Earnings Call: H1 2018

Aug 15, 2018

Ladies and gentlemen, welcome to BOC Aviation's 2018 interim earnings call. Timothy Ross, please begin. Thank you, operator, and welcome everyone to BOC's earnings call to discuss our interim results for the half year ended June 30, 2018. 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'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 in full details. Please also note that all currency references are in U.S. dollars only. A copy of our earnings announcement is available both via the Hong Kong Stock Exchange and in the investor section of our website at www.bocaviation.com. A conference call presentation is available also 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 to provide an overview of our business and strategy. Thanks, Tim, and good evening to everyone on the line. Thank you for joining us for our 2018 interim results earnings call. We're delighted to report a net profit after tax of $297 million for the first half of the year, up 24% on the first half of 2017 and equivalent to earnings per share of $0.43. Our earnings were driven by growth in our revenue and our aircraft assets. Total revenues and other income rose 23% compared to first half 2017, and the net book value of our fleet rose 18% to $14.3 billion compared with June 2017. In light of our robust earnings performance, our board has declared an interim dividend of $0.1284 per share, payable to shareholders of record on October 5. This interim dividend represents a 24% increase over the dividend paid in the first half of 2017 and is consistent with last year's distribution pattern, namely an interim payout ratio of 30% of first-half NPAT. The company's policy remains to make a total annual dividend payment of up to 35% of full-year net profit after tax. We ended the first half with total assets of $17 billion as we continued our efforts to grow our balance sheet through investment in aircraft. We enter the second half of 2018 with cash and committed liquidity of $3.9 billion. This positions the company well to fund both our contracted investments in aircraft and further growth in the portfolio. During the period in review, both S&P Global Ratings and Fitch Ratings have reaffirmed our industry leading corporate credit ratings of A minus. Turning to the market backdrop, despite some potential headwinds, macro conditions remain broadly positive for the aircraft operating leasing industry. On the airline demand side, traffic continues to perform ahead of long-term growth expectations, with air travel remaining robust. Airline passenger traffic, as measured by IATA, the trade association for the world's airlines, rose 7% in the first half of 2018, above the long-term trend rate of 5%. Freight activity remained high, with IATA reporting freight traffic growth of 4.7% for its members for the first half. However, looking forward, some airlines will be impacted by rising interest rates and fuel prices, the effects of currency volatility, and the revenue impact from delayed delivery and introduction of new technology aircraft. This saw IATA reduce its earnings expectations for 2018 for the airline industry in June to $33.8 billion. This number still represents the industry's fourth-best earnings period ever. The availability of U.S. dollar liquidity remains high. This is partly driving the strong demand for purchase of aircraft with leases attached that we continue to see from aircraft investors. Greater liquidity is also good for the funding side of the business, and long-term interest rates remain low in a historical context. We saw LIBOR rates move up for our floating rate leases and our LIBOR-based funding costs also increased. There was no adverse impact on our net lease yield due to our active hedging policy. Net lease yield, which captures both the effects of interest rate fluctuations and the competitive lease rental environment, remains stable at 8.5% for first half 2018. The supply of new aircraft to the market is barely keeping pace with demand for both narrow bodies and new technology wide bodies that account for the majority of our fleet. Capacity utilization, as measured by IATA passenger airline load factors, have been pushed up to record levels. Supply chain issues have visibly limited production ramp-up, with pressure evident in a number of areas of the manufacturer's supply chain, including at all of the engine manufacturers. These factors continue to limit timely aircraft deliveries to airlines and leasing companies. We've been actively investing in new technology aircraft with A320neo, 737 MAX, A330neo, 787, and A350 aircraft representing over 95% of our order book. In 2017, the board implemented a change in the long-term incentive plan for management, where 50% of future long-term incentives are to be invested in BOC Aviation shares. The first tranche of shares was purchased by a trustee in the secondary market following our 2017 results announcement in March this year. These shares will vest after the third year following their grant and marks part of our commitment to align management with 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. David. Thank you, Robert, and let me add my thanks to you all for joining us this evening. In the first half of 2018, we delivered 27 new aircraft from our order book to airline customers, including one where the customer exercised a purchase option at delivery, giving us 26 new aircraft added to our owned portfolio. Our total fleet stood at 487 aircraft at the end of June 2018, comprising 295 owned and 29 managed aircraft, and an order book of 163 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 20% in the first half of 2018 to $312 million and represents a sustainable long-term income stream that recurs across the cycle, given our average remaining lease term of 8.3 years. We continue to have close to $15 billion in contracted future lease revenues, similar to levels at the end of June 2017. We are also pleased to announce that we had another half year with strong portfolio utilization of 100%, and in the first half of 2018, our collection rate was 99.5%. The average appraised value of our fleet was $15.9 billion on a full life current market value basis, representing an 11% premium to the fleet's net book value of $14.3 billion. We sold 18 aircraft from the owned fleet during the first half, similar to the 19 aircraft sold in the first half of 2017. The weighted average age of our owned portfolio is now three years and remains one of the youngest in the industry. During the first half, we signed 30 lease commitments with airline customers, and all of our 2018 scheduled new aircraft deliveries have lease commitments with airlines. We have regular dialogue with our customers concerning their appetite for the most popular modern Airbus and Boeing models, and we are seeing good lease demand for our aircraft in the order book. In the first half of 2018, 52% of our fleet by net book value was deployed in Asia Pacific, reflecting the faster rates of air traffic growth in this region relative to more mature economies. Interest, fee, and other income increased substantially compared to the first half of last year to $35 million. We have 31 aircraft scheduled for delivery in the second half of the year, and we're working to add to that number. With that, I'll turn it over to Thim Fatt. Thank you, David. We reported net profit after tax of $297 million for the first half. We have now produced sustained growth in earnings per share and net asset per share over the five earnings periods since our IPO. Our earnings per share was $0.43 per share, increasing 24% over first half 2017, while net asset per share rose 5% to $5.75 from the end of 2017. The principal driver of the growth in earnings was a 23% increase in total revenue and other income. Our core lease rental contribution was $312 million, which net of operating costs represented 79% of net profit before tax. Our lease rental income rose 24% compared to first half 2017, as we increased the size of our fleet. As higher interest rate lifted our floating rate lease revenues and as new leases signed on higher fixed rate also contributed to the rise. Pre-tax gain on aircraft sales were $37 million, equivalent to 11% of net profit before tax. Interest, fee, and other income amounted to $35 million and comprised 10% of net profit before tax. Depreciation was up 23% compared to first half 2017, reflecting the growth in the size of our fleet. Finance charges increased by $42 million, driven primarily by an increase in our borrowing and as LIBOR rose. As the proportion of fixed rate leases have increased, we increased the proportion of our fixed rate debt, which also contributed to the rise in our average cost of funds to 3.1% in first half 2018, up from 2.8% for the first half of 2017. Staff costs rose by $9 million and represented approximately 5% of our total revenue and other income in first half 2018, in line with 4.8% in the first half of 2017. The increase in cost was a consequence of higher staff numbers, a lower provision for variable compensation in the first half of 2017, as earnings for the full 2017 year were much better than initially envisaged, as well as the amortization of costs in relation to the share-based incentive plan mentioned earlier by Robert. Other operating costs in first half 2018 were $25 million, 16% higher than the previous year, but growing more slowly than our revenue base. We had no impairment charges in first half 2018, and our average tax rate fell to 9.8% from 10.6% in first half 2017, primarily as a consequence of the reduction in U.S. federal tax rate. At the end of June 2018, our total asset had increased 7%, or about $1.1 billion to $17 billion from the end of 2017. Our gross debt to equity remained 2.9 times, similar to year-end 2017 levels. We had CapEx of $1.9 billion in the first half of 2018, primarily related to our aircraft delivery, and we are currently committed to aircraft CapEx of $3.5 billion for the full year. Our borrowing increased, rising 7% to $11.7 billion at the end of June 2018 compared with the end of 2017, reflecting the borrowing activity that included successful bond and floating rate note offering and raised $1.2 billion under our GMTN program. Now back to Robert for his final comments. Thanks, Thim Fatt. The six months ended June 2018 has been the most profitable first half in our company's history, as earnings per share rose 24%. Our balance sheet strength and committed future revenue of close to $15 billion position us well. The 24% increase in our interim dividend demonstrates our commitment to increasing shareholder distributions in line with earnings growth. It also underpins our focus on total shareholder return, which was an annualized 46%, according to Bloomberg, for the six months ended 30th of June this year. This compares with a decline of over 3% for the Hang Seng Index during the same timeframe. We look forward to celebrating our company's 25th anniversary in November and to a successful second half. This concludes our review of the industry and our company's financials, 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 now to the operator for the Q&A session. Thank you. Operator? 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 a queue. To cancel the queue, please press 02. Once again, 01 on your telephone keypad now. Our first question comes from the line of Arys Lin, UBS. Please ask your question. Hi, good evening, guys. Arys Lin from UBS. Congrats on the solid performance. My question, I would like to hear management comment on the industry in general, particularly on your exposure to Turkey and maybe some other markets which are recently having some problems in recent weeks. I mean, specifically, are you seeing any sign of your customer not able to take deliveries or any sort of not able to pay you on time? Okay. Well, Arys, it's Robert. Thanks for that. Thanks for the question. Let's just take Turkey head on. Our main customer in Turkey is THY, the flag carrier. I think you know from previous discussions, whenever we're dealing with more volatile markets, we tend to focus on dealing with the strongest in that market. THY have most of their revenues coming in non-lira currencies, primarily the euro, and we've seen no issues at all in their payment record so far. I believe you have more than one customer in Turkey. Yeah, but the majority of our exposure there is to THY. I see. Okay. Okay. I mean, in terms of the upcoming pipeline, do you have a lot of exposure to, say, Turkey or any other markets like startup airlines, et cetera? Because I saw that I think you have 10 new customers in the first half. Yeah. Okay. In terms of backlog to Turkey, the answer is no. All of the planes have delivered. And startups, we generally just don't deal with startups. If you remember, our strategy is to deal with those carriers who have more than 20 aircraft and better credit ratings. And so we don't tend to deal with the startup part of the market. The only exception we've done for that in the past is people like JetBlue, that were very heavily capitalized startups when they set up back in 1999. Got you. Okay. Thank you. Thank you. Our next question comes from the line of Ivan Chow, BOCI. Please ask your question. Thank you for having this call, and congratulations on the very strong results. Just got a question about the PDP finance. I see the growth on this fee, and interest income is quite robust for the first half of this year. How is the outlook of this type of income and, I mean, what is the growth outlook and how much of this is contribution from the higher interest rate of the market and how much is due to the expansion of the business of this PDP finance? Thank you. Okay. I will just give you a feeling of magnitude. In the first half of this year, I think we have done around six different PDP financings with different parties in the market. With the way that Airbus and Boeing have sold their production, predominantly on single-aisle and midsize wide-bodies, and they are going to be growing their production, we see opportunities for this business to grow. It is not necessarily going to be consistent every half year. It does tend to be a little bit lumpy because when we do these types of deals, they can be anywhere from six aircraft up to, I think the largest we have done is 17 at once. So you will tend to see some lumpiness in this, and it also depends upon the predelivery payment profile that the airlines agreed with the manufacturer. Different airlines have predelivery payment profiles, so that will also change the shape of the funding over time. Okay, I see. Thank you. You are welcome. Thank you. Our next question comes from the line of Kartik Dalal, Red Elvisa. Please ask your question. Yeah. Hi. Thank you very much for the opportunity and congrats on the strong set of results. If I look at the first half, we have sold about 19 odd aircraft, which is the same number which we sold in the first half last year. Can you give me a sense of what was the average age of the fleet that we sold this year compared to, let's say, first half last year? Okay. Thanks, Kartik. Basically, the mix of the aircraft was slightly different this year. If you remember, in the first quarter, we sold the remaining E190s in the fleet. We've been sort of focused on selling out some of the less desirable aircraft. In terms of the average age, it was somewhere close to six years. Okay. The reason I ask the question is the gain on the aircraft is down about 23 odd percent year-on-year. If I look at the proceeds from the sale, that's up about 7 odd percent. That effectively means the net book value of the aircraft that we sold this year is materially higher than what we sold last year. That's why I'm trying to get a sense of whether there was any distinction in the age of the aircraft that we sold this year compared to last year. Okay. I can give you the exact numbers now. I have just found them. For first half last year, average was 3.7 years. First half this year, average was 5.8 years. Did that have any impact on the gain or not much? No. The key thing on the gain was, as I mentioned, we were exiting some of the less desirable aircraft types in our fleet, where we think residuals could get impacted in future. The best example of that is probably the E190s. Because the E190s replacement aircraft started delivering from the middle of this year, and we wanted to exit that investment before we got to that point. Got it. Thank you. Thank you very much. No problem. Thank you. Our next question comes from the line of Jackie Zhu from Deutsche Bank. Please ask your question. Thanks, and congrats on these strong results. My question is regarding the aircraft NBV growth. Basically, our aircraft net book value grew at 3% year-on-year from my model. Just want to get a sense of the growth in the second half and the coming several years. Is the growth kind of slowing down or do you see any growing opportunities, for example, in the wide-body replacement markets? Just want to get a sense. Thank you. Okay. Let me give you some numbers then. Total CapEx committed for 2018 so far is $3.5 billion. We believe we can grow that to around $4 billion by year-end. What are things that have impacted that? Certainly, some of the delivery delays from Airbus have pushed aircraft out from the first half into the second half of the year, and it's a situation that we're continuing to monitor. There will be, I think, opportunities for us in the fourth quarter to pick up some additional assets. As you may know, the airline industry tends to be seasonal. 80% of the world's airlines are in the Northern Hemisphere, and the seasonality of those Northern Hemisphere airlines means the high season tends to be from April through till about September. Then we move into the sort of low season starting October, and we have two mini lows, one in November, one in February. That tends to be when we see opportunities to pick up either additional aircraft through purchase and lease back or alternatively, pre-delivery plus lease financings. Thanks. For the next 2-3 years, what sort of growth are you looking for for the net book value growth? Thank you. In terms of CapEx, because you remember, net book value growth is made up of three things. I think you can expect similar amounts of CapEx. We plan to sell roughly $1 billion of net book value of aircraft a year, and depreciation in very round numbers is about $0.5 billion. Got it. Thank you. Okay. Thank you. Our next question comes from the line of Kartik Chalapa from Vista. Please ask your question. Yeah. Thank you for the opportunity again. I just wanted to get a better sense of how liquid is the secondhand market when you actually wish to sell your aircraft. If I look at the gains that we have booked in the first half about, let's say, 37 odd million on 19 aircraft, that works out to almost about $2 million per aircraft. I just want to know how do you take decisions on what is the best time to sell the aircraft and how liquid is the market, and from where do you get to benchmark the correct prices? Okay. Lots of questions there, so let me try and deal with them one at a time. Firstly, what we try to do overall is optimize the long-term profits from each aircraft. The long-term profits come from two different things. One is our core lease rental contribution, which is the ongoing lease rentals, and the second then is the gain on sale. If you think back to how we started our presentation today, by far, the largest proportion of our earnings comes from the core lease rental contribution, normally somewhere between three quarters and 80%. The gains on sales relative to that tend to be smaller. Okay? Why do we do that? Because of our low cost of funding. We want to harvest as much of the core lease rental contribution as possible. That's the first point. Okay. Second point, we have about 300 active investors in the global market. They are split into different parts of the market between those who want to buy nearly new aircraft, those who buy mid-life, 10 to 15-year-old aircraft, and those who basically invest in the back end of an aircraft's life. Most of the investors we're talking to are in that mid-life section. I would say there's about 50 active investors that our sales team has talked to. We have a dedicated aircraft sales team headed by Graham Lees, who basically does nothing but talk to investors and gets feedback from them on what types of aircraft they want to invest in. Do they want fixed or floating rate leases? What type of returns they're looking for from those aircraft. We use that to come up with our annual budget as to basically what types of aircraft we want to be selling in the following year. Then we run a competitive tender to get the best prices between those participants in the marketplace. That is basically how we run the process and how we decide. What you end up with is basically our strategy is to exit most aircraft by the time they are 10 years old. In some cases, where we have got very long leases, like we had some 16-year leases to Southwest, we may hold them slightly longer than 10 years. But in general, 10 years is our limit. We tend to, if you consider, we generally write 12-year leases, first leases. We are going to exit somewhere around eight years. As I mentioned earlier in the call, there have been some aircraft, the average where we sold at this year is slightly less than that, and that is because we took a strategic decision to exit a certain aircraft type. Got it. These 300 odd people, where would they be concentrated, these investors? Broadly spread is the answer. You have got tax investors based in Japan. We have some investors in the Middle East. There is a large number of investors now in the U.S. market who are particularly involved in the ABS market and looking to build portfolios to distribute into the ABS market. Perfect. Thank you. Thank you very much for this detailed color. You are welcome. Thank you. Our next question comes from the line of Edward Xu, Morgan Stanley. Please ask your question. Hello. Hi, this is Edward from Morgan Stanley. Thank you for taking the question. First of all, congratulations on your very strong result for the first half. Very good. I have just a simple question regarding the core lease rental incomes. Specifically for this net gain on sale of aircraft. Just wonder what is your plan for this year. It seems that the first half of the gain of the sale of aircraft accounted for a large portion of our full-year estimate already. Does it mean that in the second half, are you going to have a similar size of disposal, or it is largely down. Second, may I also know anything about your interest in the fee income, which increased by more than 100%. Would that be normalized in the second half. Thank you. Okay. Two good questions. Thanks, Edward. Firstly, our plan for this year, when we did our budgeting at the start of the year, is to sell somewhere between 30 and 35 aircraft. About half of the balance is already pipelined in the third quarter. We have not got a lot left to complete, basically, by year-end. The second question to do with PDPs. Our PDP business has been very strong first half of this year, and those PDPs basically will stay on the books through the second half. No, we do not expect to see a drop-off in the second half. Oh, okay. Thank you. Thank you. Our next question comes from the line of Shashank Savla from Liontrust. Please ask your question. Hi. Thanks for taking my question. This is Shashank Savla from Liontrust Asset Management in London. I had a question on the tariff wars, which are happening. Just wanted to understand what legal entity is actually purchasing the planes, and if there is tariffs on aircraft, let us say on Boeing or something, how does that impact you? Also, how does that impact your competitiveness versus the U.S.-based leasing companies? Okay. The first thing is, as a matter of fact, there are no tariffs on aircraft. Okay? As of today, there are no tariffs put in place. Secondly, we have no undelivered Boeing aircraft to go to China. Everything that we were due to deliver to China, we have already done. We are not impacted by this. Thirdly, bear in mind that we are a Singapore-incorporated company, and so we are not caught in, ourselves, in China versus U.S. issues. Our aircraft generally are acquired either through our Cayman entity or very occasionally through Singapore. Great. How does it impact your competitiveness versus the U.S.-based leasing companies per se? I don't think there is any impact. I don't think this is something that affects our ability to place competitively versus them. Right. Okay. Thank you. You are welcome. Thank you. Our next question comes from the line of Ajith from UOB. Please ask your question. Thanks. Robert, congrats for an excellent set of results. Most of my questions have been answered except for one. This is regarding second half delivery. Perhaps you could shed some color in terms of whether it is going to be back-end loaded or towards the third quarter as you seem to have hinted. So that is my one and only question. Okay. Ajith, this is a thing that keeps me awake at night. When Phang and I budgeted for this year, our aircraft were beautifully spread throughout the year. Unfortunately, that is no longer the case. There is a large spike in the month of December, and this is because of the production delays there. Okay. That means most of the deliveries would be towards the fourth quarter. Not most. I think, if you look at our second half deliveries, I would say one third, two thirds, third quarter versus fourth quarter now. One third, two third quarter and fourth quarter. Okay. Right. So- Whereas previously, it was supposed to be half/half. Half/half. This could potentially have an impact on your lease rate factor? No, it won't impact our lease rate factor necessarily. We're also looking at other business to replace some of that business. The same happened to us last year, and we were able to go and pick up some additional business in the marketplace. I've tasked our aircraft leasing team to do the same thing this year. I see. Okay. Thank you. It's very clear. Okay. Operator, thank you very much. We'll end the call at this point. Our management team all have flights to catch, in the interest of their on-time departures, they need to get to the airport. If there's any follow-ups, please, anyone on the line, don't hesitate to contact me directly, and I'll get back to you in a timely fashion. Thank you very much. Thanks, everyone. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may all disconnect.