Earnings Call: H1 2017

Aug 28, 2017

Gentlemen, welcome to BOC Aviation's interim results earnings call for the six months ended 30th June 2017. Timothy Ross, Head of Investor Relations, will now begin. Thank you, operator, and welcome everyone to BOC Aviation's earnings call to discuss our interim results for the six months ended 30th of June 2017. With me today are our Managing Director and Chief Executive Officer, Robert Martin, our Deputy Managing Director and Chief Financial Officer, Phang Thim Fatt, and our Chief Operating Officer, David Walton. Please note that some of the information you will 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 USD only. A copy of our earnings announcement is available both via 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 investor 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 will now turn the call over to Robert Martin. Thanks, Tim, and good evening to everyone on the line. Thank you for joining us for our 2017 interim earnings call. Today, we are presenting our second interim results since the IPO in June 2016, and have produced another record earnings. Achieving the highest profit in any six-month period in our company's history. We are delighted to report a net profit after tax of $240 million for the first half of this year, up 13% on last year's first half, and equivalent to earnings per share of $0.35 based on number of shares outstanding at 30th of June 2017. This was achieved on total revenues and other income of $670 million that rose 16% compared to the first half of last year. In light of our strong performance, our board has decided to declare a dividend of $0.1038 per share, compared with $0.061 per share paid for first half of 2016, and which will be payable to shareholders who own shares on 25th of September. This represents an increase in the payout ratio of the interim dividend to 30% of first half net profit after tax, compared to 20% in first half 2016. We are also delighted to report that our board has changed our dividend policy to give the board flexibility to increase the dividend payout to up to 35% of net profit after tax for the full year. These changes demonstrate the board's confidence in the profit and cash flow generation of the business and the board's commitment to deliver a combination of earnings growth and dividend yield to our shareholders. We ended the first half with total assets of $14.4 billion, which reflected our sustained efforts to grow our balance sheet through investment in aircraft. Net book value of our fleet rose by 25% to $12.1 billion compared with June 2016, and is up over 13% since the end of 2016. We funded this through a combination of retained earnings and increased leverage, which saw gross debt to equity rise to 2.7 times from 2.6 times at the end of last year. Our cash and fixed deposits at the end of the period totaled over $330 million, down from $558 million at the end of last year, as we deployed proceeds from our successful debt and equity capital raises into our delivery pipeline. We have additional committed liquidity of over $4 billion in undrawn and committed credit facilities. This positions the company well to fund both our contracted investments in aircraft and to further finance growth in the portfolio. During the period, S&P Global Ratings and Fitch Ratings both reaffirmed our industry-leading corporate credit ratings of A-, both rated our recent unsecured debt offering as A-. We are pleased to announce that we have had another half year with strong portfolio utilization, and we ended the period with zero overdue trade receivables. As at the half year, the average appraised value of our fleet was $13.7 billion on a full life current market basis, representing a 13% premium to the fleet's net book value of $12.1 billion. Our aircraft portfolio remains one of the youngest in the industry, and the weighted average age of our own portfolio is now 3.1 years, with no aircraft in the fleet older than 10 years. 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 run growth expectations, with air travel demand remaining robust. Airline passenger traffic, as measured by IATA, rose 7.9% for the first six months above the long-term trend growth of 5%. This saw IATA lift its earnings estimates for 2017 for the airline industry in June by 5% to $31.4 billion. Geopolitical issues may have some short-term effect on pockets of regional demand for air travel. However, the fundamentally robust growth characteristics of our business remain unchanged. We have also seen a pickup in freight activity over the past year, with IATA reporting freight traffic growth of 10.4% for its members during the first half of 2017. We have a regular dialogue with our customers regarding their appetite for the most popular modern Airbus and Boeing models, and we're seeing good demand for both aircraft types. In the first half, 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 23% of lease revenue respectively, and recent transactions with new and existing customers such as TAP, LATAM, Monarch, and Air Europa underpin our confidence in our revenue growth in these regions. The availability of USD liquidity remains high. This is partly driving the strong demand for purchases of aircraft with lease attached that we continue to see from aircraft investors. Growing demand has supported our aircraft sales program as more new investors continue to enter the market. 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 in the first half of the year, closing a five-year, $500 million bond deal at the lowest spreads above benchmark rates in our history. We did see LIBOR rates move up for our floating rate leases in the 6 months to 30th of June, with LIBOR movements flowing through both sides of our profit and loss account. Our funding costs also increased, but because of our active liability management and hedging policy, there was no impact on our net lease yield. Net lease yield, which captures the effects of rising interest rates and the revenue environment, remained at 8.5% in the first half of 2017, similar to last year's levels. The supply of new aircraft to the market is tracking demand for both the narrow bodies that account for the majority of our fleet and the new technology wide bodies. Supply chain issues are limiting production ramp-up, as pressures are evident in a number of areas of the manufacturer's supply chain, such as seats and engines. Elsewhere, we've been actively investing in new technology aircraft. Additions to our fleet and next 5 years' pipeline of deliveries include A320neos, A350s, A330neos, Boeing 787s, and recently 10 Boeing 737 MAX 10s. At management level, we're pleased to welcome Mr. Wang Jian, who succeeds Mr. Wang Genshan as Deputy Managing Director and as Vice Chairman of the Board. The board has also implemented a long-term incentive scheme for management from 2017, where 50% of future long-term incentives are to be invested in BOC Aviation shares, which will be purchased by a trustee in the secondary market. These shares will vest after the third year following their grant. This will further increase alignment between our shareholders and our management team. I'll now hand the call over to David Walton to speak to our operations and business development, and then Phang Thim Fatt will take over for a more detailed review of our P&L and balance sheet. Thank you, Robert, and let me add my thanks to you all for joining us this evening. In the first half of 2017, we delivered 37 new aircraft from our order book to airline customers, including 3 where the customer exercised purchased options at delivery, giving us 34 new aircraft added to our owned portfolio. This compared with 21 new aircraft added to the owned portfolio in the first half of last year. 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 18% in the first half of the year and represents a sustainable long-term income stream that recurs across the cycle, which is highly visible given our remaining average lease life of nearly 8 years and which should grow in line with our balance sheet. We have almost $15 billion in contracted future lease revenues, and we are confident of collecting these based on strong airline cash flows. During the first half, we extended our average remaining lease term to 7.8 years. We signed 55 leases with airline customers, and we have also placed all of our 2017 scheduled deliveries with airline customers. As of today, we have also placed over two-thirds of scheduled deliveries in 2018, providing us with a strong near-term pipeline of core lease rental contribution. Turning to used aircraft, we have placed all remaining aircraft coming off lease in 2017. We sold 19 aircraft from the owned fleet during the first half of 2017 compared to 22 aircraft sold in the first half of last year as we continue to improve the quality of the portfolio. Gains on sale of aircraft accounted for close to 18% of pre-tax earnings, consistent with our long-term average and ahead of last year's 16%. We sell aircraft generally with leases attached across the cycle, although the volume of transactions typically increases during such high periods of USD liquidity as we are seeing right now. Our total fleet as at 30 June stood at 493 aircraft, comprising 261 owned and 36 managed aircraft and an order book of 196 aircraft delivering between now and the end of 2021. Since the end of June, we have committed to a further 10 737 MAX 10 aircraft for delivery in 2021. The second half of this year will be our most active in terms of order book deliveries in the company's history, with 41 aircraft scheduled for delivery into our owned portfolio, and we continue to source good opportunities to further increase our aircraft investments. With that, I will turn it over to Phang Thim Fatt. Thank you, David. Our reported net profit after tax of $240 million for the six months ended June 30, 2017, rose 13% compared to the same period last year. The principal drivers of the growth in earnings were a 16% increase in total revenue and other income. This drove our core lease rental contribution up by 18% to $259 million, which net of costs represented 76% of net profit before tax. Our lease rental income rose 18% compared to first half 2016, as higher interest rates lifted our floating rate lease revenue, and as new leases signed on higher fixed rate also contributed to the increase. This was partially offset by the reduction of rental from aircraft sale with leases attached. Pre-tax gain on aircraft sale rose 28% from the same period last year, as we were active seller of aircraft. Interest and fee related income, which comprised 5% of our net profit before tax, fell 45% compared to the same period last year on account of a decline in fees for advancing aircraft progress payment and lower interest income on account of last year high cash level, reflecting proceed from our IPO and debt offerings. Depreciation was up 16.8% in first half 2017 compared to first half 2016, reflecting the growth in the size and value of our fleet. Finance charges increased by $90 million, driven primarily by an increase in LIBOR. The same LIBOR increase that positively impacted our floating rate lease revenue. Our long-term funding strategy, under which we increased the proportion of fixed rate debt during the first half, also contributed to the increase, lifting our average cost of funds to 2.8% in first half 2017 from 2.3% in the same period last year. Staff costs were largely flat and represented approximately 4.8% of total revenue and other income in the first half of 2017, slightly down from 5.5% in first half 2016. Flat headcount and changes to the accounting of management incentive plan offset the effect of annual salary adjustments. Other operating costs increased 8% from first half 2016 to $22 million, lower than the growth rate of our fleet and reflecting management efforts to reduce controllable costs. Our average tax rate fell to 10.6% in first half 2017 from 11.4% in first half 2016. Our earnings per share was $0.35 per share for first half 2017, increasing from $0.31 in first half 2016, based on share outstanding at June 30 each year. Net assets per share meanwhile rose 5% to $5.10 per share as at June 30, 2017 from $4.87 per share at the end of last year. At the end of this half-year, our total asset had increased 7% or about $1 billion to $14.4 billion from the end of 2016. For the first half of the year, we had capital expenditure of $2.1 billion related to our aircraft deliveries. As at June 30, we had committed capital expenditure of $1.9 billion for the second half of this year. Our indebtedness also increased, rising 9% to $9.6 billion as at June 30, 2017 compared to end 2016, reflecting the borrowing activity, including our successful $500 million bond raised under our GMTN program. BOC Aviation's funding resources and balance sheet structure positioned it to both grow the business soundly in the prevailing operating climate and to capitalize upon any opportunistic investment that may arise in the future. Now back to Robert for his final comments. Thanks, Tim Fat. The first half of 2017 has been our most profitable and most active six months in our history. With 41 aircraft scheduled for delivery in the second half, this promises to be equally as exciting. Our balance sheet growth and committed future revenue position us as never before, and we look forward to delivering another robust performance over the balance of this year. The 70% increase in first half dividend of $72 million compared with $42 million for the same period last year demonstrates our confidence in BOC Aviation's earnings and cash flow power. This wraps up our review of the industry, our company's financials, and our outlook. I will pass the call back to Timothy. Thanks, Robert. This concludes management's formal commentary. We have now 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 hand the call back to the operator for the Q&A session. Thank you. We will now begin the question and answer session. Participants with questions to pose, please press 01 on your telephone keypad and you will be placed in the queue. To cancel the queue, please press 02. Once again, 01 on your telephone keypad now. Our first question, Dan from Goldman Sachs, please go ahead. Hi. Thanks very much for doing the call today. Just wanted to ask a little bit more about the dividend and your gearing. The gearing has not gone up too much in the first half. I think it is 2.7 times. The target, I think, is still 3.5-4 times. I think even in my model with pretty aggressive CapEx, and even a higher dividend payout, we probably don't get to 3.5 times. I'm just wondering, what could happen there? Does it mean that you can potentially accelerate CapEx, or can dividends go up further from here? Or am I missing something else where perhaps, sales of aircraft are not as big as we expect? It would be great to have some flavor on that. Thank you. Okay. Thanks for the question. It's Robert here. Okay, so first of all, dividends. The first thing to reiterate is we've increased the first half dividend from 20% to 30% of the interim NPAT. The second thing is we've indicated to guidance that the board today agreed that for the full year, we would look to increase the dividend up to 35% of the full year NPAT. Basically, when we talk about gearing, obviously the first thing to do after we had the IPO was deploy the cash that we had sitting on our balance sheet. If you remember, during Phang Thim Fatt's portion of the feedback from management, he talked about the high cash balances that we had in June 2016. Last year, we were focused on putting that money to work. Putting money on deposit with banks doesn't help us. We want to put it to work to make a decent return. That was our first job. We did that during last year, and then this year, we're gradually now beginning to increase the gearing. We have a plan. Obviously this year, if you look at this year, we're going to be close to 80 aircraft by the time we get to the end of the year. We were hopeful we were going to do 80, although because of the engine issues at Airbus in particular, a couple will look as if they're going to slip over the year-end. We can easily do that number again next year. Some of the deals that we mentioned that are in the pipeline, TAP, Air Europa, these involve wide-bodies where we've done pre-delivery financing and post-delivery financing. When you do your numbers, remember to include both narrow bodies and wide bodies in our CapEx. Okay. Hopefully that gives you a bit of flavor on where we're going. The 3.5, just to be clear, we're talking is at the end of 2018. Okay, great. Thank you. Just on the widebody issue, if I can follow up. Is the guidance for the balance between widebody and narrowbody still standing in terms of 70/30 kind of split? Obviously with the Turkish deal and Qatar, you are doing quite a few widebodies in the second half. Great. If you look at the portfolio as a whole, we are going to be around about 70/30. We may blip over that for periods of time. Maybe it will go as far as 60/40, 60% narrowbodies by book value, 40% widebodies. But that is the type of area we intend to be in. Okay, great. Thank you very much. Thank you. Our next question, Eric Lin from UBS. Please go ahead. Hi. Good evening, everyone. Thanks for taking my question. I have one question regarding your floating rate exposure, actually on your slide 10. Can you talk a little bit about your 70% hedge on that floating interest rate exposure and, again, the sensitivity? My impression was that last time when you had the same briefing, the hedging ratio was higher, with a lower sensitivity. Just to clarify on that point, am I correct? Of course, if there's any color you can shed on this point, that would be great. Thank you. Okay. Pang here. I will answer this question. If you look at- Thank you. page 10, you will see that while our fixed rate leases has increased, we also increased our fixed rate debt. So the difference is the exposure, and currently as at 30th June, we are 70% hedged. Now, if you compare with last year, you mentioned that it's lower. Our policy is to have a minimum hedge of 50%, and between periods, as some of the hedges expire or we increase our fixed-rate debt, this proportion will vary. This is Robert. The other thing I would add is, bear in mind, we tend to add most of our fixed rates when we do bond issues. The bond issues tend to be a little lumpy. So you will see some variability between six-month periods. Okay. Thank you. Understood. That's clear. Thank you. Thank you. Once again, participants with question to pose or to follow up, please press 0101 on your telephone keypad now. Our next question, Edward Shi from Morgan Stanley. Please go ahead. Hi, everyone. Good evening. I just have one question. Now, how do you look at the industry cycle? Because right now we see that Cathay Pacific, which is a major customer for BOC Aviation, had significant losses in first half, and they expect a pretty gloomy outlook for the next six months or so. Do you see any oversupply of capacity in this industry? Thank you. Okay. Thanks for the question. It's Robert. Firstly, bear in mind, everyone, we are always maybe individual carriers that have a particular issue, but this year will still be one of the three most profitable years in history, the other two being 2015 and 2016. We don't think it will be quite as profitable on a global basis. IATA is indicating about $31.4 billion, if I remember correctly, on the total profitability for this year. But it's significantly above what we're seeing pre-2013. That's the first point. Second point is, bear in mind, we are a senior unsecured creditor of our airline customers. We are not an equity holder. We are taking cash flow risk on our airline customers. Around the world, there are roughly 800 airline customers around the world. We focus on the roughly 140 of those who are more creditworthy and have more than 20 planes, where the default risk is a lot lower. If you look around at our history over going back to even when the company started, we've only ever had to repossess 32 planes. Providing your risk management is right and you're carefully analyzing the cash flows, you should get the right result in terms of cash collection, and you will see we had 100% cash collection effectively in the first half of this year. In terms of cycle, because I've now answered your fourth question, let me just finish. As we go through this year, a couple of things have struck us as a management team. One is, we think U.S. dollar interest rates aren't going to rise as quickly as we may have thought at the start of the year. Going forward, the number of Fed hikes, maybe one more this year, a couple next year at most, maybe even only one next year. Certainly, the long end of the U.S. dollar curve is not going up as fast as we may have originally anticipated. I think we're going to end the year definitely still in the 2s and maybe below 2.5 for the 10-year treasury rate. All of that, the benign interest rate environment, the benign fuel price environment, is good, obviously, for our airline customers. We are not seeing wage inflation pick up significantly in the industry at this point. As far as the credit of our customers goes, this year certainly will continue to be a good year absent a shock to the system. We expect that next year, the building block's already there for next year to be a reasonable year as well. Okay. Thank you. Thank you. Our next question, Paul from DBS, please go ahead. Hi. Good evening, gentlemen. Thanks for hosting the call and congratulations on a good set of results. My question revolves around the impairment charges that we saw this first 6 months of about $11 million. Could you give us some color on what the other, I think it was 5 of the aircraft is the Embraers, and what are the other 3 aircraft, and could you provide a little bit more color on those and expectations for impairment charges, if any, going ahead? Thanks. Yeah. Okay. First of all, a reminder to everyone, if you look back over the last 23 years, the total impairments that we've had in the company equate to less than 0.1% of our net book value of our aircraft. Managing our aircraft cost is one of the most important things we do in the business, and we take it very seriously. Now, when we look at what we impaired at the half year, we'd set ourselves a strategy of effectively trading out of our E190s over the next couple of years. We trade out a sixth in the first half of this year. When we sat back and looked at this as a management team, we decided to be prudent in terms of the 5 ones that remain on the balance sheet because we do intend to trade out of them in the next couple of years. That is the first point. The second thing is, the other impairments were just specific situations on individual aircraft rather than aircraft types generally relate to specific transactions. In one case related to one A330 that we are trading out in the second half of the year, and that was probably the lion's share of the balance. Generally, when we looked at the impairment review, as you can see from the hidden value in the balance sheet, we still have roughly a 13% hidden value in the portfolio as a whole. Hopefully, Paul, that answers your question. Yeah, that helps. Thanks. Yeah. Thank you. There are currently no questions in queue. Once again, participants with question to pose or to follow up, please press 0101 on your telephone keypad now. Our next follow-up question, Eric Lin from UBS, please go ahead. Hi. Thanks. It is Eric Lin again. I understand you do not give specific guidance, but any sort of color or flavor on your plan for aircraft disposal in the second half will help. In particular, just now you talk about, Robbie just talked about this remaining E190 will basically retire from fleet in the next couple of years. Are there going to be any ones going out in the second half this year? Okay. The way we do this is we set up a budget for each year for selling aircraft. We are just over halfway through the number of aircraft that we are going to sell this year. I think we are probably about 60% in terms of numbers that we intended to sell, and that will give you a rough idea of how many we are planning to sell. Our focus this year is on the smaller narrowbody types. We look at some 737-700, A319, E190s. We have made some good progress already, and we will always be looking to trade out some of the weaker lessee aircraft out of our fleet to keep the average credit quality strong. I see. If you do not mind, as a follow-up on the previous question. One of the impairments you have in the aircraft is actually a widebody, A330s. How do you see the widebody market, in terms of value in general? Is there continuous pressure you are seeing? No, I think is the word. The way that we approach the widebody market may be quite different from some of our competitors. Our approach to the widebody market is we will only really do widebodies where we can lock in at least a 12-year lease on the other side of it. We do back-to-back deals, which mean we do not tend to take placement risk, even for new widebodies. That is why you tend to find on the widebody side, we always have a very long-term lease remaining. In the first half of this year, we were even pushing some of these lease terms out to 15 years. That is the way, obviously, you want to make sure you have cash flow coming in on a contracted basis as long as possible. That is part of the reason why our average lease term remaining has increased, whereas most of the market has moved in the opposite direction. I see. That's great. Very helpful. Thanks. Thank you. Our next question, Jackie Cho from Deutsche Bank. Please go ahead. Good evening, everyone. I got a question regarding to the aircraft delivery delay. I saw in the financial statement that we mentioned, probably two A320s will be delayed from this third quarter to next year. From fourth quarter. The impact is- From fourth quarter, not third quarter, just to be clear. Okay. Yeah. Sorry. Any more delays we expected for now? I guess we have probably more than 10 A320 delivered in this year. What's the impact on the financial? Thank you. Okay. Let me give you our experience for the first half. On our own order stream from Airbus, we had one A320neo that slipped from the first half into the second half. That was a delay of about two months, and that was due to the fairly well-publicized Pratt & Whitney issues. In the second half, we don't have any Pratt & Whitney powered aircraft delivering. All of ours are CFM on the neo side. We're seeing sort of up to a month's delay, so that's why we've seen a couple slip over the year-end. But we're not seeing significant delays on those deliveries. Where we have seen delays on the 350 side, we were hopeful to get at least the lion's share of the six A350s doing PLBs on done in the first half. All of them have slipped to the second half. That's where we've seen a significant delay. But in the accounts you've seen, that's already taken into account. In terms of further A320neo delays, we had a meeting with procurement this morning. We're not seeing any yet. But if I'd have said that at the start of the year, things happen, and you can never guarantee they're not going to happen. For the Pratt & Whitney deliveries that we have first half of next year, in our own planning, we're building in a 3-4 month delay, and we have, I think, a couple of those next year. Yep. Thank you. Thank you. Our next follow-up question, Dan from Goldman Sachs. Please go ahead. Hi. Thanks for taking another question from me. I just want to ask a little bit, probably a follow-up to Eric's question on the disposals. I know asset held for sale has gone down significantly for the first half. Just wondering, the implications of that, sales will be less, or is it just that visibility is lower and you'd still be expecting similar sort of sales of aircraft for the next 6-12 months? Thank you. Okay. I wouldn't read anything into assets held for sale at all. That's just a short-term timing issue when a deal just happens to fall over a half-year period. I wouldn't read anything into that whatsoever. In terms of our execution on sales, I think we're going to be fairly light during the third quarter, but a lot of activity in fourth quarter. The reason for that is, I'm afraid a lot of the investor markets just closed down in July and August while they all go on holiday, and they come back in September and basically then sort of realize they've got to hit their budgets by the end of the year. You tend to get your LOIs signed up in September, and we reckon it takes somewhere between 10 to 13 weeks then to basically get your deal closed from the time an LOI is signed. Okay, great. Am I right to assume that the number of aircraft sold will go down from here, given your sort of cleanup of the books over the last few years? If I'm looking forward to 2018, 2019. You're talking about numbers of aircraft, are you? Yes. Well, I guess amount is- Okay, because there's two ways to look at it. One is in terms of numbers of aircraft, the number is in terms of the net book value, because the net depends on the mix between narrowbodies and widebodies that we're selling. You can assume over the medium term, we will sell in line with the split in the portfolio between narrowbodies and widebodies. I think that's a fair assumption. In terms of numbers, I think if you use the first half of this year a guide, it's not going to be far off that. Okay, great. Thank you. The first half of last year, there was specific reasons why we traded more, and that was because we wanted to sell out all of the aircraft that were older than 10 years old. That job has now been done, so we don't have to repeat that again. Okay, so we're now to a more normal trading cycle. Okay, great. Thanks. Thank you. Once again, participants with question to pose, please press 0101 on your telephone keypad now. As there are no further questions, I will now hand the session over to Timothy Ross. Please go ahead, sir. Thank you, operator, and thank you everyone for dialing in. Please feel free to follow up with me directly, should you have any questions following this call. You have my contact details, and they are at the bottom of all of our collaterals. Thank you once again, and have a good evening. Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.