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Stephen Peters: can airline leasing take off as an asset class?
by Stephen Peters on Jul 25, 2011 at 10:57
As we enter the quiet summer months it is notable that some investment companies have not succeeded in coming to market. There are any number of potential reasons for this, but sheer investor uncertainty as to how the global economy and markets will perform looking ahead is surely a major factor.
One company that is getting off the ground is Doric Nimrod Air Two*, which you might have read about last week. Raising around £145 million, it is the successor to Doric Nimrod Air One, and listed on the Specialist Fund Market (SFM) of the London Stock Exchange. The SFM is designed for institutional, professional and highly knowledgeable investors. Companies admitted to it may have sophisticated investment propositions, complicated and leveraged corporate structures, concentrated risks and variable levels of secondary market liquidity.
However, the concept of DNA 2 itself is simple. The company will buy and own three brand new Airbus A380 aeroplanes. Each plane costs around $216 million, the fund will invest around one-third of the money it raised in equity to purchase each plane. The planes are then leased for 12 years to Emirates Airlines, which operates them on a fully repairing and insuring lease.
During the 12-year period, the debt finance is paid off, capital and interest, on a straight line basis. Unless Emirates defaults, there are no loan-to-value covenants that would be applied to the loans. Equity owners of DNA 2 receive a 9% yield for the duration of that period and when it ends they are entitled to the proceeds if the planes are sold. Doric keeps a close eye on the planes during the lease, even employing its own engineers to ensure they are maintained to standard. This is not a new venture for the company – it already leases 24 aircraft, including nine A380s.
This is clearly an asset class totally uncorrelated with traditional equity markets but there are several potential risks for owners of the shares. The airline industry is not known for making huge profits for shareholders or investors.
Emirates, however, is one of the newer airlines and is not burdened with the issues of significant pension scheme deficits or heavily unionised workforces like many former European national carriers. The company was around 50% more profitable in 2009/10 than Cathay Pacific, which is one of the world’s most profitable airlines.
Emirates has one of the lowest ratios of labour cost to revenue in the sector, and A380s are estimated by Airbus to have a more efficient fuel burn per seat than its main competitor, the Boeing 747-8I. Aircraft leasing is an unusual and illiquid asset class, so it is limited in what it can do to narrow any discount to NAV the shares may eventually trade at. And while the dividend yield is not going to rise to protect shareholder income from inflation, you own a real asset that has an intrinsic value even if it is sold prior to the lease expiration or if the plane is broken up and sold off as scrap.
The terms of the lease mean the airline is responsible for full repair and insurance costs, so equity holders are not liable for any costs related to the ongoing running of the plane. Historical data suggests aircraft retain their value – Boeing 747-200 aeroplanes built in 1971 were worth around 83% of their initial value in 1983 after the period of high inflation in the 1970s, and the 747-400 model was worth in 2001 around 48.5% of the value of the plane in 1989.
Valuations also tend to be relatively stable over time – a decline in values in late-2001 was soon made up. If the plane is lost through an accident or terrorism, the appraised insurance amount is around 120% of the aircraft’s market value at that time.
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