Finance

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

There's a simple rule for making money out of initial public offerings: Try to be the smart insider selling, not the uninformed outsider buying.

That's worth bearing in mind before piling into the $1.1 billion sale of new shares in Bank of China's aircraft leasing unit, BOC Aviation. While investors including China Investment Corp., Boeing and Fosun International have already signed up for about $475 million of the shares on offer, there's good reason to hold back.

Not that aircraft leasing isn't a good business. Return on invested capital at the world's best-performing airline tends to do about as well as at its worst-performing lessor, according to a 2013 study by the International Air Transport Association.

Unlike airlines, which can swing in and out of profit on shifts in currencies and oil prices alone, leasing companies rarely take major losses. The main four U.S. aviation leasing companies -- AerCap, Air Lease, Aircastle, and Fly Leasing -- recorded just seven quarters of losses totaling $238 million over the past five years, according to data compiled by Bloomberg. The big four U.S. airlines -- Delta, United Continental, American and Southwest -- lost money in 16 quarters, totaling $9.28 billion.

The only time lessors risk getting into trouble is when an airline goes bankrupt or when orders run too far ahead of demand from carriers. Either circumstance results in an oversupply of planes, which must generally be written down when they're leased out at a reduced rate.

That's a reason for caution around BOC Aviation. Don't make the mistake of thinking of it as a play on China's domestic aviation market, whose debts are probably backstopped by the government. Only 17 percent of its lease income, and 19 percent of book value, is in mainland China, Hong Kong, Taiwan and Macau, according to the company's latest annual report.

Around the World
Greater China is the second-smallest region for BOC Aviation in terms of lease rental income
Source: BOC Aviation 2015 annual report
Note: China includes Hong Kong, Macau, and Taiwan.

The biggest share of both book value and income is made up of Asia outside of China, a diverse region that includes attractive markets such as Japan and Australia as well as some horror shows.

In Southeast Asia, IATA has warned that airlines may have to push back aircraft deliveries and Singapore Airlines last week reported passenger yields fell to a 10-year low. In India, ticket prices can run as low as two cents a flight.

If there's anywhere in the world you would look for landmines that could explode under the feet of aircraft lessors, it's those two markets. India's IndiGo, Indonesia's closely held Lion Air, and Malaysia's AirAsia alone have 1,183 planes on order from Airbus and Boeing, according to Bloomberg Intelligence. That's about four times the 293 aircraft they're currently flying.

Put It on Credit
Median net debt-to-Ebitda ratio of regional airlines
Source: Bloomberg data

Chinese and Asian airlines are also the world's most indebted based on median net debt-to-Ebitda multiples. Put that general indebtedness together with the potential overcapacity, and you're looking at a region where aircraft lessors need to tread with care.

BOC Aviation doesn't appear to be getting sufficient reward for that risk. A rough idea of the different returns in its regional businesses can be gained by comparing book value with lease income. While returns on assets have improved in all regions over the past year, in line with the better performance of the industry as a whole, they're lowest in Asia and China:

Profit Motive
Lease income-to-book value of BOC Aviation regions
Source: BOC Aviation 2016 annual report

Markets have been marking down the prospects for Asian airlines of late. The enterprise value of the Bloomberg Asia-Pacific Airlines Index stands at 5.03 times forward 12-month Ebitda, having touched its lowest levels since at least 2005 last month.

Meanwhile, the HK$29.15 billion ($3.8 billion) planned market capitalization of BOC Aviation translates to about 11 times its $343 million in net income in the year through December. AerCap, the world's largest listed lessor, trades on just 6.53 times earnings. Those hoping to make money out of that bit of the aviation value chain would be better off looking elsewhere.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net