Avolon eyes climb to big leagues with ratings focus
THERE are few sectors in which Ireland can truly be said to be a global leader. Aircraft leasing is certainly one. That fact was underlined once again last week with bumper financial results from Dublin-headquartered Avolon.
In an industry of eye-watering numbers, Avolon showed a 30pc rise in profits to $717m (€636m) and a 10pc rise in revenues to $2.57bn. Hot on the heels of the results, an upgrade of the company’s debt followed from ratings agencies.
This moves Avolon another step closer to its ambition of achieving coveted investment grade status from the agencies, giving it cheaper access to a more plentiful reserve of the real fuel for the sector — debt.
And Avolon is nothing if not ambitious in this regard.
“We are currently a good safe Premier League team and we want to be playing Champions League football,” its chief commercial officer and president, John Higgins, told the Sunday Independent.
“This is driven by a firm belief that for medium and long-term sustainability of profits and risk management we want to be an investment grade issuer,” he said.
Higgins quickly added that his football metaphor was very much applicable to Avolon’s investment grade ambitions, not necessarily to its already lofty place in the leasing industry firmament. “By most metrics — size, scale, fleet age, importance to the market — we are already a Champions league team,” he said.
The scale of Avolon is indeed impressive. It was founded in 2010 — at a time when there was little else positive to note in corporate Ireland — by Domhnal Slattery, Higgins and a team from RBS Capital. It is now the third-biggest aircraft lessor in the world with a fleet of close to 1,000 aircraft and 150 customer airlines.
But it has not all been smooth flying for Avolon. Last year, its ultimate owner, the huge Chinese conglomerate HNA, faced a debt crisis forcing it to sell billions in assets. It was an uncomfortable time for HNA subsidiaries. Avolon boss Domhnal Slattery admitted at the time that Avolon had “suffered indirectly” from HNA’s travails and that the US bond market “didn’t like that story”.
“There was blanket coverage on HNA and there is no doubt that created a negative halo effect for us in terms of the financial markets trying to understand our business,” Higgins told the Sunday
Independent in recent days. “We worked hard to make sure there was a clear understanding of the insulation between Avolon and our parent Bohoi and above that to HNA. That was effective in time.”
HNA’s problems have subsided somewhat in the meantime but the big turning point for the Irish-based lessor was the sale by HNA of a 30pc stake in Avolon to Japanese financial institution Orix.
Achieving Avolon’s investment grade goal was never going to happen without that type of sale. The ratings agencies needed to see a credible long-term shareholder with strong governance oversight take a significant share of the business. Orix fit the bill perfectly, not least because of its own investment grade status.
“That is the enabler now for us to pursue with real intent an investment grade for the business,” said Higgins.
Avolon already has most of the other metrics the ratings agencies will look for — low leverage, good liquidity and good cashflow generation. But there is one last key stepping stone remaining before the agencies will play ball. Currently on its balance sheet it has a ratio of 42pc of secured debt to total assets. That, according to Higgins, must fall to about 30pc.
“The ratings agencies are dispassionate about that sort of stuff. They look at the performance of the business, the metrics, and they rate accordingly.”
The timeline on how long it will take Avolon to bring this ratio down to the required level is “very market dependent,” said Higgins.
“We need to be in the market issuing unsecured notes and using that funding, in conjunction with our trading funding, to pay down debt to generate a higher level of unencumbered assets. That depends on conditions in the capital markets.”
But, he said, if conditions do remain reasonable, Avolon expects to make “significant progress” during 2019, taking it at least close to the 30pc level. During 2018 the metric fell from 48pc to 42pc.
So why is investment grade so important for the company? It all boils down to the simple fact that airplanes are very expensive and therefore a leasing company like Avolon must consume huge quantities of capital. The cost of that capital is one of the main differentiators between competitors in the market. Securing an investment grade rating would allow Avolon to borrow at the most competitive rates but also give it access to the deepest pools of availability. That robust source of debt would help protect Avolon in the event of a downturn in overall markets.
Higgins insists that the company’s drive to achieve investment grade status is not driven by concern about any particular existential event or fear. For example, he points out, with fewer than 20 aircraft on lease to the UK, Brexit is not a huge issue for the aircraft lessor.
Neither, he said, has Avolon given much thought to what will happen if one of its big rivals is sold or broken up. Speculation abounds that the Shannon-based number-two global aviation lessor GECAS — owned by GE Capital — is to be sold. But, in a meeting with investors, GE boss Larry Culp insisted that the rumoured sale to a private equity firm — or anybody else — had not been lined up.
However, harder to ignore for anyone in the wider aviation industry are the dark clouds that undoubtedly hang over the sector at the moment.
A combination of volatile oil prices, a strong dollar, higher interest rates and a relentless drive by airlines to fill more and more aircraft with ever-cheaper fares all seems to point to a downward trajectory for the famously cyclical industry.
Already there have been casualties, with a series of smaller airlines going out of business. Other players such as Norwegian — which has helped drive prices down on Atlantic routes — have faced serious financial hurdles. Even the strongest airlines are feeling the pressure, with Ryanair, for example, warning staff of potential cuts to come.
But Higgins says none of this is a surprise or a huge concern for aircraft lessors such as Avolon.
“We expect to see more of that happen but that, for us, is firmly in the normal course of business for our sector. It should not be viewed as a sign that there is some sort of cataclysmic serious distress in the sector.”
He goes further: “We’d actually say that for any marketplace, whether it is airlines or whether it is lessors. In order to have an efficient market in the long term you are going to get short-term corrections. So we should expect to see that some airlines will struggle and some will go out of business. Other airlines will take advantage of those opportunities and will grow. And on the leasing side we should expect to see that there will be opportunities for well-capitalised lessors who have good reach and good scale.”
Avolon, he says, is one of those players: “So, in other words, some level of distress in the marketplace will translate into opportunities for our business.”
Achieving its coveted investment grade status could give it the edge in scoring those chances when they come.