I maintain my “Neutral” rating on Hong Kong-listed BOC Aviation Limited (OTC:BCVVF, OTC:BCCVY, 2588:HK), Asia’s largest aircraft operating leasing company headquartered in Singapore. There are concerns that there will be a significant number of delivery deferrals and client defaults which could put the company’s business under pressure in challenging times like these. Also, the company is valued by the market at a premium compared with its peers on a P/B basis, and there is a risk that its book value could decline due to aircraft impairment losses.
On the flip side, BOC Aviation has an excellent historical track record of being profitable in every single year in the past 26 years, and the company could potentially capitalize on value-accretive opportunities in the current crisis, similar to what it did in the past. It added 45 new aircraft in FY2009 during the Global Financial Crisis, of which 31 were acquired via opportunistic purchase and leaseback transactions.
With a 13-year historical average ROE of 15% since FY2007, the company’s current valuations seem fair despite all the headwinds in the aviation industry, which warrants a “Neutral” rating.
This is an update of my initiation article on BOC Aviation published on August 28, 2019. The share price dropped by -46% from HK$65.85 as of August 26, 2019 to an all-time low of HK$35.55 on March 19, 2020, before rebounding strongly by +41% to close at HK$50.00 as of March 26, 2020. BOC Aviation trades at 6.4 times trailing twelve months’ P/E and 6.2 times consensus forward next twelve months’ P/E. The stock is valued by the market at 0.98 times P/B. The company also offers a trailing twelve months’ dividend yield of 5.5% and a consensus forward next twelve months’ dividend yield of 5.9%.
Readers are advised to trade in BOC Aviation shares listed on the Hong Kong Stock Exchange with the ticker 2588:HK, where average daily trading value for the past three months exceeds $12 million and market capitalization is above $4.4 billion. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage, such as Interactive Brokers, Fidelity, or Charles Schwab, or local brokers operating in their respective domestic markets.
Concerns Regarding Delivery Deferrals And Client Defaults
In challenging times for the aviation industry like these, where entire nations are in lockdowns and airlines are aggressively reducing their flight capacities to close to zero, an aircraft lessor such as BOC Aviation is not spared from the headwinds. There are concerns that there will be a significant number of delivery deferrals, and even client defaults, which could put the company’s business under tremendous pressure.
At its FY2019 earnings call on March 11, 2020, BOC Aviation disclosed that “we have received no request for deferrals of deliveries at this point.” But the company also acknowledged at the recent earnings call that “there will be some short-term delays probably in March and in the early part of the second quarter due to practical issues of people being allowed to physically go and receive deliveries.”
As of March 11, 2020, BOC Aviation has 58 aircraft scheduled to be delivered in FY2020, of which three have already been delivered. In comparison, the company achieved 54 aircraft deliveries in FY2019, which was lower than expected due to the grounding of the Boeing (BA) 737 MAX last year.
Apart from potential delivery deferrals, another key concern for BOC Aviation relates to the financial health of its airline customers and possible client defaults. Notably, the company highlighted at its FY2019 earnings call on March 11, 2020 that it is exploring the possibility of either rent deferrals for up to three months or purchase and leaseback arrangements for certain airline clients which have been adversely impacted by the current coronavirus outbreak.
Furthermore, BOC Aviation has identified certain “high-risk” clients which it has put on its watch-list, and the company has contingency plans in place to redeploy or sub-lease certain aircraft if needed. Nevertheless, in the worst-case scenario that the coronavirus outbreak takes a longer-than-expected time to be contained, some airlines could go bankrupt, and it would be difficult for BOC Aviation redeploy or sub-lease aircraft under such challenging circumstances.
Client default risks for BOC Aviation are partly mitigated by the company’s focus on relatively stronger clients, and favorable lease rental payment structures. BOC Aviation only targets 138 of the 775 airlines operating today as clients, and these 138 airlines are relatively larger companies which have a fleet of at least 20 aircraft and higher credit ratings than the peer average. Also, the company collects rental payments from its customers every month or quarter in advance, and it has security deposits placed by its clients that could be as much as 14 months of rental payments in certain cases.
Risk Of Impairment Losses For Aircraft In The Spotlight
BOC Aviation is valued by the market at a premium compared with most of its U.S. aircraft lessor peers on a P/B, and there is a potential risk that the company’s book value per share could decline due to impairment losses for its aircraft.
Aircraft Lessor Peer Valuation Comparison
|Stock||P/B||Trailing Twelve Months’ P/E||Consensus Forward Next Twelve Months’ P/E||Trailing Twelve Months’ ROE||Consensus Forward Next Twelve Months’ ROE|
|AerCap Holdings (AER)||0.35||3.0||3.3||12.6%||8.6%|
|Air Lease (AL)||0.50||4.9||4.7||11.3%||9.3%|
|Fly Leasing (FLY)||0.29||1.2||2.4||28.6%||8.9%|
However, the risk of impairment losses as a result of a severe decline in the market value of aircraft is partially offset by two key factors.
First, BOC Aviation’s net book value of its aircraft amounting to $16.8 billion as at the end of FY2019 represents a 7% discount to the market value of $18.1 billion, which is determined by the average of valuations by five independent valuers on a semi-annual basis. This implies there is a certain level of buffer before the company needs to recognize impairment losses on its aircraft.
Notably, the book value of its aircraft is not marked-to-market, but recognized at historical cost and depreciated over a 30-year period.
Secondly, BOC Aviation’s mean age of its aircraft fleet is only three years, and the company’s average remaining lease term (weighted by net book value of its aircraft fleet) is very long at 8.4 years. This should limit any downside risks relating to the decrease in market value of the company’s aircraft.
Opportunities In Crises Backed By Excellent Historical Track Record
Established in 1993, BOC Aviation has had the experience of navigating past crises, including SARS (Severe Acute Respiratory Syndrome) in 2003 and the Global Financial Crisis in 2008-2009. The company has been profitable in every single year for the past 26 years since it was started. Furthermore, its fleet utilization rate was maintained at 100% in 2008 and 2009, while its collection rate (cash collection from clients) was above 98% in those two years during the Global Financial Crisis as well.
In its FY2019 results presentation slides, BOC Aviation emphasized that it has “available liquidity of over $5 billion to support counter-cyclical investment.” It is noteworthy that during the 2008-2009 Global Financial Crisis, the company added 45 new aircraft in FY2009, of which 31 of them were acquired via opportunistic purchase and leaseback transactions.
The company trades at 6.4 times trailing twelve months’ P/E and 6.2 times consensus forward next twelve months’ P/E based on its share price of HK$50.00 as of March 26, 2020. Listed on the Hong Kong Stock Exchange in June 2016, BOC Aviation’s share price trough of HK$35.55 on March 19, 2020 implied that the stock was valued at 4.5 times trailing twelve months’ P/E and 4.3 times consensus forward next twelve months’ P/E. As a comparison, the company has traded as high as 11.3 times trailing twelve months’ P/E and 10.0 times consensus forward next twelve months’ P/E during its peak in December 2019.
BOC Aviation is also valued by the market at 0.98 times P/B. During the recent market sell-down, the company traded as low as 0.69 times last week, versus its historical P/B peak of 1.68 times registered in December 2019.
BOC Aviation offers a trailing twelve months’ dividend yield of 5.5% and a consensus forward next twelve months’ dividend yield of 5.9%. Its total dividends per share for full-year FY2019 were $0.3541, which represented a +13% YoY increase in line with earnings growth. The company’s dividend policy is to pay out up to 35% of its earnings as dividends every year.
The key risk factors for BOC Aviation include larger-than-expected number of delivery deferrals and client defaults, lower-than-expected dividends going forward and larger-than-expected impairment losses on the company’s aircraft.
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Disclosure: I am/we are long BOC AVIATION LTD. [2588:HK]. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.