Avation plc (LON:AVAP) Chief Financial Officer Iain Cawte caught up with DirectorsTalk discuss why income was down but profits were up, improving cash collection rates, why purchase rights have increased, ratings upgrade and funding for upcoming deliveries.
Q1: Iain, just looking at the results, we can see that income is down but operating profit is up, how was that achieved? Was it down to cost savings?
A1: Avation have achieved some cost savings, principally in administrative expenses, however what you’ll notice from the half year results is that operating profit has included a number of items that we would consider to be non-recurring.
So, for example, we had a $3.2 million plane receipt from Virgin Australia, a $3.2 million gain on derecognition of a finance lese, a $6.9 million unrealised gain on an equity investment, and $5.8 million of transition costs.
So, the net impact of those has been to boost operating profit.
Q2: As the aviation industry recovers, are cash collection rates improving?
A2: Yes, they are, although I’d caveat that with saying there are some localised differences in collection rates. So, if you look at the background, the regional travel market, excluding China, has recovered quicker than the international travel market.
The international travel market is recovering but the Asian market is probably recovering more slowly than the European and North American markets.
The large part of the difference is probably explained by the absence of Chinese travellers from the international market, where the Chinese market is expected to recover strongly perhaps towards the end of this year and early into 2024 as those travel restrictions are eased.
So, whilst cash collection rates for our regional airline and European airline customers have recovered strongly, Asian airlines that traditionally derive a substantial amount of their revenue from Chinese travellers are still lagging behind somewhat.
Q3: Can you explain for us why purchase rights increased in value?
A3: Obviously, the principal reason that we have a positive value to the options or the purchase rights is that the expected valuation of the asset is above our expected purchase price. We then feed that into a black-scholes option pricing model and the pricing model also takes inputs from risk-free interest rates, the expected life of the option, price volatility etc.
The fact of which has probably had the most impact on the purchase price valuation recently has been the in the increase in the risk-free interest rates. As an example, if you look at the US treasury bill rates, the one-year rate went from 2.8% as of 30th June, which is the previous measurement date that we use for the options, up to 4.7% as of 31st December. So, that has triggered part of the increase in the valuation.
Q4: What would you normally expect aircraft transition costs to be around?
A4: Theoretically, we shouldn’t incur any aircraft transition costs except for perhaps some legal fees associated with writing a new lease when we’re transitioning from one lease to a new lease. Also, perhaps some costs to move an aircraft to a new delivery location.
Generally speaking, if the lessee has performed the lease correctly, the aircraft should be returned to us with all of the major components in air-worthy condition, and in accordance with redelivery conditions that are set out in the lease. We then would also receive cash compensation for utilisation of major component s since their last overhaul. So, normally we wouldn’t expect to incur transition costs in that situation.
What’s happened recently is that, for instance, we took redelivery of a 737 from Garuda as we had to terminate the lease because of non-performance by Garuda. When we took the aircraft back, both engines needed to be overhauled so we had to incur that cost but normally, transition costs should be minor or zero.
Q5: Now, EBITDA interest increased from 1.9 to 2.1, should we expect a rating upgrade at any point?
A5: Our rating assessment at the moment is B-, with stable outlook, and that rating was issued by S&P in August 2022. The fact that we have a stable outlook means that S&P believe that the rating is not expected to change within 12 months from issuing that ratio. So, the rating isn’t expected to change perhaps until later this year when it will be reviewed again.
Obviously, it would change if there were major changes in the business or the funding of the business such as a substantial repurchase of debt or big improvements in credit ratios such as the debt to equity ratio.
Q6: Just looking towards the outlook, how is the availability of secured debt? Are you confident you can get funding for upcoming deliveries?
A6: Yes, secured debt is certainly available for airlines with good credit standing. As an example, Avation recently refinanced two aircraft lease to airBaltic and we were able to obtain competitive financing and actually increase to the LTV ratio on those aircraft.
So, we are confident that we’ll be able to arrange leases for the two ATR deliveries that we have coming in 2024, and we’ll then be able to arrange secured loans against those leases.
For airlines with lower credit standing, there’s always the backstop option of ECA-backed funding which is available for new aircraft, and we have used that in the past.