I was looking for investment opportunity in Hong Kong, and CALC
attracted my attention. It is an aircraft leasing company, and I am very
interested in this industry, so I did some research on this company to see if I
should buy its shares or not.
CALC is the first full value chain aircraft solution
provider in Asia. It is not doing leasing business only, it also provides
solutions for aging aircrafts. The group owns 48% of the first aircraft
recycling facility in China. It was listed on main board of HKEX on 11 July
2014, and it is the first aircraft lessor listed in Asia. As at 24 March 2017
(based on its 2016 Annual Report), the group owns 83 aircraft fleets, and
majority of them are A320 series. China Everbright Group is the major
shareholder of the group (so not used to the way they report their major
shareholder, in contrast if they can list their top 20 shareholders like
companies listed on SGX do, it will make this part of information much easier
to understand).
When I first look at the 5 years financial highlights, I
thought I found the future Tencent! I have attached a screenshot of their
financial highlights below. Except of 2015, the group’s ROE is always above 20%
since 2012, and it even reaches 24.4% in 2016. In 2016, the group made a profit
of 638 million HKD, which is 6.7 times more than the profit it made in 2012.
Wow, I know aircraft leasing business is growing fast in China, but this is a
lot better than my estimation. Even though the gearing is very high, but since
its major shareholder is one of the major bank in China, I thought it might be
able to finance its operation at low cost. It sounds very good to invest in
this company, right? However, is it too good to be true? What is the reason
behind the superior ROE? Is it sustainable?
I found another aircraft leasing business listed on HKEX to
do comparison. In contrast, BOC Aviation’s ROE in 2016 was only 14.4%. CALC
sounds like a more promising business, right? However, when I did more research,
I found some information that might signal that CALC might be too good to be
true. In aircraft leasing industry, the business borrows money to finance their
aircraft fleet purchases, and lease them out to airlines to earn the difference
between lease rate and interest rate. As it is a leasing business, it doesn’t
have any inventory, so I will use the depreciation charge as their cost of good
sales. CALC and BOC Aviation are registered in different countries, so the
taxation law is different, which also impact the net return of investment too.
Let’s talk about the tax rate first. In 2016, CALC’s profit
before tax was 892 million HKD, and income tax expenses were 254 million HKD.
The tax expense was around 28.48% of profit before tax. The income tax expense was
calculated based on 25% tax rate, with insignificant tax rate adjustment for
their subsidiaries which incorporated in other countries. The income not subject
to tax was offset by non-deductible expenses. The group recorded 33 million HKD
for tax losses for which no deferred income tax assets were recognised. In
contrast, BOC Aviation’s income tax expenses were 55 million USD, and its
profit before tax was 473 million USD. The tax expense was around 11.62% of
profit before tax. BOC Aviation was incorporated in Singapore, and it calculated
its tax based on 17% tax rate. The group made adjustment to different tax rates
in other countries by increasing its tax expense by 5.7 million USD, which was
offset by 23 million USD tax deduction from Aircraft Leasing Scheme Incentive,
and 9 million USD from over provision in previous years. So eventually, CALC is
paying a much higher tax rate than BOC Aviation, and why is it able to achieve 24.4%
ROE in 2016? Is it charging its customer a very high leasing rate? I don’t
think so, as the industry is very competitive too. I don’t see any reason for
it.
If CALC is unable to charge a higher lease rate compared
with its competitors, is the cost of financing the major reason of its high
ROE? In leasing business, interest rate is very important as the group is earning
the differences between leasing rate and interest rate. In its 2016 Annual
Report, the group mentioned that it got diversified financing channels. Wait, I
thought the major shareholder is one of the major bank in China? Why is it
using “diversified financing channels” when its major shareholder can provide
them a lower interest rate? The group mentioned that it issued multiple US
bonds, one of it is 300 million USD three year senior unsecured bonds with
interest rate of 5.9% per annum, and the other one is 300 million USD five year
senior unsecured bonds with interest rate of 4.9% per annum. A subsidiary of
the company issued five year unsecured medium term notes in a principle amount
of 340 million RMB with interest rate of 6.50% and 330 million RMB medium term
notes with interest rate of 4.19%. The group also borrowed money from banks
too. However, I found that the interest rate is quite high. In contrast, BOC
Aviation’s average interest rate was only 2.5% in 2016, and it was only 2.0% in
2015! Seems like BOC Aviation is the one that should be able to earn higher
profit as the cost of funds is low and it also enjoyed better tax rate. Yet
CALC recorded a far better ROE than BOC Aviation.
I think I found the reason of CALC’s high ROE at their COGS,
which is their depreciation. In their 2016 Annual Report, CALC mentioned that
they are charging aircrafts categorised under PPE depreciation at straight line
method. The estimated useful life of aircrafts is 25 years and residual value
is 15%. However, the depreciation expense was 164 million HKD, and the group
owns 81 aircrafts! In contrast, BOC Aviation’s depreciation expense was 378
million USD, which is around 3,000 million HKD, and it owns 246 aircrafts. When
the majority of aircrafts are A320 series for both groups, why is BOC Aviation’s
depreciation expense much more than CALC’s depreciation expense?
Now then I realised that, CALC classified most of the
aircrafts under Finance Lease Receivables – Net. In its summary of significant
account policies, the group mentioned that Finance Lease Receivables – Net is
the present value of the lease. The group calculated this present value by
using its finance lease receivable plus guaranteed residual values plus unguaranteed
residual values minus unearned finance income to get the present value.
In conclusion, the high ROE of CALC is not the result of
higher selling price, not lower interest rate, not lower tax rate. I think they
way under charge the depreciation cost. With 81 aircrafts and 72 of them are
A320 series, yearly depreciation charge was only 164 million HKD! The group
also recorded 562 million of gain from disposal of finance lease receivable (I
have no idea what this is after reading through the report.. I guess it should
be one-off gain, but seems like they also recorded some gain from this disposal
in 2015.) CALC’s cost of borrowing is much higher than its competitors, and its
tax rate is high compare to its competitors too. Even though CALC is increasing
its dividend, I think that it is not sustainable. They paid 202 million HKD
dividend in 2016, but they also issued new shares worth 390 million HKD (Whats
the point?).
I felt that I just wasted one whole day by studying this
group… I am planning to study its competitor – BOC Aviation, as its future looks
much better.
Dear readers, if I made any mistake in this review, please
kindly leave a comment about it. I am worried that I made mistakes when I was
trying to understand the finance lease receivable part.
Thanks for reading! DYODD
