simplyfying a bit you have the cost of borrowing, the cost of lending, and the residual value of the asset as the key drivers with the cost of administration as the other main significant factor. As AVAP only has a small fleet, though growing strongly it has few moving parts to worry about. As such we see it as being within our circle of competence.
We also like the sector AVAP is in. It is highly regulated. Planes have to be maintained and certified to a very high level so that should mean that residual values should be something that AVAP can get correct. Thereby removing one of the big risks.
As we have held AVAP we have recognised the company has the following positives;
It is focussed on a niche. The planes it is principally covering are sub $100 million and most lessors want deals on $200m + planes. The paperwork and legal costs are broadly the same whatever the size. This niche gives it some pricing power in the market. As a whole this aviation leasing market is pretty small, 200 players?, who all know most of the other players. So in many respects all players have close to full knowledge, but a niche gives a little pricing power.
Management are open to discussion with analysts and shareholders and to date we are not aware of them avoiding tough questions. (See below for some thoughts on their answers).
The company is growing strongly this year with a good forward order book. Currently 29 planes with 4 added in the year. Another 12 on Order and Options on a further 22.
The company has recently completed debt financing that should give them a strong funded basis for growth for the next couple of years.
The company does seem to be getting noticed in the US. Most lessors and most lessor financing is US based. The company's latest debt funding was largely from the US and some US based analysts are beginning to ask questions on analysts calls. We believe that an ADR at a suitable time could be a catalyst for a rerating or a substantive growth in equity interest and managment seem to be both aware and receptive to this.
The negatives we currently have are;
The FD - Richard Wolanski seems to be overly focussed on promoting the shares. We would prefer a focus on building the business. Share promotion isn't the role of an FD and unless he is travelling economy and staying in a holiday inn it is likely to be a big expense for a small company.
We do wonder why a company the size of Avation needs both an FD and a Chief Financial Officer. During a recent conference call one of the analysts asked some reasonably specific financial questions. The call had been until then dominated by the FD but these got thrown over to Iain Cawte the Chief Financial Officer who answered them easily. I do not expect the FD to know all the details on everything, but this is 29 leases on planes. Its not thousands of moving parts.
At a recent investor show Mr Wolanski was asked why he did so much promotion and he suggested he was doing it to find some big private investors who could take out any excess liquidity in the shares. We see this as unrealistic. If the current institutional investors felt the price was too low they would pick up. Serious investors who can put up £1mill + want a meeting. If Mr Wolanski was seriously looking for a few take out investors he would not be doing it from a stall but by setting up meetings with the money at their offices.
We are concerned that residual values are a problem. The $1.2 mill write down in CLA (a subsidiary) this year was because they got a residual value wrong. Avation ha salso recently changed the depreciation period from 30 to 25 years because they were getting the residuals wrong. In conversation Avation suggested that the CLA error was very much a one off mistake, but we are not terribly convinced. The point was made that the plane had the wrong type of engine and was a very old airframe (NO# 53) so couldn’t command full price. But both of these seem to be factors that AVAP/CLA should have known years ago and adjusted depreciation accordingly. We are hoping that the change in the rate and the obvious cock up on the CLA plane means they have learnt their lesson. There was also a bad debt issue in AVAP = £800k. Which was covered by a deposit. In part this may also be related to residual values – but only in part.
Avation in promoting its position and knowledge has previously made the point that this is a small industry where all the players know each other and what costs what. So in our opinion writing off $1.2 mill should not have happened.
We are also not convinced that there is a good reason for CLA to exist. Avation currently owns circa 97% of it. The suggestion from Avation is that it potentially provides a vehicle for deals Avation may not want to do because of the risk. This does not sound realistic to us. Currently AVAP owns 96-97% of CLA. Is it really sensible for management to put risky business, that might blow up, into an almost wholly owned asset and see that possibly destroyed. The whole ethos of a leasing business is decent assets fully covered by future rental income that is funded by low cost borrowings with the differential paying off the asset and allowing a profit. These are planes. Who wants to get into a section of the market with dodgy dealing, risky cashflows and therefore risky maintenaince. When this question was asked I walked away persuaded by the argument but the more I think about it the more stupid it seems to me. I will be looking at what if any benefits the Directors of Avation are taking from CLA.
As stated we do like leasing businesses. And on paper Avation seems to have many things going for it with in particular a significant catalyst for value in a few years through ADR's. But we are not currently persuaded that we should increase our holding given our concerns. We will therefore continue to monitor our position.