Earnings Call: H2 2017

Mar 14, 2018

Ladies and gentlemen, welcome to BOC Aviation's full year results call for the year ended 31st December 2017. Mr. Timothy Ross, please begin. Thank you, operator, and welcome everybody to BOC Aviation's earnings call to discuss our final results for the year ended 31st of December 2017. With me today are our Managing Director and Chief Executive Officer, Robert Martin, our Deputy Managing Director and Chief Financial Officer, Thim Fatt, and our Chief Operating Officer, David Walton. Please note that some of the information you'll hear during our discussion today may consist of forward-looking statements, which are subject to risks and uncertainties that may cause actual results to differ materially from statements made today. You should not place undue reliance on any forward-looking statements, and you should review our results announcements for full details. Please also note that all currency references are in U.S. dollars only. A copy of our earnings announcement is available both by the Hong Kong Stock Exchange and in the investors section of our website at www.bocaviation.com. A conference call presentation is also available in the investors section of our website. This call is being recorded and will be available for replay from our website within the next 24 hours, as is a transcript of today's management presentation. I'll now hand over the call to Robert Martin, who coincidentally has just celebrated his 20th anniversary with the company. Thanks, Tim, and good evening to everyone on the line. Thank you for joining us for our 2017 full year results earnings call. Today, we're presenting our second full set of annual accounts since our IPO. As we continue to produce record earnings, achieving the highest profit in our company's history and a return on equity of 16.3%. We're delighted to report a net profit after tax of $587 million for the year, up 40% on 2016, and equivalent to earnings per share of $0.85 based on the number of shares outstanding at year-end. To put this in context, our after-tax earnings for 2017 exceeded Bloomberg's consensus estimates at the time of our IPO by 35%. Our earnings were driven by revenue growth. Our total revenues and other income of $1.4 billion rose 17% compared to 2016. The NPAT also includes $91 million adjustment in net deferred tax liabilities as a consequence of changes in the U.S. tax code, which resulted in a positive tax provision for 2017. In light of our exceptional performance, our board has recommended declaring a final dividend of $0.192 per share, payable to shareholders of record on 7th of June. This final dividend brings the total dividend for 2017 to $0.2958 per share, a 64% increase over the dividend paid for 2016. The dividend represents an increase in the payout ratio for the full year from 30% in 2016 to 35% of net profit after tax, which is at the top end of the guidance range provided in August and consistent with the board's aim of continuing to create value for our shareholders. The full-year dividend is equivalent to a dividend yield of 5.5% based on our opening stock price at the beginning of 2018 versus 3.4% for the Hang Seng Index. We ended 2017 with total assets of $16 billion, which reflected our sustained efforts to grow our balance sheet through investment in aircraft. Net book value of our fleet rose by 28% to $13.7 billion compared with 2016, driving growth in our lease rental revenues. We funded our fleet development through a combination of retained earnings and increased leverage with our gross debt to equity rising to 2.9 times at the end of 2017 from 2.6 times a year earlier. We started 2018 with cash and committed liquidity of $4 billion. This positions the company well to fund both our contracted investments in aircraft and to further finance growth in the portfolio. During the year in review, both S&P Global Ratings and Fitch Ratings reaffirmed our industry-leading corporate credit ratings of A-. Turning to the market backdrop, macro conditions remain supportive of the aircraft leasing industry. On the airline demand side, the industry continues to perform ahead of long-term growth expectations with air travel demand remaining robust. Airline passenger traffic, as measured by IATA, the trade association for the world's, rose 7.6% in 2017, above the long-term trend rate of 5%. This saw IATA lift its earnings estimates for 2017 for the airline industry in December of last year by 10% to $34.5 billion. We also saw a continuation of the resurgence in freight activity, which was visible in the first half of 2017, with IATA reporting freight traffic growth of 9% for its members for the full year. The availability of U.S. dollar liquidity remains high. This is partly driving the strong demand of purchases of aircraft with lease attached that we continue to see from aircraft investors. Greater liquidity is also good for the funding side of the business. Long-term interest rates remain low in a historical context, and we took advantage of that throughout the year, raising $2.9 billion in total debt, including our first ever $1 billion dual tranche bond offering. We saw LIBOR rates move up for our floating rate leases, and our LIBOR-based funding cost also increased. Because of our active liability management and hedging policy, there was no adverse impact on our net lease yield. Net lease yield, which captures both the effects of interest rate fluctuations and the competitive lease rental environment, rose slightly to 8.4% for 2017. The supply of new aircraft to the market is tracking demand for both the narrowbodies that account for the majority of our fleet and the new technology widebodies. Supply chain issues are limiting production ramp-up as pressures are evident in a number of areas of the manufacturer supply chain, such as seats and engines. These issues have led to delivery delays affecting the timing of new deliveries to airlines and leasing companies. We have been actively investing in new technology aircraft. Additions to our fleet and the next four years delivery pipeline include A320neos, A350s, A330neos, Boeing 787s, and in July, we were a launch customer for the Boeing 737 MAX 10. For 2017, the board implemented a change in the long-term incentive plan for management, where 50% of future long-term incentives are now to be invested in BOC Aviation shares. The first tranche of shares will be purchased by a trustee in the secondary market beginning in the first half of 2018, following this results announcement. These shares will vest after the third year following their grant. The effect of this change to the long-term incentive plan will be to further align management with the shareholders. I will now hand the call over to David to speak to our operations and business development, and then Thim Fatt will take over for a more detailed review of our P&L and balance sheet. Thank you, Robert. Let me add my thanks to you all for joining us this evening. In 2017, we delivered 74 new aircraft from our order book to airline customers, including three where the customer exercised purchase options at delivery, giving us 71 new aircraft added to our owned portfolio. This compared with 56 new aircraft added to the owned portfolio in 2016. Our total fleet stood at 491 aircraft at the end of 2017, comprising 287 owned and 31 managed aircraft, and an order book of 173 aircraft delivering between now and the end of 2021. Our core lease rental contribution, which is defined as lease revenue less finance expenses and depreciation and amortization of debt issuance and lease transaction closing costs, continues to be the principal component of our pre-tax earnings. This rose over 24% in 2017 and represents a sustainable long-term income stream that recurs across the cycle and which is highly visible given our remaining average lease life of over eight years. This should grow in line with our balance sheet, given the stability of our net lease yield. We are pleased to announce that we had another year of strong portfolio utilization of 99.8%, and in 2017, our collection rate was 99.9%. The average appraised value of our fleet was $15.3 billion on a full life current market value basis at year-end, representing a 12% premium to the fleet's net book value of $13.7 billion. We now have in excess of $15 billion in contracted future lease revenues, a number that moves up as our fleet grows, having risen 24% compared to the end of 2016. Our aircraft portfolio remains one of the youngest in the industry, and the weighted average age of our owned portfolio is now 3 years. During 2017, we extended our average remaining lease term to 8.2 years, and we signed 103 leases with airline customers. In addition, all of our 2018 scheduled deliveries have lease commitments with airlines. We have a regular dialogue with our customers regarding their appetite for the most popular modern Airbus and Boeing models, and we are seeing good lease demand for the aircraft in our order book. In 2017, we generated 56% of our lease revenues out of Asia Pacific, reflecting the more rapid rates of air traffic growth in this region relative to more mature economies. The Americas and Europe still accounted for around 16% and 24% of lease revenue, respectively, and recent transactions with new and existing customers such as LATAM and WestJet in the Americas, and Turkish Airlines, TAP, and Air Europa in Europe, underpin our confidence in our revenue growth in these regions. We sold 30 aircraft from the owned fleet during 2017, compared to 37 aircraft sold in 2016, as we continue to improve the quality of our portfolio. Gains on sale of aircraft accounted for 14% of pre-tax earnings, consistent with our long-term average, but reflecting fewer aircraft sales than in 2016. 2017 was the most significant in terms of fleet growth in the company's history, and we continue to source good opportunities to increase our aircraft investments. With that, I will turn over to Thim Fatt. Thank you, David. Our reported net profit after tax of $587 million for the year rose 40% compared to 2016. Our earnings per share was $0.85 per share, increasing 40% over 2016, based on share outstanding at December 31st in each year. Net assets per share, meanwhile, rose 13% to $5.50 in 2017. The principal driver of the growth in earnings was a 17% increase in total revenue and other income. This drove our core lease rental contribution up by 24% to $542 million, which net of operating costs represented 79% of net profit before tax. Our lease rental income rose 22% compared to 2016, as we increased the size of our fleet, and as higher interest rate lifted our floating rate lease revenues, and as new leases signed on higher fixed rates also contributed to the rise. Pre-tax gain on aircraft sales was $78 million. Interest, fee, and other income amounted to $30 million and comprised 7% of net profit before tax. Depreciation was up 22% compared to 2016, reflecting the growth in the size of our fleet. Finance charges increased by $44 million, driven primarily by an increase in our indebtedness as we lifted our financial leverage and as LIBOR rose. As a proportion of fixed rate leases have increased, we increased the proportion of our fixed rate debt during the year, which also contributed to the increase, lifting our average cost of funds to 2.8% in 2017, up from 2.5% the previous year. Staff costs fell $2 million and represented approximately 5.2% of our total revenue and other income in 2017, down from 6.3% in 2016. There was no increase in employee numbers. Other operating costs in 2017 were $47 million, roughly equivalent to that of 2016, despite the growth of our fleet. Excluding the $91 million adjustment to deferred tax liability in the U.S., our average tax rate fell to 10.1% from 11.8% in 2016. At the end of the year, our total assets increased 19% or about $2.6 billion to $16 billion from the end of 2016. We had capital expenditure of $4.4 billion in 2017, primarily related to our aircraft deliveries, and we are currently committed to aircraft capital expenditure of $2.6 billion in 2018. As in previous year, we expect to build on this number over the course of the year. Our indebtedness increased, rising 24% to $10.9 billion at the end of 2017, reflecting borrowing activity that included our successful bond offering and raised $2 billion under our GMTN program. Now back to Robert for his final comments. Thanks, Thim Fatt. The 2017 year has been the most profitable and the most active in our company's history. Earnings per share rose 40%. Our balance sheet strength and committed future revenues of over $15 billion position us well, and we look forward to delivering another robust performance over the balance of this year. The 64% increase in recommended full-year dividend demonstrates our confidence in BOC Aviation's earnings. The result is a testament to the quality of our team, and I'd like to thank our team for all of their hard work. This year, we look to deliver more growth as we celebrate our company's 25th anniversary. This concludes our review of the industry, our company's financial, and our outlook, and I'll pass the call back to Timothy. Thanks, Robert. This wraps up management's formal commentary. We now have time for Q&A and request that each participant restrict themselves to one question and one follow-up, unless time permits for additional queries. I'll hand the call back to the operator for the Q&A session. Thank you. We will now begin the question and answer session. If you have a question to raise, please press 01 on your telephone keypad now. Once again, please press 01 on your telephone keypad now. Our first question today, we have Vincent from Goldman. Please go ahead. Hi, evening. Thanks, Robert and team. This is Vincent and Ben calling from Goldman Sachs. Just two quick questions, basically they're related. Earlier, Robert, you mentioned that it was the active hedging policy that allowed the company to keep interest rate at 2.8%, similar to first half of the year, despite the rising market rates. This allowed us to achieve a relatively high net lease rate of 8.4%. How should we think about net lease use going forward? I guess it's really a question of an update of the competitive dynamics in the leasing market. Okay. Well, first of all, thanks for the question. If you look back over the last five years, we've maintained a net lease yield of between 8% and 8.5%. We don't just look at the revenue environment here. We also look to take cost out, particularly on refinancing debt. We actively did that last year, and I can assure you we're actively doing that this year as well. We would aim to still be within that range. Right. Can you give us an update of the competitive dynamics in the leasing market, as of what you're seeing? Yeah, no problem. past few quarters? The first thing is, when you think of net lease yield, you must remember it's on our whole portfolio. So actually the incremental transactions that we add to the portfolio, probably only about 20% of the balance sheet each year at most. And so remember, we've got 8 years remaining on most of our leases. So actually for 80% of our balance sheet, it stays constant and actually the yield slightly increases each year as we depreciate the assets. Okay. So that's what gives us confidence. We already have visibility of what's going to go on the books in 2018 because 100% of our aircraft delivery in 2018 have been placed. So the only way in which competition affects that really is to do with incremental purchase and leaseback type business that we would do this year. I think as you've heard from us before, we're pretty disciplined as to what we add to the books. We're not interested in adding low-yielding asset to the books, in terms of purchase and leaseback business. So that's what gives us confidence we should still be in that range. Now, the competitive environment, as we move into 2019, 2020, 2021, the number of lessors on the Boeing and Airbus A320neo and 737 MAX programs do increase. But at the same time, we have plans to keep ETA at our cost base at the same time. And so the key thing is to deal with both sides of the P&L, the revenue side and the cost side. Right. Thank you very much. Yep, no problem. Thank you. Our next question, we have Edward from Morgan Stanley. Please go ahead, sir. Thank you. Hi, Robert and team. This is Edward from Morgan Stanley. I have two questions. One is regarding your sale of aircraft, because we found that in first half, actually, the net gains on sales of aircraft increased. But in second half, it actually decreased and also below our expectation. Just want to know why. Is there any delay of the disposal, and what is the plan for 2018? The second question is just regarding your cost, because what I found, your staff cost actually controlled very well. It declined and also below our expectations. Can you give us further color on the staff cost? Thank you. Okay. First of all, let us talk about sale of aircraft. You will see variations between half years on sales of aircraft because it depends what we are selling. What is determined by that is, the aircraft type we may be selling, the length of lease term remaining, and of course, obviously, investor appetite for that type of aircraft. For last year, in the second half of the year, we are moving on some of the more difficult assets into the market. That is why you may have seen some of the gains being relatively lower than in the first half. For this year, we have got a very clear sales plan. Number one on the sales plan was we wanted to exit our remaining E190 investments, which I can tell you we have done as of the end of February. In addition to that, we're continuing to work away at some of the aircraft with shorter lease terms remaining. Remember, we have a policy of not wanting planes left in the portfolio of older than 10 years, and aircraft that we think where the residuals may be more under pressure looking forwards than the average. That's really the sort of the forward look. Turning to staff costs, there's a number of things at play in staff costs. The first thing is we didn't increase our headcount last year. It actually reduced, I think by one, if I remember correctly. That was one of the reasons. Second thing is, going forwards with us moving on to the share-based scheme, you will see that element of our staff cost going forwards being spread over the three-year period of the share scheme, while the shares are held in trust for the company, which will give you a slight reduction in the staff cost in the two early years of the scheme. So you can expect that to impact this year as well. But we want a company that's performing, and so we want our employees to do well. We intend to pay bonuses. As you can see, this year was a good year, and so the employees will be adequately rewarded related to that performance this year. Okay. Thank you. Yep. Next in line, we have Eric from UBS. Please go ahead. Hi. Good evening. Congrats on the strong performance. Actually, my questions have been addressed, but, if you don't mind, I ask a small follow-up. The first one is still regarding the sale of aircraft for 2018. Given you have a clear plan for the year, how shall we look at your income from sales of aircraft versus your historical average? Is it going to track in line with historical average? That's my first question on sale of aircraft. Then the second question is regarding the new aircraft to be delivered, 53, as you have guided, in the presentation. What is the expected, CapEx equivalent for that in absolute dollar amount? Thanks for that. Okay, let me answer the second one first. We've already given you the CapEx amount in the presentation, which was $2.6 billion. Okay? Now, on top of that, we aim to add other aircraft this year as well. If you look back as last year as a guide, during the year, we added about $1.5 billion of CapEx above that we had in place at the start of the year. So we hope to see that number increase during the year as new transactions come in. We're working on a number of transactions at the moment. Going back to sale of aircraft, there's always two elements to consider when we're talking about sale of aircraft. The first thing is the net gain on sale that will pass through a P&L, and the second thing is the loss of the core lease rental contribution in relation to selling the aircraft. So if you sell an aircraft, let's say on January 31st, you'll lose 11 months of core lease rental contribution. So what we're always looking to do is optimize our overall return from owning any particular aircraft and when we exit that aircraft. If I look at this year, I think it's probably going to be split half-half between the first and second half, and our aim is to sell somewhere just under 30 aircraft this year. That's very clear. Thank you. Okay. Next in line, we have Aaron Toh from BOC International. Please go ahead, sir. Thank you. Congratulations on the very strong results. Here I've got one question about the tax you said from the US tax cut. I understand there will be a huge gain this year. Going forward, how will it impact the effective tax rate of our company, like the subsidiaries in the United States? Thank you. First thing I would say is, obviously, the reversal of the deferred tax liability, that's looking backwards. Looking forwards, aircraft that we have booked in our U.S. subsidiary will now be attracting a lower tax rate. Maybe Thim Fatt, do you want to just comment on that? Yes. Going forward for 2018, since we have reversed the deferred tax liability, going forward, it will be taxed on current income on our U.S. subsidiary. Obviously, the rate is now 21% instead of 35%. How much it reduce will depend on my revenue and how many aircraft I sell during the year. Okay. Thank you. Yep. Next question. Our next question, Gavin from Daiwa. Please go ahead, sir. Hi. Thank you for taking questions. First, I would like to ask two questions. One is about the purchase and leaseback, how much amount do you expect? Do you expect similar amount like last year? Also 2020, I see the delivery actually down to 26 aircraft only. Should we expect some number to be picking up close to 53? Final question is on the dividends, because this year probably is your kind of anniversary year, would you expect to raise the payout further? Thank you. Let me answer the last one first. We already have just raised the dividend for the anniversary year. We were formed on November 25, 1993. We have already started the 25th year. Do not expect any other special dividend, if that was your question. In terms of purchase and leasebacks then for this year, it is our target to do around another $1.5 billion. Our sales team are in discussions on that at the moment. In relation to 2020, you are correct. It will be our intention to smooth out our deliveries profile and gradually increase the numbers delivering in 2020 up to around the same numbers as we have this year and next year. Okay, thank you. Yep. Our next question, Jackie from Deutsche Bank, please go ahead. Hi. Thank you for giving me the chance to ask questions, and congrats on the results. First one is on the leverage. I think we guided 3.5x leverage by end of 2018. Are we still to that leverage? Are you still comfortable with that leverage target? Second question is regarding to our fixed rate assets. I saw we have like 66% of fixed rate assets versus 47% fixed rate borrowing. I saw there is one or $1.2 billion gap there. Do you see we will raise our fixed rate proportion in the future? Do you see rate hike impact on this, on our net lease yield because of the gap? Thank you. Okay. Let me answer your last question first, if I may, Jackie, because I've got those numbers in my head. Sure. Since year-end, we've done two things that have raised the hedging on the fixed rate portfolio. The first one is, you may have seen, we did a $300 million fixed rate bond issue in January. The second thing is we've also taken out a number of hedges, fixed rate hedges, on another $300 million of debt. After the year-end, you will see that increase. In terms of the overall leverage, we are moving towards the 3.5. Whether we get there this year, frankly, depends on the amount of additional balance sheet business we do this year. We're still very comfortable with that number. In our discussions with the rating agencies, they're comfortable with us going to 4 to 1 and maintaining our credit ratings of A-. We don't see that as being an issue. We are planning to get towards that 3.5 as soon as we can see assets that give us the correct return. Thank you. Our next question comes from Ajith from UOB Kay Hian. Please go ahead, sir. Hi, Robert. Thanks for taking the call. I've got two or three questions. First, regarding the CapEx. The guidance as per the results release was about $2.6 billion, and subsequently, you mentioned that it could be higher by about $1.5 billion or so. Are we to take it as it's going to be somewhere in the range of $4 billion or so for the- Yeah, I think it's a working assumption. You can work on that. This, just to give you an idea, Ajith, this just follows what we did last year, where we started the year at one number, and we added about $1.5 billion during the year. It's achievable. We've done it before. I see. Okay. Second question is regarding the aircraft deliveries. In 2017, you took about 34 aircraft, and for 2018 now you're guiding for 53. It is a reduction. You also mentioned that you'll be doing lower PLBs. It seems like it's a substantial reduction in total fleet deliveries for 2018. Is there any particular reason for the- You need to add in the $1.5 billion. If you were to say $50 million per plane on average, that will be another 30 aircraft. I see. Okay. Okay. That's where the difference is. Okay. All right, great. Thanks, Robert. Okay. Many thanks. Thank you. Okay, operator, I think there doesn't seem to be any more questions in the queue. We would like to thank everyone very much for coming onto the call, and feel free to let Tim Ross know if you have any more questions. With that, we will finish the call, and thank you very much, everyone, for your time. It is much appreciated. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.