Financial Institutions Singapore BOC Aviation Limited Credit Report Ratings Overview LTICR ............................................. A- We have assigned a first-time global-scale long-term issuer credit rating (LTICR) of ‘A-’ to BOC Aviation Limited (BOC Aviation) with a Stable Outlook. Outlook ................................... Stable The rating incorporates a standalone credit profile (SACP) of ‘bbb’, which reflects BOC Aviation’s strong operating profile, robust funding capabilities, resilient earnings outlook, and seasoned management. In addition, the rating considers the extraordinary support from the company’s parent, Bank of China Ltd (BOC). We are of the view that BOC has a strong willingness to support BOC Aviation in a distressed scenario, given the latter’s status within the group and potential reputation risks associated with any failure of this subsidiary. Contents These strengths are partially offset by BOC Aviation’s asset-heavy balance sheet, increasing cost of debt as it adjusts its funding structure, and uncertainties around Overview .......................................... 1 Boeing 737 MAX deliveries. However, we note that many of these credit characteristics are intrinsic to the aircraft leasing industry and BOC Aviation’s Financial Summary........................... 1 standalone profile compares favorably with its peers’ globally. Key Rating Factors ........................... 2 The Stable Outlook reflects our opinion that, despite a potentially more challenging NBFI Industry Credit Index (NICI) .... 3 global economic environment, the company’s profitability, capitalization and asset quality are likely to remain commensurate with our expectations for the current rating Business Profile Assessment ........... 5 level in the next 12 months. Capital Formation ............................. 6 We would consider a downgrade if BOC Aviation’s financial profile is materially Capital Adequacy ............................. 7 impaired by a sharp increase in debt leverage and/or if the company’s liquidity deteriorates significantly. We would also consider a downgrade if we believe BOC’s Peer Comparison ............................. 8 willingness to support BOC Aviation will weaken materially, which may be reflected Scorecard Summary......................... 9 by a substantial reduction in shareholding and/or a change in the group’s strategic intent. Financial Statements ...................... 10 We would consider an upgrade if BOC Aviation can consistently demonstrate an Related Criteria .............................. 10 improvement in leverage, driven by a combination of a more conservative expansion strategy and a reduction in balance-sheet gearing. Contacts Financial Summary Primary Analyst USD million 2017A 2018A 2019E 2020E 2021E Revenue 1,401 1,726 1,973 2,222 2,534 EBITDA 1,282 1,581 1,808 2,044 2,337 Name Stanley Tsai, CFA Net Profit 587 620 677 746 879 Assets 16,040 18,256 20,089 22,715 24,551 Title Managing Director Debt 10,682 12,279 13,315 15,130 16,047 Direct (852) 3615 8340 Equity 3,819 4,199 4,670 5,160 5,737 % E-mail [email protected] ROAE 16.3 15.5 15.3 15.2 16.1 ROAA 4.0 3.6 3.5 3.5 3.7 Net Lease Yield 8.5 8.6 8.6 8.6 8.6 Secondary Analyst Net Lease Yield After Depreciation 4.7 4.6 4.8 4.6 4.6 Liquidity Coverage 21.1 16.4 26.8 24.1 23.9 Name Cyrus Chan Capital Adequacy Ratio* 22.8 22.3 22.4 21.9 22.6 x Title Analyst Net Debt / EBITDA 8.1 7.6 7.1 7.2 6.7 Interest Coverage Ratio 4.9 4.5 4.0 4.0 4.2 Direct (852) 3615 8319 E-mail [email protected] * Economic Capital / Tangible Assets; Source: Company financials, Pengyuan International estimates 15 January 2020 Page | 1 RA03020200004 Financial Institutions Singapore Key Rating Factors Credit Strengths . Strong Operating Profile. We believe BOC Aviation has a strong operating profile, underpinned by an exceptionally high fleet utilization rate and cash collection rate, which averaged 99.8% and 99.5% respectively from 2008 to 1H19. We expect the long duration and low termination rate of the company’s lease portfolio will continue to produce a steady cashflow and bolster its debt repayment capacity going forward. The portfolio’s diversification by geography and client is also a significant credit strength in a procyclical industry. Robust Funding Capabilities. We view the company’s funding capabilities favorably. As at 1H19, BOC Aviation had USDD3.5 billion in undrawn committed credit facilities, of which USDD2 billion were provided by BOC. We note the firm has made substantial efforts in strengthening its asset-liability structure since 2015, with 73% of its interest-bearing liabilities and 79% of its lease book quoted in fixed-rate terms as of 1H19. Over 90% of the mismatched interest-rate exposure is hedged. We also believe the BOC brand could be a positive factor for BOC Aviation in obtaining external financing. Resilient Earnings Outlook. With a long track record of strong earnings, we expect BOC Aviation’s profitability profile to remain more resilient than its closest peers’. We anticipate management will be able to deliver a return on average equity (ROAE) of between 15 and 16% and a return on average assets (ROAA) of 3.5 to 3.7% from 2020 to 2021. Our assumptions are based on a net lease yield of around 8.5%, which we believe will continue to be supported by a relatively young fleet age of about 3 years, a high-quality airline client base, and the firm’s well-established position in fast-growing geographical segments. Seasoned Management. We believe BOC Aviation is run by a team with long experience with the firm. The company’s financial management appears conservative, with its aircraft’s appraisal value exceeding their net book value by 10 to 15% since 2015. In monetary terms, this amounted to USDD1.5 billion as of 1H19, which is an adequate buffer even in a moderately negative economic scenario, in our view. The firm’s improving asset-liability profile in terms of pricing structure and duration is also a notable credit strength. Credit Weaknesses . Asset-heavy Balance Sheet. Due to the nature of the aircraft leasing industry, BOC Aviation has a high net debt to EBITDA ratio, which we expect to average around 7x over the period of 2020-2021. While this level may seem high on an absolute basis and as compared to some other non-bank financial sectors, we note that it may underestimate the firm’s ability to monetize its assets in the medium to long term. In particular, we believe the firm’s high leverage is partially mitigated by the marketability of its fleet, as well as the stability of its future lease cashflow. Increasing Cost of Debt. It is noteworthy that the firm’s overall cost of debt increased from 2.0% in 2015 to 3.6% in 1H19, against the backdrop of a low interest rate environment. According to management, this is mainly due to a significant shift towards fixed-rate funding, which accounted for 73% of debt in 1H19, compared to only 20% in 2015. While we recognize the benefits that this may provide in terms of asset-liability management in the longer term, this strategy may continue to be a drag on run-rate earnings, which has been factored into our forecasts for 2020 and 2021. Uncertainties Around Boeing 737 MAX Deliveries. In 1H19, 18 aircraft scheduled for delivery were delayed, of which six were Boeing 737. Furthermore, we note that at end-1H19, BOC Aviation had 162 aircraft in the order book, 87 of which belonged to the Boeing 737 MAX family. While we do not expect the continued grounding of the 737 Max aircraft to have a major impact on the company’s credit profile, continued delivery delays could cloud its revenue growth outlook. 15 January 2020 Page | 2 RA03020200004 Financial Institutions Singapore NBFI Industry Credit Index (NICI) The Non-Bank Financial Institution Industry Credit Index (NICI) score applicable to BOC Aviation is ‘bb+’, based on the scores of the aircraft leasing industries in the following regions: China ‘bbb-‘; Southeast Asia ‘bb-’; Europe ‘bbb-’; North America ‘bbb-’; and the Middle East ‘bb’. These regional scores are weighted by BOC Aviation’s lease portfolio distribution in terms of net book value to derive the company’s overall NICI score. Since the NICI is designed to capture structural credit quality rather than cyclical performance, it would be unlikely for the above regional NICI scores to change in 2020-2021. Business Environment As of 1H19, BOC Aviation’s portfolio by net book value is distributed with 30.8% for Greater China, 22.2% Asia-Pacific ex- Greater China, 27.0% Europe, 11.8% Middle East and Africa, and 8.2% Americas. To arrive at a composite score on the business environment in which the company operates, we have considered the business risk profiles of the regions in Exhibit 1 below. Exhibit 1: Business Environment Segment Region Score Risk Profile With a GDP per capita exceeding USDD10,000 in 2019, we classify China in Stage 3 of economic development. The country’s long-term economic performance compares favorably with its peers’. Although there are significant headwinds in the near term, we believe China’s growth prospects continue to foster a favorable business environment, relative to its Stage 3 peers. In our view, the key risks lie in the property market and the ongoing uncertainties around the US-China trade dispute. China We have a favorable view of China’s ability to maintain a relatively stable business climate, based on our assessment of the government’s effectiveness in pushing through social and economic reforms. Long-term inflation trends also suggest policymakers have the flexibility to pursue an effective monetary policy. However, these strengths are moderated by the market’s high private-sector leverage and developing capital markets.