Avation is James Faulkner’s small cap of the week

Avation Plc (AVAP) is a commercial jet aircraft owner and leasing provider, formed in July 2006, as a spin-off from the former Advent Air Ltd (now Skywest Airlines Ltd). Avation itself initially focused on servicing Skywest but a diversification strategy, of leasing a variety of types of aircraft to a wider range of airlines, saw a subsidiary – Capital Lease Aviation – de-merged in 2007, with Avation retaining a majority stake in Capital Lease, now an AIM-listed company.

In recent years the firm has done a good job of diversifying itself further away from its historic ties to Skywest, now part of Virgin Australia, and the share price has responded.

Results for the year to 30th June were strong despite the fact that contributory profits from Avation’s 69% owned subsidiary Capital Lease Aviation PLC were “less robust than expected” during the period. Avation added two new ATR 72-600 aircraft to the fleet during the period, taking the fleet size to 25 aircraft.

The delivery of two new ATR 72-600 aircraft direct to airlines and the addition of new airline customers also put the firm on a strong footing to continue growth in FY15. Indeed, Avation expects growth to accelerate in 2015, with 44% growth in the aircraft fleet by way of committed deliveries anticipated in calendar 2015. In addition to the eight new ATR 72-600 aircraft and three ATR 72-600 aircraft scheduled to be delivered before the end of calendar 2015, Avation is “actively evaluating” additional aircraft acquisition opportunities.

ATR 72-600

Balance sheet savagely understated?

At the current price of 155p, Avation trades on a forward P/E of c.7.3 times (using broker WH Ireland forecasts). With the last stated net asset value at c.£67.4 million, Avation currently trades at a c.20% premium to (mostly tangible) net asset value. Although the firm is currently in growth mode, we see scope for increasing levels of returns to investors over time and as the business matures, especially given the cash generative nature of the business. However, there are several ‘wild cards’ that could potentially give the shares a boost and which we believe aren’t really reflected in the current valuation.

Avation has been gradually refinancing its debt at lower rates of interest, with the latest deal in February seeing the $33 million refinancing of two ATR 72 aircraft in the existing fleet with a new facility which approximately halved the cost of those funds. With the transaction representing approximately 14.2% of the total debt of the company, the transaction was significantly earnings accretive with annual interest saving on the funding of these two aircraft being in excess of $1.6 million per year.

As the company grows it is possible that it will be able to gradually refinance all of its debt at more favourable interest rates, which could entail a significant uplift to earnings. Broker WH Ireland points out that Avation’s largest peers have recently demonstrated an ability to borrow at rates in the region of 3%. If the company could refinance all of its debt at half its current rate, this would add c.50% to pre-tax profits, according to the broker.

Meanwhile, WH Ireland also notes that Avation currently has options over 27 new ATR aircraft, which are currently on the balance sheet for nil value. Given that two planes were recently sold for an estimated profit in excess of $1.4 million each, the broker believes it is possible that these assets could be understated by as much as $38 million.

Broker Liberum goes even further, having suggested that there may be as much as an additional $90 million of hidden value on the balance sheet.

In any case, growth looks well underpinned by the agreement with Virgin Australia and corresponding purchase orders/options with manufacturer ATR, which leaves Avation looking set to more than double its fleet over the next 3 years.

ARE THE MARKETS OVER-VALUED?

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