Aircraft Leasing Sector

Transcription

1 China / Hong Kong Industry Focus Aircraft Leasing Sector Refer to important disclosures at the end of this report DBS Group Research. Equity 26 Jul 2017 Undervalued and under-appreciated BOCA and CALC s share prices have lagged behind US listed lessors and HK aviation plays, which we see as unjustified given their robust growth prospects and cheap valuations HK-listed aircraft lessors are a good proxy for firm long-term travel demand growth globally, and are undervalued versus their peers, offering an attractive combination of yield and growth BOCA and CALC are well positioned to see strong earnings growth over the next few years as they continue to acquire aircraft assets for growth, which should help drive share prices higher We maintain BOCA (BUY, TP HK$54.1) as our Top Pick, and keep our BUY call on CALC (TP HK$12) BOC Aviation and CALC are undervalued, and are poised for a re-rating. Despite delivering strong earnings growth for 2016, both BOCA and CALC s share price have underperformed the Hang Seng Index and other HK-listed aviation plays. As a result, BOCA and CALC are now trading at the lowest PE among HK aviation plays despite having better-than-average earnings growth and offering high dividend yields. The stocks may have underperformed due to worries about the impact of higher interest rates and a potential over-supply of aircraft but we believe such concerns are overblown. Asset growth is a key driver of earnings and share price, and both BOCA and CALC are projected to grow their aircraft portfolios aggressively over F. Based on our case study of AerCap s share price performance in the last decade, we believe that asset growth, with the appropriate use of leverage, is a key driver of earnings and therefore share price. With BOCA and CALC well poised to grow their aircraft assets organically and inorganically over the next few years, both are expected to see robust earnings growth. We expect their share prices to re-rate as they deliver on earnings growth. Compelling valuations. We see current valuations for BOC Aviation as very attractive at 7.4x FY17F PE, declining to 6.1x FY18 PE on 14% EPS CAGR over FY16-19F, and at less than 1x FY17F P/BV against 13.5% ROE. The stock also offers a good yield of 4%. At the same time, CALC is offering an attractive FY17F dividend yield of 5.7%, rising to 6.7% for FY18F while its FY17F PE of 8.8x declining to 7.5x FY18F PE against a projected EPS CAGR of 16% is also undemanding. HSI: 26,852 ANALYST Paul YONG CFA paulyong@dbs.com Recommendation & valuation Company Pric e M k t Cap T P Rat ing F Y 17F HK$ US$m HK$ PE BOC Aviation (2588 HK) BUY 7.5 CALC (1848 HK) BUY 9.0 Source: Thomson Reuters, DBS Vickers BOCA and CALC share price performance 180% 170% 160% 150% 140% 130% 120% 110% 100% 90% 80% Jan-17 Feb-17 Mar-17 Apr-17 Source: Thomson Reuters, DBS Vickers May-17 Jun-17 Jul-17 BOCA CALC Air China BCIA Travelsky HSI ASIAN INSIGHTS VICKERS SECURITIES ed-th / sa- AH

2 China / Hong Kong Industry Focus Aircraft Leasing This report is a continuation of our Aircraft Leasing: Asian Lessors in the Ascendancy DBS Asian Insights SparX report issued on 20 February The DBS Asian Insights SparX report is a deep dive look into thematic angles impacting the longer term investment thesis for a sector, country or the region. We view this as an ongoing conversation rather than a one off treatise on the topic, and invite feedback from our readers, and in particular welcome follow on questions worthy of closer examination. Table of Contents What drives and impacts share price for aircraft lessors? 3 An AerCap case study Asset growth helps drive earnings and ultimately, share price What are investors concerned about? 6 Will higher interest rates impact aircraft lessors? Is there or will there be an oversupply of aircraft in the market? Valuations: HK aircraft lessors are undervalued and are poised for a re-rating 8 HK listed aircraft lessors are trading at attractive valuations versus peers Top pick BOC Aviation with CALC also rated a BUY Global travel demand robust in the first five months of Asia-Pacific and China lead with double-digit growth IATA upgrades forecasts for industry earnings but regional divergence remains HK-listed lessors well positioned to grow firmly 12 Asian and Chinese lessors feature prominently globally BOC Aviation interim update: Ramping up aircraft acquisitions to drive earnings growth CALC interim update: Primed for robust long-term growth Company Guide Profiles BOC Aviation 15 China Aircraft Leasing 23 Page 2

3 Industry Focus Aircraft Leasing What drives and impacts share price for aircraft lessors? A study on AerCap to see what drives a lessor s share price Given BOC Aviation and CALC s relatively short listing history (they were listed in 2016 and 2014 respectively), we look towards AerCap, the world s largest aircraft leasing company and listed on the NYSE, to decipher what drives and impacts an aircraft lessor s share price. The chart below and accompanying notes recount key events that impacted AerCap s share price performance since it was listed. AerCap has generally outperformed the Dow Jones Industrial Average index when reporting strong earnings and underperformed in times of weaker profitability. Notably, AerCap saw a 33% overnight increase in its share price after it announced the acquisition of International Lease Finance Corporation (ILFC) for a total consideration, including debt, of US$26bn to become the world s largest aircraft lessor. More details on AerCap s share price drivers and the ILFC transaction in the following pages. AerCap's share price vs Dow Jones Industrial Average 25,000 23,000 21,000 19,000 17,000 15,000 13,000 11,000 9,000 7,000 5,000 b c d e f h g i Nov 06 Feb 07 May 07 Aug 07 Nov 07 Feb 08 May 08 Aug 08 Nov 08 Feb 09 May 09 Aug 09 Nov 09 Feb 10 May 10 Aug 10 Nov 10 Feb 11 May 11 Aug 11 Nov 11 Feb 12 May 12 Aug 12 Nov 12 Feb 13 May 13 Aug 13 Nov 13 Feb 14 May 14 Aug 14 Nov 14 Feb 15 May 15 Aug 15 Nov 15 Feb 16 May 16 Aug 16 Nov 16 Feb 17 May 17 j k l m DJIA (LHS) AerCap US$ (RHS) Source: Thomson Reuters, DBS Bank Estimates a) AerCap IPOs on 21 November 2006 at US$23 per share, with a market cap of c. US$1.5bn b) FY2006 EPS growth of 76% y-o-y c) 2Q07 EPS declines 11% y-o-y to $0.40, including $0.28 in non-recurring interest expense d) Dow Jones Industrial Average exceeds 14,000 e) Start of subprime crisis in the US f) Lehman Brothers file for bankruptcy g) Dow Jones Industrial Average reaches a trough of around 6,600 h) EPS for AerCap remains generally flat though i) EPS declines and ROE stays depressed at less than 8% in 2011 and 2012 j) Earnings start to improve markedly from 2Q13 onwards k) Announces the US$26bn acquisition (including US$21bn debt) of ILFC for cash and shares l) EPS jumps 78% y-o-y for FY14 m) EPS improves 26% y-o-y Page 3

4 China / Hong Kong Industry Focus Aircraft Leasing The transformative ILFC transaction. On 16 December 2013, AerCap announced that will acquire 100% of ILFC from AIG for US$3bn in cash and US$2.43bn in AerCap shares. Including the assumption of ILFC s debt of c. US$21bn, the total enterprise value of the transaction was US$26bn still the largest ever transaction in aircraft leasing. This transaction led to the formation of the world s largest aircraft lessor with an existing fleet of over 1,300 aircraft and an order book of 385 aircraft, and an airline customer base of over 200. The combined entity had aircraft assets of over US$35bn (total assets of c. US$41bn), with total debt of c. US$31bn and equity of US$5bn to US$6bn. The transaction was completed in 2Q14. AerCap s book value per share rose from US$21.31 as at end-2013 to US$37.04 by end Earnings accretion mainly from higher leverage. The ILFC acquisition was highly earnings accretive for AerCap shareholders (EPS improved from US$2.54 per share for FY13 to US$4.54 for FY14), which can be substantially attributed to the increase in AerCap s leverage to fund the transaction. AerCap s adjusted debt-to-equity ratio rose from 2.6x at the end of 2013 to 3.7x at the end of June 2014 (the quarter the ILFC transaction was completed). Other factors that helped lift EPS was the fact that ILFC s fleet was older, which thus generated a higher margin, and that the greater combined business benefitted from economies of scale and operating leverage. AerCap s share price vs EPS (correlation = 91%) Source: Thomson Reuters, DBS Bank estimates Unsurprisngly, AerCap s share is highly correlated and largely driven by its Earnings Per Share, with the exception of periods of exceptional market volatility, being namely the GFC in and stock market sell-off in Meanwhile, AerCap s share price also has a strong correlation with book value per share, though not as strong as that with EPS, due to the fluctuation in AerCap s ROE over the period AerCap s share price vs BVPS (correlation = 84%) 60.0 GFC AerCap Share Px (LHS) stock market sell off EPS (RHS) AerCap Share Price Source: Thomson Reuters, DBS Bank estimates Book Value per share Page 4

5 Industry Focus Aircraft Leasing Asset growth helps drive earnings and ultimately, share price Based on AerCap s key operating and performance metrics, we make several observations about what impacts and drives its earnings. The margin (defined as basic lease rents less interest expense divided by aircraft assets) that AerCap makes on its aircraft portfolio holds fairly steady through periods of relatively higher or lower interest costs, and is more impacted by the average age of its portfolio. Generally speaking, the older the portfolio, the better the margin and vice versa. We also note that AerCap has been growing its book value per share steadily over the years through retained earnings (AerCap has not paid any dividends since its IPO in 2006) as well as through share buybacks. AerCap s gearing vs. ROE Debt to Equity (LHS) ROE (RHS) Source: AerCap, DBS Bank estimates 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Unsurprisingly, the higher the leverage that AerCap employs, the higher the ROE it usually generates (The depressed ROE of 7.4% and 7% AerCap reported in 2011 and 2012 included some one-off charges). Notably, the highly successful ILFC acquisition was achieved on the back of AerCap utilising leverage to fund the transaction. Given that margins for aircraft leasing are relatively stable, we conclude that asset growth, with the appropriate level of leverage, would be the key driver for a lessor s earnings, and therefore a critical factor for (a listed lessor s) share price. Key operating and performance metrics for AerCap (2007 to 2016) FYE Dec BVPS (US$) EPS (US$) Growth 60.9% -19.4% 8.4% -6.7% -35.4% 6.0% 105% 78.7% 26.0% -3.5% ROAE 22.2% 14.8% 13.9% 12.2% 7.4% 7.0% 12.7% 15.6% 14.5% 12.3% Lease yield 16.4% 14.6% 12.8% 12.2% 12.0% 11.9% 11.6% 12.8% 12.8% 12.6% Margin 10.0% 10.1% 10.2% 9.2% 9.0% 8.7% 8.6% 9.8% 9.8% 9.5% Debt to equity ratio Avg owned fleet age Source: AerCap, DBS Bank Estimates Page 5

6 China / Hong Kong Industry Focus Aircraft Leasing What are investors concerned about? Will higher interest rates impact aircraft lessors? In a rising interest rate environment, investors are naturally worried if it may negatively impact aircraft lessors. However, we believe rising interest rates should not affect lessors very materially as they are generally able to pass on the higher debt funding costs to airline customers. Firstly, AerCap s share price had a negative correlation of just 5% compared with the 6-month LIBOR in the last decade. AerCap s share price vs 6M LIBOR (correlation = -5%) Secondly, aircraft lessors generally have in place a) natural hedging, which means having a fixed rate debt that match with fixed rate leases and floating rate leases that match with floating rate debt and b) aircraft lessors also actively hedge a large proportion of any mismatch e.g. fixed rate leases with floating rate debt in a rising interest rate environment. In the case of CALC, less than a quarter of its owned portfolio is not naturally matched or hedged, and these could be further dealt with through disposal or securitisation. For BOCA, it has significantly matched or hedged its interest rate exposure, and a 25-basis point increase in interest rates would have impact its earnings by just $0.1m (0.03% of earnings). BOCA s proportion of fixed vs floating rate leases % 74% 65% 56% 46% % 26% 35% 44% 54% AerCap Share Price US$ (LHS) 6M LIBOR % (RHS) Source: Thomson Reuters, DBS Bank estimates CALC s interest rate exposure Fixed rate leases Floating rate leases Source: BOCA BOCA s proportion of fixed vs floating rate debt Fixed rental vs floating interest not hedged 19 57% Securitised (Realisation) 21 89% 86% 88% 80% Floating rental vs floating interest 3 Fixed rental vs floating interest with hedging Source: CALC Fixed rental vs fixed interest % 11% 14% 12% 20% Fixed rate debt Floating rate debt Source: BOCA Page 6

7 Industry Focus Aircraft Leasing Is there or will there be an over-supply of aircraft in the market? There are currently about 16,000 aircraft on order, which is dominated by Airbus and Boeing. As at 30 June 2017, Airbus had an aircraft order backlog of 6,771 aircraft while Boeing s backlog stood at 5,774 aircraft. This has sparked concern from investors that we could be entering a period of aircraft oversupply. We believe such concerns are overblown. Global passenger load factors have been climbing in the last decade, and have held above 80% in the last few years, compared with c. 76% ten years ago. This is because travel demand has been growing quicker than seat growth and it indicates that the supply-demand dynamics of aircraft is currently very healthy. Global Passeger Load Factor (Monthly) 90.0% Looking ahead as well, we believe persistent oversupply of aircraft globally is unlikely as well. While the current order book of aircraft seems like a large number, it should be readily absorbed by the market due to the growth in travel demand as well as aircraft replacement demand. According to Boeing, of the nearly 40,000 new aircraft expected to be delivered between 2016 to 2035, c. 43% or almost 17,000 aircraft are to replace the existing base fleet, while another nearly 23,000 aircraft are to meet growth demand. Global aircraft demand 42.6% of new aircraft deliveries are to replace retired aircraft 22, % 22,510 16, % 75.0% 70.0% 65.0% Jan 06 Sep 06 May 07 Jan 08 Sep 08 May 09 Jan 10 Sep 10 May 11 Jan 12 Sep 12 May 13 Jan 14 Sep 14 May 15 Jan 16 Sep 16 May 17 Source: IATA, DBS Bank estimates Seat Growth vs RPK Growth 10.0% 8.0% Source: Boeing CMO (July 2016) 5, F Base Fleet Replacement Demand Growth Demand Meanwhile, while aircraft orders tend to be quite volatile and lumpy, the growth in delivery of aircraft (from Airbus and Boeing) has been much smoother and as mentioned, generally not exceeded that of demand growth. Combined orders and deliveries for Airbus and Boeing 3,500 3,000 2, % 2, % 2.0% 0.0% -2.0% Seat Growth RPK Growth Source: CAPA, IATA, DBS Bank Estimates; *IATA Estimates 1,500 1, Orders Deliveries Source: Airbus, Boeing Page 7

8 China / Hong Kong Industry Focus Aircraft Leasing Valuations: HK aircraft lessors are undervalued and are poised for a re-rating HK-listed aircraft lessors are trading at attractive valuations versus their aviation peers in Hong Kong Despite delivering strong earnings growth for 2016, both BOCA and CALC s share price performance since the beginning of 2017 has been unexciting. In fact, both of their share prices have lagged behind that of the Hang Seng Index, as well as other aviation plays listed in Hong Kong. BOCA s share price is up by 5.5% YTD and for CALC, it is up by 9.1%. This pales in comparison to the HSI s 20.3% gain, and 29.7% for Air China and over 60% for Beijing Capital International Airport. BOCA and CALC share price performance YTD (relative) 180% As a result, BOCA and CALC are now trading at the lowest PE among HK aviation plays despite having better-than-average earnings growth and offering high dividend yields. Based on consensus estimates, BOCA is trading at 7.5x FY17F PE, declining to 6.4x FY18 PE against a FY16-18F EPS CAGR of 15%, and offering a FY17F dividend yield of 3.8%. Meanwhile, CALC is trading at 9x FY17F PE, declining to 7.3x FY18F PE against FY16-18F EPS CAGR of 12, and offering a very attractive dividend yield of 5.9%. From a P/BV vs ROE perspective, BOCA and CALC are also undervalued versus their fellow HK-listed aviation plays. Both of these names have a higher ROE compared to other aviation names trading at a similar price-to-book. P/BV vs ROE for selected HK-listed aviation plays 25.0% 170% 160% 20.0% CALC 150% 140% 130% 120% ROE 15.0% 10.0% BOC Aviation CEA CSA BCIA Air China Travelsky 110% 100% 5.0% 90% 80% Jan/2017 Feb/2017 Mar/2017 Apr/2017 May/2017 Jun/2017 Jul/2017 BOCA CALC Air China BCIA Travelsky HSI Source: Thomson Reuters, DBS Bank estimates 0.0% P/B Source: Thomson Reuters, DBS Bank estimates Hong Kong-listed aviation plays valuation table (consensus estimates) 25-Jul-17 Mkt Cap PER EPS Price-to-Book ROE Crnt Company Last Px US$m Hist Crnt Forw CAGR Hist Crnt Hist Crnt Yield Cathay Pacific Airways HKD , % % -2.0% 0.2% Air China Ltd HKD , % % 9.8% 1.8% China Eastern Airlines HKD , % % 11.6% 2.2% China Southern Airlines HKD , % % 11.4% 1.9% Beijing Capital Intl Airport HKD , % % 11.1% 2.0% TravelSky Technology Ltd HKD , % % 15.9% 1.4% CALC HKD % % 20.7% 5.9% BOC Aviation HKD , % % 13.0% 3.8% Average % % 11.4% 2.4% Source: Thomson Reuters, DBS Bank Estimates Page 8

9 Industry Focus Aircraft Leasing and aircraft leasing peers in the US. Among US- and HK-listed aircraft leasing companies, BOCA is trading at the lowest FY17F PE of 7.5x despite offering above peer average EPS growth. CALC, at 9.1x FY17F PE, is also trading below the sector average PE of 9.5x FY17F PE. In terms of dividend yield, CALC offers the highest yield among lessors (with a payout ratio of 50%) at 5.9% for FY17F while BOCA s dividend yield (at a payout ratio of 30%) of 3.8% is also above the peer average of 2.5%. Against fellow lessors, BOCA s share price is up by 5.5% YTD and for CALC, it s up by 9.1%. This lags behind AerCap s 18.7% gain this year, Air Lease s 16.5% gain and even AirCastle s 10.5% improvement, despite strong earnings performance and outlook. Aircraft leasing companies valuation table (consensus estimates) 25-Jul-2017 Mkt Cap PER EPS Price-to-Book ROE Crnt Company Last Px US$m Hist Crnt Forw CAGR Hist Crnt Hist Crnt Yield AerCap Holdings NV USD , % % 10.8% 0.0% Air Lease Corp USD , % % 9.7% 0.7% Aircastle Ltd USD , % % 9.6% 4.4% FLY Leasing Ltd USD % % 6.3% 0.0% CALC HKD % % 20.7% 5.9% BOC Aviation HKD , % % 13.0% 3.8% Average % % 11.7% 2.5% Source: Thomson Reuters, DBS Bank Estimates Top Pick BOC Aviation with CALC also rated a BUY BOC Aviation is our Top Pick in the aviation sector. BOCA is well positioned to deliver firm double-digit earnings growth over the next few years as it optimises and raises its gearing to more aggressively grow its aircraft portfolio. We see current valuations as very attractive at 7.4x FY17F PE declining to 6.1x FY18 PE on 14% EPS CAGR over FY16-19F, and at less than 1x FY17F P/BV against 13.5% ROE. The stock also offers a good yield of 4%. We re-iterate our BUY call on BOCA with a target price of HK$54.10, based on 1.3x P/BV against a projected FY17F ROE of 13.5%. Where we differ: Our FY18 and FY19 forecasts are higher than consensus as we believe BOCA can grow its aircraft portfolio more quickly than expected over the next few years. We project its aircraft portfolio to nearly double from HK$10.4bn at end-2016 to HK$20.3bn by end-2019f. CALC offers a unique a combination of high yield and high growth. As a leading independent Chinese lessor with a growing global presence, CALC is poised to record firm double-digit EPS growth over the next few years, driven by both organic (delivery from Airbus) and inorganic (purchaseand-leasebacks) growth in its aircraft portfolio. Coupled with an attractive prospective dividend yield of 5.7% that is growing quickly, we rate CALC a BUY with HK$12 TP. Where we differ: Our FY18 and FY19 forecasts are slightly lower than consensus as we have more conservation revenue growth assumptions. There could be upside to our forecasts if its aircraft disassembly joint venture can make significant contributions to CALC s bottom line from 2018 onwards. Potential catalysts: CALC s share price should re-rate as it delivers strong earnings growth and/or as it executes on ARI, its aircraft disassembly and used aircraft leasing joint venture. Potential catalysts: BOCA's share price should re-rate as it delivers strong earnings growth and/or as it grows its aircraft portfolio more aggressively. Page 9

10 China / Hong Kong Industry Focus Aircraft Leasing Global travel demand remains robust Asia-Pacific and China lead with double-digit growth Global air passenger traffic rose 7.9% y-o-y in the first five months of the year. According to IATA, global air passenger traffic (as measured by Revenue Passenger Kilometres) rose by 7.9% in the first five months of 2017, against capacity growth of 6% y-o-y and a load factor improvement of 1.4ppt to 80.4%. Monthly RPK Growth Total Market and Asia-Pacific of 8.7%. Load factors for the top three regions of Asia-Pacific, North America and Europe continue to hold well above 80%. While the Middle East region saw firm traffic growth of 8% y- o-y from January to May, this was outpaced by capacity growth and load factor fell to 74.4% (-0.3ppt). The region s performance has been in recent months hampered by several disruptive factors, which may take time to clear up. China s robust domestic market RPK growth and PLF 16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% 2.0% Jan 12 May 12 Sep 12 Jan 13 May 13 Sep 13 Jan 14 May 14 Sep 14 Jan 15 May 15 Sep 15 Jan 16 May 16 Sep 16 Jan 17 May 17 Total Market Asia Pacific 85% 84% 83% 82% 81% 80% 79% 78% 77% 76% Mar 12 Jun 12 Sep 12 Dec 12 Mar 13 Jun 13 Sep 13 Dec 13 Mar 14 Jun 14 Sep 14 Dec 14 Mar 15 Jun 15 Sep 15 Dec 15 Mar 16 Jun 16 Sep 16 Dec 16 Mar 17 3M avg PLF (LHS) 3M avg RPK growth (RHS) 18% 16% 14% 12% 10% 8% 6% 4% 2% 0% Source: IATA, DBS Bank Estimates Air Passenger Market First five months of 2017 Region RPK ASK PLF PLF Chg Africa 8.5% 3.8% 69.7% +3.0ppt Asia-Pacific 10.5% 7.7% 80.8% +2.1ppt Europe 8.7% 6.1% 81.7% +2.0ppt Latin America 6.6% 4.0% 81.4% +2.0ppt Middle East 8.0% 8.4% 74.4% -0.3ppt North America 3.8% 3.3% 82.3% +0.4ppt Total Market 7.9% 6.0% 80.4% +1.4ppt Source: IATA Source: IATA, DBS Bank Estimates China s domestic market continues its stellar performance. Air travel in China s domestic market grew by 14.7% in the first five months of 2017, extending the strong growth seen since the second half of Passenger load factor in China s domestic market was also exceptionally strong, hitting 84.2% for the first five months of Lower airfares have continued to spur demand. According to IATA, after adjusting for inflation, the price of air travel coming into 2Q17 was about 6% lower y-o-y, which has helped travel growth remain above the 10-year average growth of 5.5%. Asia-Pacific led traffic growth across all regions, registering a robust 10.5% growth in the first five months of 2017, with load factor improving to a healthy 80.8% (+2.1ppt). Meanwhile, Europe also posted very strong YTD traffic growth Page 10

11 Industry Focus Aircraft Leasing On 5 June 2017, IATA raised its 2017 industry profit forecast for airlines to US$31.4bn from US$29.8bn previously on revenues of US$743bn, up from US$736bn in the previous forecast. While the US$31.4bn profit forecast for 2017F represents a 9.8% y-o-y decline from 2016, it represents the third consecutive year the industry is posting a return that is above its cost of capital. Net post tax profit for Airline industry (US$bn) There is, however, quite a divergence in terms of projected airline industry earnings regionally. North America is forecasted to have the healthiest level of profit among all regions, accounting for nearly half of global profit while Europe and Asia-Pacific are expected to have nearly 24% of global profit. Meanwhile, just 3% of global profit is projected to come from Latin America and the Middle East. Projected airline industry profit by region in 2017F Source: IATA The higher industry profit forecast was a result of IATA raising its travel demand (RPK) growth expectation substantially, as a result of expected stronger global economic growth. IATA raises forecasts for Airline sector North America Source: IATA From another perspective, airlines in North America are expected to make double the industry average net profit per passenger, while other regions lag far behind. 0.8 Europe Asia Pacific Latin America Net post tax profit per passenger 2017F 0.4 Middle East 0.1 Africa % chage or % of revenues GDP Pax Yields RPKs ASKs Operating Margins Previous Forecast Current Forecast Source: IATA Source: IATA Page 11

12 China / Hong Kong Industry Focus Aircraft Leasing HK-listed lessors well positioned to grow firmly Asian and Chinese lessors feature prominently globally While AerCap and GECAS continue to dominate the sector in the top 2 positions, with more than double the aircraft of their nearest rivals, the rest of the chasing pack feature plenty of Asian, and in particular, Chinese names. The ongoing acquisition of AWAS by DAE (Dubai Aerospace Enterprise) when completed, will also propel the Middle Eastern player into the global top 10. Top 12 lessors by seats globally (including orders) BOC Aviation s Net Book Value of Aircraft (US$m) 25,000 20,000 15,000 10,000 5,000 Lessor In-service On order Total AerCap 199,617 80, ,564 GECAS 182,611 80, ,220 Air Lease Corporation 48,423 87, ,727 Avolon 89,543 41, ,589 SMBC Aviation Capital 62,362 38, ,257 BOC Aviation 60,995 38,051 99,046 ICBC Leasing 57,841 26,302 84,143 Aviation Capital Group 36,946 25,512 62,458 China Aircraft Leasing 13,995 34,450 48,445 AWAS* 40,353 2,733 43,086 Aircastle 35,217 3,175 38,392 Source: CAPA, *Pending acquisition by DAE. As at 20 June 2017 Backed by firm orders and supplemented by the acquisition of pop-ups and purchase-and-leasebacks, both BOC Aviation and China Aircraft Leasing Group (CALC) are poised to post robust growth in their respective aircraft portfolios and gain market share (in a relatively fragmented market) over the next few years. BOCA s owned aircraft portfolio to almost double by With a significant number of deliveries of aircraft from its firm order book of 196 aircraft as at 30 June 2017, which should be further bolstered by purchase-and-leaseback transactions, we project BOCA s aircraft portfolio to grow from a net book value of US$10.4bn as at end-2016 to US$13.8bn in 2017F, US$17.1bn by end-2018f and US$20.3bn by end-2019f. This represents a near doubling of its owned aircraft portfolio in three years, and will be funded solely through debt and retained earnings. 0 Source: BOCA, DBS Bank Estimates CALC s owned aircraft portfolio to also grow quickly. CALC s owned aircraft portfolio, made up of finance lease receivables and net book value of aircraft on operating leases, is also expected to rise at a CAGR of 16% from 2016 to 2019 to a total of c. HK$33bn. This represents a nearly 60% increase over the three-year period. CALC s owned aircraft portfolio (HK$m) 35,000 30,000 25,000 20,000 15,000 10,000 5, F 2018F 2019F F 2018F 2019F Finance lease receivables, net Source: CALC, DBS Bank Estimates Net book value of aircraft Page 12

13 Industry Focus Aircraft Leasing BOCA interim update: Ramping up aircraft acquisitions to drive earnings growth Projected delivery schedule for BOCA 60 Owned fleet has grown to 261 aircraft by end-1h17 from 246 aircraft six months ago. In a recent operational update for the quarter ending June 2017, BOCA reported that its owned fleet had grown to 261 aircraft, representing a net increase of 15 aircraft over the last six months. The group took delivery of 37 aircraft in the first half of 2017 (including three acquired by airline customers on delivery) and sold 19 owned aircraft during this period BOCA s owned aircraft fleet as at period end H Source: Company, DBS Bank estimates As at 30 June 2017, BOCA expects to receive a total of 80 aircraft for delivery in 2017 with a firm order book of 196 aircraft to be delivered over the next five years. At the recent Paris Airshow, BOCA also signed an MOU with Boeing for ten B737-MAX 10s, with details and delivery dates yet to be firmed up FY15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 Source: Company, DBS Bank estimates At the same time, BOCA has also been reducing the number of regional jets (Embraer E190s) in its portfolio, with a higher mix towards widebodies and freighters. Expect more PLBs and pop-ups. BOCA has also been adding to both its order book and portfolio through pop-up orders from the manufacturers and purchase-and-leasebacks (PLBs) respectively. We expect this trend to continue as BOCA looks to continue to grow its aircraft portfolio. Purchase-and-leasebacks and Pop-ups 25 BOCA s owned aircraft fleet as at period end 21 Fleet breakdown 1H16 FY16 1H17 Narrowbody jets Regional jets Widebody jets Freighters Total % Narrowbody jets 82.7% 83.3% 83.5% Regional jets 4.9% 4.5% 1.9% Widebody jets 11.5% 11.4% 13.0% Freighters 0.9% 0.8% 1.5% Source: Company, DBS Bank estimates Q16 2Q16 3Q16 4Q16 1Q17 2Q17 Source: Company, DBS Bank estimates Page 13

14 China / Hong Kong Industry Focus Aircraft Leasing CALC interim update: Primed for robust long-term growth Aggressively growing aircraft portfolio organically and inorganically: Based on current deliveries and orders, CALC s aircraft portfolio is set to grow to 110 aircraft by end-2017, from 81 aircraft at the end of As at June 2017, CALC s aircraft portfolio stood at 90 and growth is expected to accelerate as it takes delivery of more aircraft from OEMs and completes more aircraft purchases, such as the two aircraft recently bought from BOC Aviation. CALC s Fleet Expansion Plan (Base Case, firmed orders) Another strong year for sale of finance lease receivables: CALC continues to execute strongly on the securitisation of its finance lease receivables, having already chalked up the sale of ten finance lease receivables in the first six months of 2017, and is well on track to exceed 2016 s figure of 14. Aircraft disassembly joint venture progressing well: Meanwhile, CALC s 48% owned Aircraft Recycling International (ARI), is making good progress in terms of both its aircraft disassembly business as well as old aircraft leasing, which focuses on the leasing and trading of aircraft that are in their second lease cycle or older. Firstly, construction of ARI s aircraft disassembly should be completed in 3Q17, and will commence testing in 4Q17. Secondly, the acquisition of Universal Asset Management (UAM), which has 25 years of experience and track record of disassembling over 300 aircraft, will also greatly boost the feasibility, reputation and customer reach of ARI. ARI s Harbin aircraft recycling centre Source: Company, DBS Bank estimates With the recent order of 50 Boeing 737 MAXs, CALC will now take delivery of 138 new aircraft over the next few years, and has a base case of reaching 232 aircraft by However, we expect the growth in CALC s aircraft portfolio to be quicker than this as it looks to continue to add through either pop-ups or secondary purchases (purchase-andleasebacks or portfolio trades). Number of finance lease receivables sold Source: Company, DBS Bank estimates At the same time, ARI s old aircraft leasing and trading business in Tianjin has also taken off. This business currently has four aircraft leased to Sichuan Airlines (one of which is under a joint venture) and has also recently acquired six aircraft from Xiamen Airlines, which will be either traded or disassembled. Source: Company, DBS Bank estimates We currently have not factored in any contribution from ARI to CALC but it is likely that ARI can make significant positive contributions to CALC s bottom line in the long run. Page 14

15 China / Hong Kong Company Guide BOC Aviation Ltd Version 4 Bloomberg: 2588 HK Equity Reuters: 2588.HK Refer to important disclosures at the end of this report DBS Group Research. Equity 26 Jul 2017 BUY Last Traded Price ( 25 Jul 2017):HK$40.65 (HSI : 26,852) Price Target 12-mth: HK$54.10 (33% upside) Analyst Paul YONG CFA paulyong@dbs.com What s New BOC Aviation is our preferred proxy to ride on strong travel demand growth globally Aggressive aircraft acquisitions to drive 14% EPS CAGR over FY16-19F and ROE increase to 15% Valuation very attractive at 7.4x FY17F PE and less than 1x FY17F P/BV, with a dividend yield of 4% Maintain BUY and HK$54.10 TP (1.3x P/BV) Price Relative Top Pick in Aviation Reiterate BUY, TP HK$ BOC Aviation (BOCA) is well positioned to deliver firm double-digit earnings growth over the next few years as it optimises and raises its gearing to more aggressively grow its aircraft portfolio. We see current valuations as very attractive at 7.4x FY17F PE declining to 6.1x FY18 PE on 14% EPS CAGR over FY16-19F, and at less than 1x FY17F P/BV against 13.5% ROE. The stock also offers a good yield of 4%. Where we differ: Our FY18 and FY19 forecasts are higher than consensus as we believe BOCA can grow its aircraft portfolio more quickly than expected over the next few years. We project its aircraft portfolio to nearly double from US$10.4bn at end-2016 to US$20.3bn by end-2019f. Potential catalysts: BOC Aviation s share price should re-rate as it delivers strong earnings growth and/or as it grows its aircraft portfolio more aggressively. Forecasts and Valuation FY Dec (US$ m) 2016A 2017F 2018F 2019F Turnover 1,193 1,419 1,816 2,213 EBITDA 1,086 1,313 1,685 2,058 Pre-tax Profit Net Profit Net Profit Gth (%) EPS (US$) EPS (HK$) Core EPS Gth (%) DPS (HK$) BV Per Share (HK$) PE (X) EV/EBITDA (X) Net Div Yield (%) P/Book Value (X) Net Debt/Equity (X) ROAE (%) Earnings Rev (%): (0.4) (0.5) new Consensus EPS (US$) Other Broker Recs: B: 9 S: 0 H: 2 Source of all data on this page: Company, DBSV, Thomson Reuters, HKEX Aircraft acquisitions to drive 14% EPS CAGR over FY16-19F. We project BOCA s EPS to grow at a 14% CAGR over FY16-19F, driven by rising lease revenue income to nearly US$2.1bn by 2019F from US$1.05bn in 2016 as BOCA grows its aircraft portfolio. We believe there is upside risk to our numbers as our aircraft acquisition assumptions only take the group s gearing to 3.4x by 2019F versus a long-term target of 3.5x to 4x. Valuation: Target price of HK$54.10 based on 1.3x FY17 P/BV. Taking into account the quality of its aircraft portfolio against its peers, we believe that BOCA should have an implied cost of equity of 10.5% and hence be valued based on 1.3x P/BV against its projected 13.5% ROE. Key risks: In our view, these include a) intense competition for aircraft investments, b) a spike in interest rates, and c) unfavourable demand-supply dynamics. At A Glance Issued Capital (m shrs) 694 Mkt. Cap (HK$m/US$m) 28,218 / 3,614 Major Shareholders Bank of China Group (%) 70.0 Free Float (%) m Avg. Daily Val. (US$m) 3.7 ICB Industry : Industrials / Industrial Transportation ASIAN INSIGHTS VICKERS SECURITIES ed-th / sa- AH

16 Company Guide BOC Aviation Ltd WHAT S NEW Ramping up aircraft acquisitions to drive earnings growth Projected delivery schedule for BOCA Owned fleet has grown to 261 aircraft by end-1h17 from 246 aircraft six months ago: In a recent operational update for the quarter ending June 2017, BOCA reported that its owned fleet had grown to 261 aircraft, representing a net increase of 15 aircraft over the last six months. The group took delivery of 37 aircraft in the first half of 2017 (including three acquired by airline customers on delivery) and sold 19 owned aircraft during this period Aircraft portfolio has grown quickly since IPO. Since BOCA s IPO in June 2016, its owned aircraft portfolio has grown by 35 aircraft from 226 at the end of June 2016 to 261 aircraft at the end of June BOCA s owned aircraft fleet as at period end FY15 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 Source: Company, DBS Bank estimates H Source: Company, DBS Bank estimates As at 30 June 2017, BOCA expects to receive a total of 80 aircraft for delivery in 2017 with a firm order book of 196 aircraft to be delivered over the next five years. At the recent Paris Airshow, BOCA also signed an MOU with Boeing for ten B737-MAX 10s, with details and delivery dates yet to be firmed up. Expect more PLBs and pop-ups. BOCA has also been adding to both its order book and portfolio through pop-up orders from the manufacturers and purchase-and-leasebacks (PLBs) respectively. We expect this trend to continue as BOCA looks to continue to grow its aircraft portfolio. Purchase-and-leasebacks and Pop-ups At the same time, BOCA has also been reducing the number of regional jets (Embraer E190s) in its portfolio, with a higher mix towards widebodies and freighters BOCA s owned aircraft fleet as at period end Fleet breakdown 1H16 FY16 1H17 Narrowbody jets Regional jets Widebody jets Freighters Total % Narrowbody jets 82.7% 83.3% 83.5% Regional jets 4.9% 4.5% 1.9% Widebody jets 11.5% 11.4% 13.0% Freighters 0.9% 0.8% 1.5% Source: Company, DBS Bank estimates 0 0 1Q16 2Q16 3Q16 4Q16 1Q17 2Q17 Source: Company, DBS Bank estimates ASIAN INSIGHTS VICKERS SECURITIES Page 16

17 Company Guide BOC Aviation Ltd CRITICAL FACTORS TO WATCH Net book value of aircraft (US$ m) Critical Factors Growth in lease rental income to be mainly driven by expanding aircraft portfolio. With a significant number of deliveries of aircraft from its firm order book, which should be further bolstered by purchase-and-leaseback transactions, we project BOCA s aircraft portfolio to grow from a net book value of US$10.4bn as at end-2016 to US$13.8bn in 2017F, US$17.1bn by end-2018f and US$20.3bn by end-2019f. Following its IPO in June 2016 which raised c. US$550m in new equity, BOCA s gearing stood at 2.6x debt-to-equity, well below management s long-term target of 3.5x to 4x. Hence, the projected robust growth in BOCA s aircraft portfolio will be funded by an increase in gearing towards 3.4x by 2019F, as well as by retained earnings. Lease rate factor to rise along with cost of debt. Given the rising interest rate environment, we have assumed that the average lease rate factor for BOCA will rise from 10.4% in 2016 to 10.8% in 2017F, 11% in 2018F, and 11.2% in FY19F while at the same time, we expect cost of debt to rise from 2.4% in 2016 to 2.8% in 2017F, 3.3% in 2018F and 3.8% in FY19F. Coupled with the expected growth in BOCA s aircraft portfolio, we project the company's lease rental income to grow at a 26% CAGR from US$1,048m in 2016 to US$2,086m by 2019F. Steady gains on aircraft disposal assumed. We have assumed that BOCA will dispose c. US$14bn net book value worth of aircraft between 2017F and 2019F, with a margin on net book value of 5%. This translates to gains on sale of aircraft of c. US$70m per annum between 2017F and 2019F. Stable depreciation costs and operating leverage. As a percentage of lease rental income, we project depreciation costs to decline marginally (given higher average lease rate factors) from 36% in 2016 to 35% in 2017F and 34% in 2018F and 2019F (our assumption for depreciation is c. 3.4% of average gross book value of aircraft). Meanwhile, as a percentage of total revenue, we project SG&A expenses (which include staff costs, travelling and marketing expenses, as well as other operating expenses), to decline marginally over time, from 6.3% in 2016 down to 5.8% in 2017F, 5.6% in 2018F and 5.5% in 2019F. Lease rate factor (%) Sale of aircraft at net book value (US$ m) Trading gain margin (%) Cost of Debt (%) Source: Company, DBS Vickers ASIAN INSIGHTS VICKERS SECURITIES Page 17

18 Company Guide BOC Aviation Ltd Appendix 1: A look at Company's listed history what drives its share price? BOCA has a relatively short listing history Source: Company, DBS Bank estimates Page 18 ASIAN INSIGHTS VICKERS SECURITIES

19 Company Guide BOC Aviation Ltd Balance Sheet: 94-96% of total assets between F are in aircraft and aircraft progress payments, of which 83-94% are in aircraft assets. The bulk of the remaining 3-4% of total assets consist largely of cash, including restricted cash. Debt ratio to increase through to 2019F as the group moves to optimise its capital structure. While BOCA s debt-to-equity ratio had fallen to 2.6x by end-2016f after raising net IPO proceeds of US$550m, it is expected to increase to c. 3.4x by end-2019f as the group continues to buy aircraft and fund them using a targeted debt-to-equity ratio of : 1. Share Price Drivers: Recommend BUY with TP of HK$ Taking into account P/BV vs ROE for BOCA s peers in aircraft leasing as well as other Asian lessors, plus BOCA s own qualities versus its aircraft leasing peers, we believe that BOCA s cost of equity should be 10.5%, translating into a target of 1.3x P/BV, against a projected ROE of 13.5% for 2017F. Hence, we derive a TP of HK$54.10 for BOCA and this translates to FYE December 2017 PE of 10x, against projected EPS CAGR of 14% over F. We believe BOCA's share price will re-rate as the company delivers on consistent earnings growth, and executes on its growth plans both organically (aircraft deliveries) and inorganically (purchase-and-leasebacks). Leverage & Asset Turnover (x) Capital Expenditure ROE Dividend payout of 30% assumed. We have assumed that BOCA will pay dividends equal to 30% of its profits going forward, as signalled by the dividend paid out in 2016, which was c. 30%. BOCA s dividend policy is to pay out up to 30% of earnings as dividends. Key Risks: Key Risks. 1) Highly competitive environment for aircraft investments could impact BOCA s ability to acquire sufficient aircraft or at a value adequate to reach its targeted returns; 2) A rapidly increasing interest rate environment would lower BOCA s earnings. Company Background BOC Aviation (BOCA) is the largest Asia-headquartered aircraft operating lessor, as measured by the value of owned aircraft. Founded in 1993, BOCA had total assets of US$13.4bn at the end of 2016, and has recorded 23 consecutive years of profit with US$2.5bn in cumulative profits. The company is also among the world s top 6 operating lessors by fleet size (including firm order backlog). Forward PE Band PB Band Source: Company, DBS Vickers ASIAN INSIGHTS VICKERS SECURITIES Page 19

20 Company Guide BOC Aviation Ltd Key Assumptions FY Dec 2015A 2016A 2017F 2018F 2019F Net book value of aircraft (US$ m) 9, , , , ,303.0 Lease rate factor (%) Sale of aircraft at net book value (US$ m) 1, , , , ,400.0 Trading gain margin (%) Cost of Debt (%) Source: Company, DBS Vickers Segmental Breakdown (US$ m) FY Dec 2015A 2016A 2017F 2018F 2019F Revenues (US$ m) Lease Rental Income 975 1,048 1,302 1,691 2,086 Interest and Fee Income Net gain on sale of aircraft Others Total 1,091 1,193 1,419 1,816 2,213 Source: Company, DBS Vickers Income Statement (US$ m) FY Dec 2015A 2016A 2017F 2018F 2019F Revenue 1,091 1,193 1,419 1,816 2,213 Cost of Goods Sold (382) (378) (457) (575) (709) Gross Profit ,241 1,504 Other Opng (Exp)/Inc (120) (107) (105) (131) (156) Operating Profit ,110 1,349 Other Non Opg (Exp)/Inc Associates & JV Inc Net Interest (Exp)/Inc (187) (234) (304) (436) (587) Dividend Income Exceptional Gain/(Loss) Pre-tax Profit Tax (58) (56) (72) (91) (103) Minority Interest Preference Dividend Net Profit Net Profit before Except EBITDA 971 1,086 1,313 1,685 2,058 Growth Revenue Gth (%) EBITDA Gth (%) Opg Profit Gth (%) Net Profit Gth (%) Margins & Ratio Gross Margins (%) Opg Profit Margin (%) Net Profit Margin (%) ROAE (%) ROA (%) ROCE (%) Div Payout Ratio (%) Net Interest Cover (x) Source: Company, DBS Vickers Page 20 ASIAN INSIGHTS VICKERS SECURITIES

21 Company Guide BOC Aviation Ltd Interim Income Statement (US$ m) FY Dec 1H2015 2H2015 1H2016 2H2016 Revenue Cost of Goods Sold (193) (188) (186) (192) Gross Profit Other Oper. (Exp)/Inc (61) (78) (52) (55) Operating Profit Other Non Opg (Exp)/Inc Associates & JV Inc N/A N/A N/A N/A Net Interest (Exp)/Inc (82) (87) (101) (133) Exceptional Gain/(Loss) Pre-tax Profit Tax (28) (30) (27) (28) Minority Interest N/A N/A N/A N/A Net Profit Net profit bef Except Growth Revenue Gth (%) N/A N/A Opg Profit Gth (%) N/A N/A Net Profit Gth (%) N/A N/A Margins Gross Margins (%) Opg Profit Margins (%) Net Profit Margins (%) Source: Company, DBS Vickers Balance Sheet (US$ m) FY Dec 2015A 2016A 2017F 2018F 2019F Net Fixed Assets 11,717 12,605 15,449 18,576 21,569 Invts in Associates & JVs Other LT Assets Cash & ST Invts Inventory Debtors Other Current Assets Total Assets 12,474 13,445 16,312 19,473 22,439 ST Debt Creditors Other Current Liab LT Debt 7,649 7,542 9,892 12,342 14,542 Other LT Liabilities 1,170 1,331 1,501 1,755 2,007 Shareholder s Equity 2,440 3,382 3,719 4,128 4,590 Minority Interests Total Cap. & Liab. 12,474 13,445 16,312 19,473 22,439 Non-Cash Wkg. Capital (227) (277) (287) (335) (384) Net Cash/(Debt) (7,883) (7,635) (9,962) (12,379) (14,607) Debtors Turn (avg days) Asset Turnover (x) Current Ratio (x) Quick Ratio (x) Net Debt/Equity (X) Net Debt/Equity ex MI (X) Capex to Debt (%) Z-Score (X) NA NA NA NA NA Source: Company, DBS Vickers ASIAN INSIGHTS VICKERS SECURITIES Page 21

22 Company Guide BOC Aviation Ltd Cash Flow Statement (US$ m) FY Dec 2015A 2016A 2017F 2018F 2019F Pre-Tax Profit Dep. & Amort Tax Paid 0 (1) (1) (1) (1) Assoc. & JV Inc/(loss) (Pft)/ Loss on disposal of FAs Chg in Wkg.Cap Other Operating CF (42) (89) (13) Net Operating CF ,030 1,359 1,577 Capital Exp.(net) (1,318) (1,200) (3,232) (3,632) (3,632) Other Invts.(net) Invts in Assoc. & JV Div from Assoc & JV Other Investing CF Net Investing CF (1,318) (1,200) (3,232) (3,632) (3,632) Div Paid 0 (42) (125) (144) (174) Chg in Gross Debt 536 (120) 2,350 2,450 2,200 Capital Issues Other Financing CF 0 (29) (30) (30) (30) Net Financing CF ,195 2,276 1,996 Currency Adjustments Chg in Cash (7) 3 (59) Opg CFPS (US$) Free CFPS (US$) (0.67) (0.52) (3.17) (3.28) (2.96) Source: Company, DBS Vickers Target Price & Ratings History HK$ S.No. Date Closing 12-mth Rating Price Target Price 1: 27-Jul-16 HK$37.75 HK$48.40 Buy 2: 30-Aug-16 HK$38.10 HK$48.40 Buy 3: 27-Mar-17 HK$42.00 HK$54.10 Buy Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Source: DBS Vickers Analyst: Paul YONG CFA Page 22 ASIAN INSIGHTS VICKERS SECURITIES

23 China / Hong Kong Company Guide China Aircraft Leasing Group Version 3 Bloomberg: 1848 HK Equity Reuters: 1848.HK Refer to important disclosures at the end of this report DBS Group Research. Equity 26 Jul 2017 BUY Last Traded Price ( 25 Jul 2017):HK$9.29 (HSI : 26,852) Price Target 12-mth: HK$12.00 (29% upside) Analyst Paul YONG CFA paulyong@dbs.com What s New Well positioned for growth in the medium term; backed by firm order book of 138 aircraft Aircraft disassembly joint venture could provide further upside if well executed Attractive dividend yield of 5.7% in FY17F, growing to 6.7% in 2018F and 7.0% in FY19F Maintain BUY with HK$12 TP Price Relative Fast-growing high-yield play Recommend BUY, TP HK$12. As a leading independent Chinese lessor with a growing global presence, CALC is poised to record firm double-digit EPS growth over the next few years, driven by both organic (delivery from Airbus) and inorganic (purchaseand-leasebacks) growth in its aircraft portfolio. Coupled with an attractive prospective dividend yield of 5.7% that is growing quickly, we rate CALC a BUY with HK$12 TP. Where we differ: Our FY18 and FY19 forecasts are slightly lower than consensus as we have more conservation revenue growth assumptions. There could be upside to our forecasts if its aircraft disassembly joint venture can make significant contributions to CALC s bottom line from 2018 onwards. Potential catalysts: CALC s share price should re-rate as it delivers strong earnings growth and/or as it executes on ARI, its aircraft disassembly and used aircraft leasing joint venture. Strong cash position to fund growth. Following a series of fund-raising exercises including the issuance of bonds, medium-term notes and syndicated debt funding during 2016, the group had a cash balance of HK$5.84bn at the end of Forecasts and Valuation FY Dec (HK$ m) 2016A 2017F 2018F 2019F Turnover 2,448 2,865 3,259 3,829 EBITDA 2,085 2,427 2,777 3,293 Pre-tax Profit ,118 1,317 Net Profit ,001 Net Profit Gth (%) EPS (HK$) EPS Gth (%) DPS (HK$) BV Per Share (HK$) PE (X) EV/EBITDA (X) Net Div Yield (%) P/Book Value (X) Net Debt/Equity (X) ROAE (%) Earnings Rev (%): (0.1) 0.4 New Consensus EPS (HK$) Other Broker Recs: B: 6 S: 0 H: 2 Source of all data on this page: Company, DBSV, Thomson Reuters, HKEX Valuation: We value CALC based on a blended valuation of 10x FY18F PE and 2.2x FY18F P/BV to derive a 12-month target price of HK$12. The higher-than-peer average target P/BV multiple of 2.2x reflects the group s industry-leading ROE of over 22%. Key Risks to Our View: CALC derives a substantial portion of its revenues from government subsidies and gains from sale of finance lease receivables and should these fall short of expectations, it would significantly impact the group s earnings. At A Glance Issued Capital (m shrs) 670 Mkt. Cap (HK$m/US$m) 6,292 / 806 Major Shareholders China Everbright Ltd (%) 32.3 Friedmann Pacific A.M. (%) 27.3 Free Float (%) m Avg. Daily Val. (US$m) 1.9 ICB Industry : Industrials / Industrial Transportation ASIAN INSIGHTS VICKERS SECURITIES ed-th / sa- AH

24 Company Guide China Aircraft Leasing Group WHAT S NEW Primed for robust long-term growth Aggressively growing aircraft portfolio organically and inorganically: Based on current deliveries and orders, CALC s aircraft portfolio is set to grow to 110 aircraft by end-2017, from 81 aircraft at the end of As at June 2017, CALC s aircraft portfolio stood at 90 and growth is expected to accelerate as it takes delivery of more aircraft from OEMs and completes more aircraft purchases, such as the two aircraft recently bought from BOC Aviation (BOCA). CALC s Fleet Expansion Plan (Base Case, firmed orders) Another strong year for sale of finance lease receivables: CALC continues to execute strongly on the securitisation of its finance lease receivables, having already chalked up the sale of ten finance lease receivables in the first six months of 2017, and is well on track to exceed 2016 s figure of 14. Aircraft disassembly joint venture progressing well: Meanwhile, CALC s 48%-owned Aircraft Recycling International (ARI), is making good progress in terms of both its aircraft disassembly business as well as old aircraft leasing, which focuses on the leasing and trading of aircraft that are in their second lease cycle or older. Firstly, construction of ARI s aircraft disassembly should be completed in 3Q17, and will commence testing in 4Q17. Secondly, the acquisition of Universal Asset Management (UAM), which has 25 years of experience and track record of disassembling over 300 aircraft, will also greatly boost the feasibility, reputation and customer reach of ARI. ARI s Harbin aircraft recycling centre Source: Company, DBS Bank estimates With the recent order of 50 Boeing 737 MAXs, CALC will now take delivery of 138 new aircraft over the next few years, and has a base case of reaching 232 aircraft by However, we expect the growth in CALC s aircraft portfolio to be quicker than this as it looks to continue to add through either pop-ups or secondary purchases (purchase-andleasebacks or portfolio trades). Number of finance lease receivables sold Source: Company, DBS Bank estimates At the same time, ARI s old aircraft leasing and trading business in Tianjin has also taken off. This business currently has four aircraft leased to Sichuan Airlines (one of which is under a joint venture) and has also recently acquired six aircraft from Xiamen Airlines, which will be either traded or disassembled. We currently have not factored in any contribution from ARI to CALC but it is likely that ARI can make significant positive contributions to CALC s bottom line in the long run. Source: Company, DBS Bank estimates Page 24 ASIAN INSIGHTS VICKERS SECURITIES

25 Company Guide China Aircraft Leasing Group CRITICAL FACTORS TO WATCH Critical Factors Operating assets to rise steadily with the expanding fleet. CALC s fleet, which stands at 81 aircraft at the end of 2016, is expected to nearly triple to 232 aircraft by 2023 through CALC s firm order book of 138 aircraft as at 30 June Driven by this expansion, CALC s main operating assets, made up of finance lease receivables and net book value of aircraft on operating leases, is also expected to rise at a CAGR of 16% from 2016 to 2019 to a total of c. HK$33bn. It should be also noted that we expect the growth to be driven from operating leases while finance leases stay flat. Lease rate factors to remain healthy. Buoyed by robust regional and global aviation markets, we assume that CALC s lease rate factors, both for financial and operating leases, should remain stable or in a slight upward trend. We expect that as CALC attempts to broaden its customer base outside of China, it may have to be more price competitive in terms of operating leases hence our flat assumption. Meanwhile, for finance leases, we have assumed a slight increase in the lease rate given the rising interest rate environment and assuming CALC can pass some of the increase on to customers. Net book value of aircraft (US$ m) 35,000 30,000 25,000 20,000 15,000 10,000 5, F 2018F 2019F Finance lease receivables, net Net book value of aircraft Lease rate factor (%) 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% F 2018F 2019F Finance leases Operating leases Higher gains from sale of finance lease receivables. To augment its earnings and cash flow, CALC consistently disposes of its finance lease receivables to investors such as banks and insurance companies for gains. In March 2015 and January 2016, CALC signed a framework agreement with the Bank of Communications Company Limited and the Shanghai Branch of China Construction Bank for the realisation of lease receivables for 20 aircraft and 15 aircraft respectively. Underpinned by these agreements and given firm demand for such products in China, CALC targets to realise 15 aircraft or more annually from 2017 onwards, and we have assumed that CALC will sell 20 finance lease receivables in 2017, followed by 22 in 2018F and 24 in 2019F. Stable government subsidies assumed. Compared to government subsidies of HK$243m received in 2015 and HK$260m received in 2016, we have assumed that CALC will receive subsidies of HK$260m per annum from 2017F to 2019F. Cost of debt to increase slightly in 2017F. In a rising interest rate environment, we project CALC s cost of debt to rise in 2017F and hold constant, as with the company's increasing scale and improving track record, it should be able access bank loans with lower cost of debt. Additionally, the recent issuance of bonds (at 5.5% to 5.75%) has provided CALC with funds to gradually switch out debt with a higher cost of interest % 5.0% 4.0% 3.0% 2.0% 1.0% 0.0% Sale of aircraft at net book value (US$ m) F 2018F 2019F Cost of Debt (%) F 2018F 2019F Source: Company, DBS Vickers ASIAN INSIGHTS VICKERS SECURITIES Page 25

26 Company Guide China Aircraft Leasing Group CALC s share price has primarily been driven by its earnings performance Source: ThomsonReuters, DBS Bank Estimates Page 26 ASIAN INSIGHTS VICKERS SECURITIES

27 Company Guide China Aircraft Leasing Group Balance Sheet: Due to rising and consistent profits, leverage expected to go down. With the delivery of consistent profits and expected positive operating cash flows from 2017, it is expected that leverage will go down from c. 9x in 2015 to c. 7x in 2018F. Strong cash position as at end Following a series of fund-raising exercises, including the issuance of bonds, medium-term notes and syndicated debt funding during 2016, the group had a cash balance of HK$5.84bn at the end of We believe CALC could use this to more aggressively grow its aircraft asset portfolio beyond the aircraft that will be delivered from Airbus. Leverage & Asset Turnover (x) Capital Expenditure Share Price Drivers: Favourable deals to sell aircraft. Since the group generates a significant amount of revenue and earnings through gains from sale of finance lease receivables, better-than-expected gains from this segment can drive earnings substantially. Aircraft disassembly could be another earnings driver. CALC has a 48% stake in an aircraft disassembly business that is slated for commencement in 2H17, and targets to disassemble up to 20 aircraft per annum in While we have yet to factor contributions from this business into our forecasts, if successfully executed, this could provide further earnings and share price upside. Key Risks: Interest rate impact. CALC is partially vulnerable to higher interest rates as it has not perfectly matched or hedged its leases with its debt. A sharp increase in interest rates could substantially impact CALC s earnings. In the longer term, CALC could also be vulnerable to interest rate volatility if it cannot balance fixed and floating rate debt to match its own fixed and floating rate aircraft leases. Company Background Established in 2006, China Aircraft Leasing Group (CALC) is a leading independent aircraft lessor in China, and also provides customers with aircraft full-life solutions - covering fleet planning consultation, structured financing, fleet replacement package deal and third-party aircraft resale. The group has also made a recent foray into the aircraft disassembly business, which is slated to commence in 2H17. ROE Forward PE Band PB Band Source: Company, DBS Vickers ASIAN INSIGHTS VICKERS SECURITIES Page 27