Quite a positve article on the plane leasing business that just camw out. Allco seem to have a great reputation in this area. 49 planes currently leased and another 30 to come.
Allco stuff towards the end of the article or visit
There is no doubt that the leasing industry has enjoyed unprecedented growth over the past three years, flying to new heights on the back of rocketing demand for air travel and strong output from manufacturers. The good times have been fuelled by five years of record economic growth. Technological improvements and environmental pressures have driven the need for fleet replacement, resulting in a record backlog of orders. While lease rates are sky high and continue to climb, renewal rates for existing aircraft are running years ahead of industry norms and the weak dollar affords greater returns.
In such a favourable atmosphere, a host of lessors have come to the party, with Gecas, ILFC, Awas and Aircastle placing substantial orders in 2007. Everyone, it seems, wants a slice of the leasing cake and even the increased competition – far from being detrimental – has generated greater liquidity, helping to satisfy lessors' appetites.
The continued growth of low-cost carriers and the high traffic growth in India and China has been the icing on the cake. The sheer sense of exuberance was captured when Dubai Aerospace Enterprise signed letters of intent for 100 Airbus and 100 Boeing aircraft at the Dubai Air Show at the end of last year.
Aircraft leasing has changed the face of commercial aviation. More than 30% of the world's jet fleet is leased, with expectations that the share will rise to 50% over the next decade. Leasing brings airlines greater financial and operational flexibility, enabling a quicker response to changing market forces, and avoids asset exposure. It also carries the benefits of better debt/equity ratios because leased aircraft do not appear on an airline's balance sheet.
It seems everyone wants to cash in on the leasing bubble, with a glut of new players entering the field in the past two years – and the rules of the game have changed, with some lessors expanding their business models to provide financing and becoming key sources of funding.
Banks, too, have also climbed aboard the leasing bandwagon, with Standard Chartered acquiring Pembroke and Bank of China acquiring Sale, now BOC Aviation. Publicly listed lessors now have obligations to shareholders, creating a new business model. The boom is very much a global phenomenon, with Chinese banks poised to enter the scene and shake things up.
What's in store?
But with the prospect of a bumpy ride in 2008, has the leasing sector reached a watershed?
The rules of physics dictate that what goes up must come down and some lessors are bracing for a crash landing. There is little doubt that the sector has reached a critical crossroads because of the impact of a host of negative factors. Chief among these are the price of oil, the poor performance of the US economy resulting from the credit crunch and a slowdown in economic growth.
There are concerns that a crisis in consumer confidence in the US will severely dent demand for air travel. Despite the prevailing notion that the industry has largely escaped the brunt of sub-prime, the global credit crunch has raised the price of aircraft and lessor funding. The consensus seems to be that the aviation cycle has passed its peak with, at best, the prospect of a levelling plateau and, at worst, a severe downturn coinciding with a global recession.
Feeling the heat
Such concerns came to a head when shares in Allco Finance Group's structured finance, property and aircraft leasing group plunged 40% amid fears it would be the next victim of the credit crunch. Allco's shares dropped to a low of A$1.70 ($1.51) – a considerable fall from the A$13.24 high of last February – but then rallied to A$3.40. It was the first listed aircraft lessor to suffer a drop in share price because of the global credit crisis.
While the plunge may reflect an overreaction by panic-stricken investors lacking an understanding of the sector, it has nevertheless raised questions about the viability of the listed aircraft lessor.
Richard Klein, a partner at Chicago-based law firm Chapman and Cutler, thinks that public lessors face challenging times. "The listed aircraft lessor has certainly enjoyed boom years but the sector has since peaked and the market has now plateaued," he says. "The next few years will be more difficult for them."
For Allco, the negative press has been unfortunate and demonstrates the importance of perception, often displacing underlying financial realities. Worries that the company would be unable to refinance debt were unfounded – it only has one A$250 million facility due to mature this year.
But the share shock – a product of investor paranoia rather than prudence – should not take the shine off what has arguably been a very successful couple of years for Allco.
Indeed, the lessor has joined the premier league of Australian lessors, alongside Babcock & Brown and Macquarie. "2007 has gone well for us," says director David Veal, who was speaking in January before the share price plunge. "We have experienced solid growth and this is a continuous trend."
Ominously, Veal adds: "We take a cautious view. The aviation market is a fast way to lose money if you get ahead of yourself."
Echoing the sentiments of many inside the industry, Veal says that sub-prime has had no adverse impact on business. To the contrary, it had even created opportunities.
"We have perhaps benefited from sub-prime," he says. "This is because the more recent competition has exited the market. New players had entered the market which competed aggressively to levels that we just weren't prepared to go to."
Veal adds that the crisis had introduced a much needed reality check for a sector experiencing rapid growth on the back of easy financing. "The credit crunch has given us a renewed appreciation of the financial market place," he says.
"Beforehand, bank debt was very easy to get. But sub-prime has taken securitization out of play and reduced liquidity. In terms of ability to fund, it has obviously created upward pressure on margins. But upward pressure is capable of being absorbed and we are having great success in the debt market."
He views sub-prime as a manageable crisis. "We are sufficiently flexible to handle market movements when lending dries up," says Veal.
Allco has come a long way since its first deals for Jetstar and Qantas, expanding its global reach considerably. "Our customers include Qantas, Emirates, Ryanair, China Eastern, BA, Singapore Airlines, EVA, Flybe, ClickAir and Asiana," says Veal. The company has 49 aircraft, with a further 33 on order. Qantas remains its biggest customer.
Global outlook
An important factor in Allco's rise to prominence has been its reluctance to follow the prevailing trend. While recognizing the potential of the emerging Asian-Pacific market, the lessor does not single out the region for any special attention.
"Our market is global," asserts Veal. "It is a relatively borderless market. Worldwide, we're happy to operate anywhere. We are active in China and India but it's not as if we're being handed aircraft for free in these regions. We have to compete everywhere."
With Chinese banks on the verge of entering the market and generating additional competition, Veal's strategy seems shrewd.
This individualistic approach is also evident in Allco's approach to its aircraft portfolio, with a large emphasis on widebodies compared with other lessors. Such a philosophy flies in the face of conventional wisdom – narrowbodies offer higher output, stable technology, low reconfiguration costs and a lower risk. "Yes, you could say a focus on widebodies is part of our strategy," confirms Veal. "The market focuses on narrowbodies, but we see a lot of value in widebodies. The narrowbody market is exceptionally competitive. The market consensus is that narrowbodies are more mobile assets than the widebodies. While this is accurate, history shows that widebodies hold their value well in all points of the cycle. Widebodies are the bread and butter for strong credit, long-haul airlines and these aircraft are pretty much the last aircraft that airlines will retire in tough times. We reckon that operating widebodies with strong airlines creates a de-risked solution."
In doing so, it has carved out its own market niche. "Allco has dominated the Asia widebody market," says one rival lessor. "They are clever people who are doing a great job because they have a clearly defined strategy."
While the emphasis is on widebodies, the lessor still operates a mix of aircraft type with no allegiance to one particular manufacturer. "We have A320s, 737-800s, 777-300ERs and A330s," says Veal. "We also have Embraer 190s, 747s and 767s. All are highly remarketable assets with long-term sustainable potential."
This concentration on asset type is a central plank of Allco's business model and explains why the lessor focuses solely on operating leases. The preference for the operating lease is part of a wider evolution that has seen the company develop from purely a finance house into an asset-owning company.
"Allco was founded on finance leases," explains Veal. "We did our first finance lease in 1980, but we now totally focus on the operating lease. Why? In the last 15 years, tax leases and finance leases have brought less and less benefit, because of lower depreciation allowances, lower tax rates and lower interest rates. Our model is now that of an asset ownership house. We want to acquire assets and this requires a different skill base. There was no asset management involved in finance leases. We're essentially blending structured finance skills with asset management skills." The resulting hybrid is a sound business model.
Allco usually approaches airlines, rather than manufacturers, asking if they would like to lease aircraft. Sale/leasebacks are often used.
The penchant for operating leases represents a departure from a more diversified approach a few years ago. In 2005 it closed an innovative export credit guaranteed lease for Asiana.
Another aspect of Allco's strategy that sets it apart is its focus on long-term leases. In a highly cyclical industry, long-term leases offer a degree of protection from market volatility.
"It's simple maths," says Veal. "If you have an aircraft with a 25-year life cycle, we would prefer to have two 12.5-year leases on that aircraft, thus exposing the asset to two cycles. Providing you have return dates spread across the cycle, this is much more preferable than having a series of short-term leases where you are consistently exposed to the market cycle. Our average operating lease is for about 10 years. Long-term leases give you an ability to ride out the cyclical impact."
Forward planning
Such a strategy should stand Allco in good stead when the downturn sets in. While conceding there are signs the downturn will come soon, Veal does not see it as a foregone conclusion. He cites the emerging markets and a steady growth in passenger numbers as indicators that the market will continue to grow.
"The market fundamentals are quite strong," he says. "But this does not necessarily mean it won't come back and bite us."
Should the downturn take hold, Veal thinks its impact on lessors will be limited.
"It could even be positive – in a downturn, airlines might want to dispose of assets, and this could be beneficial for the leasing market, and from a financing perspective, lessors can generally raise capital at lower rates than airlines. When airlines find it difficult to raise capital, the operating lease market represents a viable alternative." He does see over-capacity, however, as a potential problem.
"A number of airlines have obviously made huge orders – punting on their estimates of the growth market," he says. "But whether passenger growth increases at the rate airlines want is another question. I also get particularly concerned with long-dated orders because the CPI escalation of the purchase price over a long-term delivery period can result in a seriously scary purchase price when it comes time to deliver the aircraft."
Allco Finance Group reported net profit after tax of A$211.7 million for the year ended June 30 2007 – a 41% increase on the previous year. Its business model has three areas – funds creation, funds management and asset origination.
The company, which is listed on the Australian Securities Exchange, commenced operations in 1979. The group has developed from its origins as a leveraged lease packager to a diversified finance group with operations around the world. But asset management is the central part of its operations, under which the leasing of aircraft plays a major role.
Veal puts Allco's success in the aviation sector down to three things. "Firstly, we understand assets very well," he says. "Secondly, we have very good structured finance skills which have enabled us to access financial markets and tap into a broad pool of finance. Thirdly, we have a cautious view of where the market is going. It is this combination that has worked very well."
Looking to the year ahead, it is very much a case of a continuation of the modus operandi. "We focus on aircraft of sustainable value over the long term, and not get too worked up about growth prospects versus the risk of any downturn. We need to understand that industries get hit by shocks and we plan accordingly. We will keep a high degree of discipline. In terms of sub-prime, we will stay close to the debt markets and monitor what is going on."
He says it is important for the company to keep focusing on its relationships with banks. "We need to understand what challenges they face".
In terms of the environment, Allco focuses on current technology aircraft. "We don't have old technology," says Veal. "We only have stage 4 aircraft. It is obviously critical that the world understands global warming. It is in the forefront of European thinking and fortunately this is beginning to expand to Asia and the US. This is very good to see."
He thinks that environmentalists unfairly single out the aviation industry.
"Aviation is the pin-up boy for the environment movement – pictures of huge aircraft spewing contrails create powerful images – but the facts give a different spin. Most experts acknowledge that aviation is not the main culprit. The fact that fuel represents between 40% to 55% of most airlines' expense base means that airlines are economically compelled to reduce fuel consumption and, as a result, emissions. If only the major polluting industries, even industries as core as commercial property and agriculture, were so compelled."
Expecting more growth
Despite concerns that current growth levels cannot be sustained, aircraft lease rates are holding steady. This should go a long way in keeping the publicly listed lessor a profitable business model.
Veal does not share the view that the leasing bubble is about to burst.
"The argument for the operating lease is a compelling one and we expect continued solid growth."
The simple fact is that demand for aircraft remains robust. In its most recent outlook, Boeing predicts worldwide passenger traffic to increase by 5% over the next two decades. Allco might well look back at its share price plunge as nothing more than a temporary blip.
AFG Price at posting:
0.0¢ Sentiment: Buy Disclosure: Held
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