1 undervalued growth stock that I think could really take off…

Avation PLC (LON:AVAP) looks set to take off, writes Thomas Carr.

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An undervalued growth stock is the holy grail of investing. One stock that I believe is very attractive from both a valuation and growth viewpoint is Avation (LSE: AVAP). Avation specialises in leasing commercial aircraft to mid-market airlines. Basically, Avation profits from the difference between the rate that it borrows at (to fund aircraft acquisitions) and the rate that it leases its aircraft at.

Since 2014, operating profit is up by 75%, and revenues have more than doubled to $109 million, with average yearly revenue growth of 20% over the last four years. Net asset value – a key metric for an aircraft lessor – has increased by 85% since 2014. In fact, Avation has shown consistent growth right across the board, and shows no signs of slowing down. In the first half of this year, revenues were 40% higher than at the same point the year before, whilst operating profit is up 60%.

The current market backdrop and outlook for the future also bodes well for Avation. Recent history has seen the demand for air travel roughly double every 15 years, with annual growth of over 4% predicted for the period 2017-2032. Aircraft lessors are also playing an increasingly more important role in the global aviation industry, where leased aircraft now make up 40% of the entire global commercial aircraft fleet.

To date, Avation’s execution of its strategy has been impressive. The company is focused on adding aircraft, diversifying aircraft type, diversifying the customer base, reducing aircraft age, lengthening lease terms, and reducing borrowing costs. The portfolio now consists of 48 aircraft, with 10 added in the last year alone. The customer base has increased to 17 airlines in 13 countries – up from 13 airlines last year – including the likes of easyJet, Air France and Virgin Australia. The average age of the fleet is kept young, by strategic disposals of older aircraft. This reduces the risk of technology obsolescence. Meanwhile, long lease lengths ensure revenue visibility.

The shares currently trade at around 10 times last year’s earnings, making them cheap, in my opinion. Furthermore, they are priced at a discount to the net asset value. The market is undervaluing the shares, presumably due its high debt load. But interest expenses are easily covered by operating profit, and the true value creation comes through the increase in net asset value. Crucially, AVAP doesn’t own a Boeing 737 Max, and so has managed to avoid any fallout from the ongoing grounding. There is also a progressive 2% dividend thrown in for good measure.

The management own over 20% of the company, and so their interests are aligned with those of the shareholders. Their focus is on unlocking shareholder value, which includes the strategic trading of aircraft. Avation has consistently shown an ability to sell aircraft at prices that are at a premium to their book value. This means that the reported net asset value is actually lower than the realisable net asset value. I also believe that Avation’s size, discounted share price and diversified portfolio makes it an attractive takeover target for larger lessors. Taking this into account, I think the shares are undervalued by as much as 20% and expect them to kick on from here.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Thomas owns shares in Avation. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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