BCVVF - BOC Aviation Limited: Good Performance But Relative Value Is Lacking

2023-05-15 10:27:51 ET

Summary

• BOC Aviation has had relatively strong recent performance and has done well throughout the turbulence caused by COVID.
• Shares trade at a premium to peers, which may be deserved, but also leaves relatively lower room for appreciation in my view.
• I rate the shares a Hold and would consider investing on a pullback.

I recommend a Hold rating on the shares of BOC Aviation Limited ( BCVVF ). Shares trade at a premium to peers and the stock has limited liquidity in U.S. markets. It also faces significant refinancing needs in the next few years which could eat into net profit after tax (NPAT).

Company and industry overview

BOC Aviation is one of the oldest and largest commercial aircraft leasing companies. The company was originally founded as Singapore Aircraft Leasing Enterprise Pte. Ltd. and was purchased by Bank of China in 2006. It was listed approximately a decade later and trades OTC as well as on the Hong Kong Stock Exchange. Bank of China continues to be a majority shareholder.

Source: Airfinance Journal, August 2022.

Bank of China still owns ~70% of outstanding shares and also provides a $3.5 billion dollar line of credit to the company. This support and the company's stellar performance has contributed to its A- rating from both S&P and Fitch, the highest rating of any publicly traded aircraft lessor. This rating is instrumental in allowing the lessor to benefit from the lowest-cost funding in the marketplace. The company had Boeing (BA) as an initial investor in its IPO, but it appears that the manufacturer has divested of its stake.

BOC Aviation financials and projections

My projections for BOC Aviation's earnings are as follows:

Source: Author's own calculations; *2022 reflects "core" earnings that exclude net charges taken on aircraft lost due to the Russia-Ukraine conflict

This implies that shares are currently trading at around 90-95% of 2023 book value and approximately 8.5-9 times forecast EPS.

Asset sales

I assume that aircraft sales normalize in the ~$1 billion per year range going forward, with sales margins in the high single digits. This is fairly consistent with the past several years' worth of results, with some volatility around volume and margins on a year-to-year basis. As the portfolio grows, the company may increase its churn and likely would also increase its contribution to earnings.

Gradual reduction in receivables

The company, like all lessors over the past two years, entered into certain lease restructurings, payment deferrals and similar arrangements to help customers get through the tremendous impact COVID had on the airline industry. BOC Aviation's trade receivables were ~$163 million at YE22, up ~9x from 2019 levels and even higher still if looking back at its pre-pandemic averages, which is a testament to its risk management and the quality of its portfolio of lessees. The current balance is modestly lower than during the height of COVID distress. I am not assuming that they reduce receivables from these levels, even though the market has recovered materially and there is potential that these balances could be whittled down substantially over the next 2-3 years. The company has recently reported collection rates in excess of 100%, which means that at least some amount of arrears are being repaid in accordance with whatever agreements they have struck with the customers.

Relative value against other lessors

BOC Aviation shares trade for a healthy premium to other publicly traded airplane leasing companies, as is demonstrated by the comps to AerCap ( AER ) and Air Lease Corporation ( AL ) below:

Source: Author's own calculations

Return on equity outperformance

The company's ROE has consistently been at the higher end of its peer group. A sample of this can be found below:

Source: Author's own calculations. 2022 results exclude impairments related to loss of aircraft in Russia / Ukraine conflict. Aircastle 2020-2022 year-end is February of the following year.

Risks to investment thesis

Limited liquidity

There's limited trading in BCVVF. This may result in limited ability to quickly trade out of shares and wider bid-ask spreads. It is technically possible to acquire shares on the Hong Kong stock exchange (2588.HK) and given the relatively stable USD/HKD exchange rate and the fact that aircraft assets are predominantly valued in USD, this could be a way to pursue exposure to the company instead.

Inflation and longer-term rise in interest rates

Much of BOC Aviation's debt is long-term and fixed-rate in nature, which insulates it at least partially from higher rates. However, approximately $9.2 billion of it comes due during 2023-2025, so the direction of rates could materially impact profitability going forward. Inflation is likely to benefit hard assets like aircraft. BOC Aviation retains the highest credit ratings of any publicly traded lessor at A- from both Fitch and S&P. This allows it to fund almost entirely with unsecured debt and should allow it to achieve market-leading pricing irrespective of the prevailing interest rate environment.

Another confiscation event

Perhaps a remote risk, but an important one in light of the recent Russian seizure of billions worth of commercial aircraft from western lessors. It is noteworthy that BOC Aviation recently received a favorable judgment related to a lease default driven by the Russia-Ukraine war and related sanctions. It is also 70% owned by Bank of China, which could at least partially insulate it from any distress amongst Chinese carriers relative to its peers.

Conclusion

The company has shown an ability to weather the COVID storm while positioning itself for prudent growth as the market recovers. However, there is an argument that shares are relatively fully valued at the moment, with fewer catalysts on the horizon to propel shares higher. The shares do have a healthy dividend, so you are at least somewhat compensated while waiting for further growth. Potential upside triggers include M&A or another shakeup in the market which BOCA has historically capitalized on to make attractive investments into aircraft.

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