|Shares Out. (in M):||147||P/E||0||0|
|Market Cap (in $M):||8,000||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
Aercap is a high quality specialty finance company that has grown its book value at an average rate of 17% a year over the last 10 years, without a down year. The company focuses on leasing commercial jets to airlines and its book value and earnings potential is based on an evolving portfolio of around 1,500 planes. The average age of a plane in the portfolio as of today is 7 years and the average remaining lease term is around 6.6 years. The company has repeatedly had its assets appraised by outside advisors at a premium of around 5%-10% to the stated book and that metric has been verified annually as they sell assets and recognize an average gain on sale of around 7% (showing the FMV>Book in real time marks). Buying this stock at $54.00 would be at only 0.8x our 2018 year end book value and even less on an intrinsic value considering the conservatism in depreciating their assets. This seems to provide a margin of safety to the downside – especially given the nature of the assets (described below) and history of continued book value growth even through the recession. This also translates into around 8.5x this year’s earnings (2018) on a reported basis and 9.0x on a core earnings basis. The difference between the two is primarily the gains on asset sales as they sell around $1 billion of assets a year as part of their operations. One way to look at the gains is that they are just reversing the over depreciation that depresses core earnings as they depreciate planes faster than their value actually depreciates. Like most financials – the growth of earnings is a function of how management allocates capital and manages the business. They can invest in additional assets when they have attractive returns or sell assets when the market is tight and prices are high and return capital to shareholders by buying back stock. In this case, the history of this management team is strong – as you can see in the results of the earnings growth (averaging 14%) and book value growth (averaging 17%) and neither with any real draw down to speak of including during the financial crisis. This management team has consistently generated a ROE in the mid teens with a conservative balance sheet – levered now only 2.7x – and the only independent aircraft finance company that is investment grade. I think they can growth book value to around $80-$85 by 2020 and if it traded at just book, then our investment would generate a 17%-19% return. If it traded to 1.2x (which would be historically high but consistent with the ROE and returns demonstrated) the stock would be $98-$101 or a 26% to 29% compounded return.
Getting to a higher than book value multiple seems realistic. While there are concerns about the cycle and overproduction, the aircraft leasing business is more attractive through the cycle than many specialty finance segments and arguably deserves a higher multiple. Looking at returns on assets and returns on equity, aircraft leasing is more stable and predictable than many other niche finance companies that get premium multiples, a gap that should close over time.
While trading close to an average type multiple, as the chart below demonstrates, there is an opportunity to rerate as the industry matures and investors spend more time beginning to really understand the fundamentals. In addition, stock prices have lagged earnings growth, leading to multiple compression despite strong fundamentals and potential upcoming catalysts.
The business is relatively stable and predictable given its all under contract/lease. 95% of the company’s revenue through 2020 is already contracted. The company does not take interest rate risk and hedges changes in interest rates. A 100 bps change in interest rates would only have a $25 million effect ($0.14 per share). In a rising interest rate environment – given the all in yield on a plane is about 13% with current debt costs of about 4%, they would not need to push price much to maintain margins and the alternative of buying vs leasing gets equally more expensive so presumably pricing power remains intact as long as demand is not destroyed. The obviously offset also being if higher rates are indicative of higher demand then price/values should be higher to meet demand. This is particularly true if stronger global growth is lifting commodities and the emerging economies as that is where most of the incremental demand for aircraft will be. Lastly, it is also likely that in a higher inflationary/higher interest rate environment, the asset value of planes depreciates more slowly especially if the price of new planes is being inflated, thereby increasing the value of the portfolio.
They maintain good liquidity with at least 1.2x the NTM cash needs (which includes cap ex and debt maturities) and usually around 1.5x the NTM. The business has shown remarkable stability in margins. The basic math on an aircraft is that it is leased at an 11%-12% yield (the younger the avg plane the less the yield because its less depreciated therefore higher denominator vs a more depreciated plane). The interest cost is about 4% leaving a Net Spread of about 8%-9%. Depreciation runs 5%-6% (lower on younger fleets because it’s a higher denominator), for a consistent 3% Net Margin.
In a very basic analysis – you can see how a well run company can generate low/mid teens ROE’s from a plane by plane perspective (AER runs 2.7x-3.0x):
The core of the investment thesis rests on the quality of the assets and the quality of the management team – both of which seem high here. Management is very well regarded and considered the best in their space. They have been smart allocators of capital, having bought back 28% of the shares outstanding since 2015 below book value. They have also found smart and highly accretive deals to do, like purchasing the aircraft leasing business out of AIG at an attractive price that proved to be a catalyst for the stock. Of note, GE is said to be shopping their aircraft leasing business, which might make for either a smart/accretive deal by Aerocap or a good mark for what these businesses are worth should someone step up and pay more than book for the business. The elevated debt levels from mid-2014 were the result of the highly accretive AIG deal – which they quickly reduced to below target levels on strong free cash flow and asset sales.
The asset underpinning the book value – planes – seems a good asset to finance. There are long term secular trends driving air miles flown globally. Since 1986 air traffic has doubled every 15 years – a trend that should continue if not accelerate for the foreseeable future according to all forecasts. In 2017 global air traffic is growing at 8%. This secular growth is driven by a number of factors. First is the global growth of the middle class which correlates well with air travel (both leisure and business). The global middle class is expected to grow from 2.9 billion people to 4.9 billion people in the next 20 years. In addition, much of the emerging middle class in coming from countries where the average distance traveled is much further than the existing average distance traveled in mature nations. For instance, travelers in the middle east, India and China have a propensity to travel distances greater than their counterparts in the US (flights from NYC to Chicago, NYC to Boston, DC to Florida…etc are relatively short flights compared with common flights out of Dubai or Hong Kong). And lastly net fleet increases have not kept up with traffic as airlines have driven efficiency in seating – a game that seems to be coming to a close (ie getting more people on a plane and flying the plane more hours/day). In addition retirements of airplanes have been below normal, signaling that the global fleet has been stretched and aged beyond what is normal. This might have been helped by low fuel prices as it has allowed older less efficient planes remain economical for longer than normal, but over time these trends should regress to the mean and drive further demand as the plane parc stops aging.
In addition to the growing secular trend of global air traffic, there has also been a secular trend for more airlines to lease vs buy aircraft. This is being driven by several factors. Among the large established air carriers some of this trend is driven by balance sheet concerns and increasing returns on capital for shareholders. In addition, as air traffic grows in emerging markets, new airlines with less balance sheet power and weaker credits are becoming an important source of growth. For emerging airlines lacking the financing and the strong industry standing to get orders into Boeing and Airbus, they are increasing relying on lease companies like Aercap for their planes.
In thinking about the risks to an investment in Aercap, from a credit perspective, one concern would be the financial stability of the airlines leasing the planes. One consideration is that airlines are currently in an unprecedented period of profitability. Some argue that airlines have finally discovered that if run correctly, they actually have real businesses. Seems like even Berkshire has bought into this theory. But as Aercap points out what really matters is that someone is flying planes – its easy to repaint the tail. Planes are easy to take back and replace – they are very liquid assets. So a failed airline will just have its routes replaced by another airline that needs planes assuming air traffic continues to grow. They point out they grew book value through the financial crisis. In addition, as highlighted below, this is one area that they think they excel at given their size, sophistication and expertise – they can react quicker to any credit issue than any other competitor.
In addition to a strong management team and good demand for the underlying asset that Aercap finances, Aercap has some other unique characteristics that help distinguish it in what most would assume is a rather commodity like industry. First and foremost is the size and scale of Aercap. This gives it market insight into an otherwise opaque market (private aircraft sales) such that they claim they know better than anyone where demand is, for what planes and at what prices in both the new and used market place. They claim that information advantage is core to them delivering best in class results – and leads to optimal decision making…Buy/Sale/lease decisions as they manage their portfolio.
Aercap’s focus is on maintaining a liquid portfolio of the most desired planes. Keeping a conservative cap structure, conservative leasing terms with high security deposits and maintenance reserves and not taking interest rate risk. As already mentioned Aercap is the only independent aircraft leasing company that is Investment Grade, giving them a financing cost advantage over their competition and many of their customers. In addition, their size (largest buyer of many versions of aircraft) gets them better pricing and better placement in the order book. For instance, they are the largest buyer of the 787 and made up a lot of the early deliveries. This puts them in an advantaged position to basically “sell their place in line” to lesser airlines that would need to wait years to get the 787.
Aercap is the world’s most active trader of mid life aircraft, giving it unique insights and abilities to place aircraft. One example given is there is a current industry concern with the number of widebody jets on order from a select group of Middle Eastern airlines. In some cases, certain Middle Eastern airlines have more new widebody jets on order than they currently fly and this at a time of weak economic environment in the Middle East driven by low oil prices. In addition to the large widebody order book, with the ramping of Boeing’s 787 (Dreamliner) and the upcoming revamp of the 777 (Boeing’s most successful widebody plane of the last several decades), investors have been concerned with residual values and demand for existing 777’s in the portfolio. As the chart below shows, Aercap has successfully placed or sold almost their entire 777 fleet – something they point to as a good example of their expertise and market knowledge.
Another example given was the recent bankruptcy of Berlin Airlines. Their claim was that most of the lessors or OEMs with aircraft placed with the bankrupt airlines were left waiting around, in part because of pressure from the German government, waiting to see if Deutsche Air was going to assume the leases. Aercap had the strong leases, expertise and infrastructure to immediately take the planes back, get them out of Germany and placed with other airlines around the world before a single other plane in Berlin Air’s fleet was taken back by another creditor. As it turns out, Deutsche Air did not take any of the widebody planes, leaving other lessors with unpaid leases for sometime and then they first had to try and begin getting their planes re-placed.
One reason for this expertise is the business model Aercap has. They look to trade out of airplanes midway through their life and have extensive networks of investors and contacts that they place hundreds of planes with. The Aercap business model is to buy airplanes and place them with airlines under 12 year leases. This gives them high visibility into revenue and lets them manage through downturns. They sell most of their planes within 8-15 years, usually with at least 3-4 years left on lease (or lease extension) mostly to investors looking for stable yield.
Overtime, management can flex their portfolio – buying newer planes to expand and get younger, and selling more planes to shrink the portfolio and return capital and let the average plane age a bit. Currently, Aercap is in the process of getting the fleet a little younger as it takes deliveries of newer planes – which in theory should make the portfolio more valuable.
Like all specialty finance companies, Aercap needs access to external financing. Any debt crisis is an issue. Management tries to mitigate this by always operating with a prudent amount of liquidity to manage through any crisis – assuming that they can re-access capital markets within a reasonable period (2 years or so). The company itself generates in the area of $3 billion of operating cash flow a year and usually sells around $1-2 billion of aircraft a year – so it internally generates large amounts of cash before cap ex/new plane buys. Furthermore, its average debt maturities roughly matches its average life left on leases (about 6 years) to keep the duration of debt and lease rates consistent. See debt maturity schedule (below).
A second consideration would be residual values of planes. One issue would be an oversupply of planes by OEMs into a market (because of over production or decreased demand as a result of a recession or political/terror concerns) could depress plane values and lease rates leaving residual values below Aercap’s book and making placing/selling planes that are coming off lease book value losses. Historically this seems to have not been the case and the current demand forecasts seem to lead that supply and demand should be in balance. In addition, Aercap thinks the duopoly structure of the industry has imposed discipline and that the OEM’s are careful to keep the supply well matched with demand. Furthermore, Aercap thinks the development of the aircraft leasing industry has helped stabilize residual values as before the lack of visibility, expertise and liquidity would lead to larger swings in residual values during downturns as assets were dumped into illiquid and unsophisticated markets. But this remains something to track. Residual values are something to watch. With $34 billion in assets – a 5% change in residual values would lower the book value by about $10/$11 per share or about 19% on its face…ie ($34 bn * 5% / 157 shares) but if you assume book is understated by about 7% on average then the net effect would be about $4.00 less. But the real math is more complicated. First, Aercap is in newer more liquid planes, where moves in residual values are much less than the overall market. Where softness in the industry has the largest effect on residuals is on older planes in a segment where new versions are launching – that was the concern with the 777 within the Aercap portfolio described above and they manage the business to avoid those issues. The second thing to keep in mind is that Aercap planes are on leases and generally sold with leases attached, so near term fluctuations in residual values have little to no effect on current fundamentals. Should leases need to be signed during a period of panic or weak global conditions, what Aercap did during the recession was sign short term leases at a discount to cover costs on deliveries or planes coming off lease, then look to resign them at better rates for a normal length lease a year or two later. While not optimal, with the fleet under long term contracts and the sale of most planes before they get to the end of its contract or contract extension, there is usually on a relatively small % of planes coming off lease in a given year that have not already been placed of sold, so this effect should not be dramatic but bears watching as the portfolio is in constant motion. Lastly, it is worth thinking about reported book represents a plane with an average age of about 6 years under a 10-12 year lease. The time frame that residual value would matter most is the end of a lease – or about 6 years later on average. Depreciation is straight line, so the delta between expected residuals (predicted by book) and potential discounted values as a result of a weak market, would be based on the much lower depreciated value of a 10-12 year old plane, not the average book today. Not sure how that exact math would work, but is you assume deprecation is about 6% a year and on average there are 6 more years left on the average lease – the base for a hit to residual values on a like-for-like basis is probably closer to $23 bn than $34 bn such that a 5% hit would be more like $7.00/share and $3.00-$4.00 net of the imbedded conservatism. But will need to verify this calculation with the company. From the chart below, you can see the weakness in values hits older plane models much more than newer ones. The hit to the 777-300, 787, A-330-300, and 737-900 during the crisis was much less than many of the older models that were facing newer versions in the market place. Aercap has managed through this whole period taking gains on sales – including net gains in 1q 2016. Book value has grown throughout.
In addition, one concern might be the increased competition from easy money looking for yield which could depress margins for what looks like a commodity business from the outside. Aercap points to the increased interest from Chinese and other Asian banks in the space. But Aercap explains its view that there has always been competition in the space, so that is not new. It claims most of the easy and “dumber” money goes to sales-leaseback deals, something Aercap has not done in years now because of the lower yields. Those deals are competitively shopped and require less sophistication – more just providing of balance sheet financing to an airline that already has a plane. Aercap sees their value added in the form of the platform they have built and the expertise they have developed to buy the right planes, place them and then sell them across their network over the course of the plane’s life cycle. The stability of the ROE and margins generated seems to speak to this claim, but again, this is something worth watching. It does make some sense given the biggest cost to the lessee is basically covering the deprecations. The net margins are not that wide and Aercap has an advantage in being investment grade on the debt costs. The wide network of placing planes helps Aercap with the residual values and high utilization – both competitive advantages and barriers to anyone that wanted to buy hundreds of planes on spec without that knowledge and infrastructure as opposed to a plain vanilla sales-leaseback.
Lastly there is the risk to how the stock trades vs the actual fundamentals. Although the fundamentals are not correlated, it does seem that these stocks often trade in sympathy with airline stocks, at least over the short term:
There have been periods of strong drawdowns in the stock – especially in early 2016 when the stock was briefly in a free fall:
Looking back at the early 2016 time frame – this seems to have been panic driven as a number of overlapping concerns came together:
Boeing and Airbus both announced production issues and delays – which hit their stocks (particularly Boeing). Ironically, this should be a positive, as less production and a slowdown in the Dreamliner deliveries should have made Aercap’s position more valuable – but people shoot first. (BA stock chart:)
Although a stock chart of BA post that sell-off seems interesting and does not speak top a pending collapse in the cycle:
There was a growing concern about a China slowdown. Aercap has about 10% of its portfolio in China – and China is an important source of growth. Aercap was quick to point out air miles flown was still strong and growing – whether China grew at 4% or 8% and that they had strong demand from their customers there.
There was a concern about air traffic in Russia and Russian airlines going BK especially with the collapse in the Ruble. Aercap had anticipated this and already reduced its planes in Russia from 90 to 70 on a base of about 1500.
Boeing and Airbus were both having trouble placing end of life aircraft and new versions were about to launch. This is why Aercap was focused on getting out of the 777 it owns over the last few years.
There was a risk off trade. URI fell 45%, HTZ fell 65%, MS fell 38%, GS fell 39%, GLNG fell 70%...levered risk assets tied to global growth got hammered and post the AIG deal, Aercap was more levered then.
Couple of interesting points about that period:
Citibank did a FMV analysis plane by plane of Aercap in 1q 2016 and came up with a value still greater than book despite all the panic – which represented almost 50% upside.
The mgt team stepped up with aggressive buys. The CEO and CFO each bought around 500,000 shares personally.
The company got very aggressive on the share buyback.
As mentioned above – the company continued to realize net gains on sales of aircraft during the period.
Required Debt Repayment Schedule:
Stock buybacks, M&A, and continued increase in market cap which can bring more attention to the name/sector and help close the book value discount to other financials.
|Subject||market perception of this stock|
|Entry||06/23/2018 02:54 AM|
this is my largest PA position so clearly i agree with most everything you say. one thing i have trouble with, however, is your contention that over time the valuation will rise to a more appropriate multiple of book value given the track record of RoE significantly above cost of equity and the returns of the business through the cycle. What exactly is going to drive this? This is not a small/uncovered company; it is incredibly well owned by a diverse investor base (indeed regularly called a hedge fund hotel); and there is not much new or novel about what you are saying or the business's performance (indeed that is its main strength, the long-term consistency of the returns). surely the market isnt missing something here - it has simply decided that - for spurious reasons, we would agree - aircraft leasing is simply not worth the multiple of other financial services businesses.
the stock can continue to do fine give astute and shareholder friendly management (ie driving returns through funneling capital mostly back to shareholders). i fully expect the shares to be bought back, continously, for the next 10yrs. but absent an acquisition - which would likely occur at 1.2-1.3x book value - i dont necessarily see how we can expect the stock to ever get back to those kinds of multiples.
|Subject||re: over depreciating|
|Entry||06/25/2018 11:53 AM|
Can you speak further to your conclusion that they are over-depreciating? I think all the public lessors depreciate to 15% resiudal over 25 years, or 3.4% straight line. The US airlines depreciate more aggressively I think, DAL uses a 5-10% residual but has some range on their useful life period depending on the plane, I don't know for sure but I think they use a number higher than 3.4%.
|Subject||Re: re: over depreciating|
|Entry||06/25/2018 12:03 PM|
Mostly- while Seastreak explained it as over-depreciating as a way to highlight they could be reporting higher 'core' earnings given the consistency of sales gains over a decade, perhaps a better way to think about it is in terms of the business model: when lessors commit capital to buy plans on order from the OEMs, they get pretty chunky discounts vs list prices (which are more reflective of market values) to account for committing capital years in advance of delivery; large order sizes; and helping the OEMs get the capital needed to develop new technology aircraft. I believe a good chunk of the experienced gain on sales in AER's portfolio, for example, came from embedded gains from the below-market-value order book held at ILFC (one of the major reasons for AER's takeover, given ILFC had been the first customer for a couple of new technology aircraft and so go really generous deals).
so it is not that they are 'over-depreciating' versus the useful life in a way different to airlines or other lessors, just that for lessors like AER (and AL to a lesser extent), the underlying cost basis of the assets is, from inception, lower than the market accepts (and has been consistently over a decade). They are simply amortizing this structural cost advantage into the PnL over time using the medium of asset sales. Of course supply/demand has a lot to do with this but ultimately they will still be able to source aircraft cheaper than most any other lessor (or airline) given the size of their orders/power vs the OEMs and so this advantage is definitely structural.
|Subject||Re: Re: re: over depreciating|
|Entry||06/25/2018 01:06 PM|
Well put. i meant over depreciating as in the fmv > bv, largely for reasons puppyeh explaind. Or said another way core eps is understated a bit as the true cost of the planes is to aer is being overstated given their discounts...which then just comes back as a gain.
|Subject||Re: market perception of this stock|
|Entry||06/25/2018 01:19 PM|
My sense is that there has not been much market cap in the space for very long. Its not the hedge fund guys that will help rerate it, but the bigger long only guys who need to have a reason to do the work and hold it. It sort of falls between aerospace guys - who get the asset - but likely are much more focused on where the beta is...like BA (if you like the cycle go with the OEM's or some of the parts guys) and the specialty fianance guys who likely paint it with the same brush and have not invested the time to get to know the asset as there is just no enough going on in the space.
What might close it? Not sure. maybe need to make it through the cycle...maybe some M&A (like GE asset trading). Over time the markets tend to be efficient - what gets them there is less clear. I have wondered why some big Japanese financial in desperate need of yield does not take one out. Guess we will see.
|Entry||06/27/2018 04:48 PM|
Defy - what price do you think would be acceptable for management and co to sell? There is no way Gus Kelly and co would sell anywhere close to tangible book (nor should they); it is also less clear to me why Buffett would pay the 1.3x P/B it would take to get the deal done...
|Subject||Re: Re: Buffett?|
|Entry||06/27/2018 05:46 PM|
Buffett was asked about aircraft leasing at an annual meeting, and here's what he said:
But you will not see us get in — aircraft leasing doesn’t interest me in the least. We’ve looked at
that a lot of times, at various aircraft leasing companies offered to us. And that’s a scary
business. And some people have done well in it by, in recent years, by using short-term money
to finance longer-term assets which have big residual risks, and that just isn’t for us.
CHARLIE MUNGER: I think you’ve said it pretty well. We’re well located now but we — I don’t
agree that we have huge opportunities.
|Subject||Re: Re: Re: Buffett?|
|Entry||06/27/2018 05:56 PM|
point taken, but he said much more negative things about airlines themselves and now owns a bunch, so he's not above changing his mind. that said - the 'buffett might buy them' part of the thesis here should be well below the fold in terms of why anyone should think about owning the stock...
|Subject||Re: Re: Re: re: over depreciating|
|Entry||06/28/2018 04:21 PM|
I think the large lessors are buying at 40%+ discount to list, but concentrated buyers like LUV get better deals than that. How much difference do you think there is between what a large scale lessor pays and where the market rate is?
|Subject||Re: Re: Re: Re: re: over depreciating|
|Entry||06/30/2018 10:56 AM|
Are you sure the airlines get better deals than the lessors? It may be possible in isolated cases, but conceptually I find it hard to believe - for the largest lessors at least. AER and GECAS, for example, are by far the OEMs' largest customers and far more important to them than any one airline so that should be reflected in prices. They also have a history of committing capital to new models in advance of some airlines (not all, but definitely earlier than LUV) which again should translate into value.
you are of course right on the time arbitrage, it is helpful in rising markets and the opposite in falling markets, and it has certainly been helpful in the last few years. having said that - remember AER has made money on aircraft sales every year in aggregate the last 10yrs - in other words throughout the credit cycle. Aircraft values have not been secularly rising for AER's entire listed history, and yet they've kept making money. so the embedded discount must be a big contributor to this.
also, having thought about it more, AER has actually been selling mostly quite old aircraft that has been bid up by new buyers, low interest rates, low fuel, etc, and not really new technology aircraft (makes sense as their avg fleet age has been coming down). in other words we dont really know how much embedded value there remains in the newer planes, especially the ones coming into the fleet over the next couple years.
|Subject||Re: Re: Re: Re: Re: re: over depreciating|
|Entry||07/02/2018 12:07 PM|
Since they are the largest and often earliest buyers of new aircraft - i beleive they get the biggest discounts. As far as cycles go - they have not only taken gains every year in the last 10, but they grew book value even in the recession. One nice thing about the business model is that their assets are under long term leases. So even in a down cycle, only a small % come off lease or need to find a home when things are weak. In the great recessson they manged this by placing planes on short term leases at bad prices rather then sell or lock in long term leases at the bottom. Then as the environment noralized, they were able to place those planes at much better rates. So while it is true, when the global economy turns down, that is not great for asset values, luckily they only have a small number of planes that will likely come up in that market, so it makes it much more managable. In addition, the new planes should make the portfolio even stronger as they have new technology and better economy as fuel prices rise.
|Entry||07/02/2018 12:34 PM|
There is a very good book on this business, Crash Landing, that details the history of GPA and gives very good insight into what can go wrong in aircraft leasing. Aercap management seems really good and well-incentivized so they could avoid many of the problems that befell GPA, but probably worth being aware of nonetheless.
|Entry||07/05/2018 12:53 AM|
|Subject||Re: Re: Re: Re: Re: re: over depreciating|
|Entry||07/05/2018 01:19 PM|
puppyeh - not 100% sure. I've heard Air Lease say that Southwest gets a better discount than any lessor, but that they are "competitive" with most buyers. Aercap is bigger and spends $5B buying planes, shared across 2 manunfacturers and a variety of plane types. Southwest spends a little less than half that, but they only buy 737s... I assume that Indigo or Air Asia with 400+ A320/321s on order get the best pricing available.
|Subject||the most frustrating stock i have ever owned/covered|
|Entry||12/22/2018 02:31 AM|
i have been a shareholder of AER for at least 4yrs, and it is my largest PA position, so count me a hopeless bagholder before you read this, but this has got to be the most frustrating and efficient-market-threatening stock I have ever encountered. this is possibly one of the most boring names to cover/follow on a quarterly basis - and I mean that in the most complementary way. every quarter the company puts up numbers, buys back stock, and speaks to the underlying strength of demand for air travel and, thus, the aircraft AER provides. every quarter the (many) analysts that cover the stock wring their hands and contort themselves into worrying about the various airlines that are getting distressed; or the high (or low) oil price and how that affects old vs new technology aircraft; or the high (or low) interest rates and how that is increasing (or decreasing) easy money flowing into the sector looking for yield; and any number of other things that analysts like to worry about. Every quarter - for years - Gus and the team deftly manage the business, demonstrating over and over again the resilience of the model. They have not, to my knowledge, ever had a single quarter where the cost of lease terminations and asset impairments exceeded the maintenance revenues/collateral they keep when such events occur - but even if they did, they certainly have never had a full year where this occurred. Meanwhile we now have numerous examples of this management team protecting asset value over and above other lessors, by being more nimble/quick to act/better underwriters of risk (Malaysian Airlines B/K; Air Berlin B/K; Monarch B/K; Russian exposure two years ago, etc). Moreover the team has demonstrated superior capital allocation for a multi-year period, re-directing excess capital to reduce the sharecount by 35% over the last 4yrs (putting it in the top 4% of capital-returning cos in the S&P 500). Of course this completely ignores the value-adding M&A (ILFC, etc) that AER has managed along the way, let's not forget about that either.
But despite all this - and the fact that this business never lost money, not even in the depths of the financial crisis - the stock has done nothing but derate. It used to trade at >10x P/E and a premium to book value (levels I still considered attractive); it now trades at <6x P/E and - by my math - a near 40% discount to Dec'18 book value (a book value that is likely to grow at least at 10% for the foreseeable future). I get that the future may not look like the past, and that this is a crowded hedge fund stock, but the unwillingness to give any kind of credit for a 10+yr track record of value creation (indeed not even to come close to giving value for the asset base, let along the platform on top of the asset base), and a management team that is clearly superior to most all other operators in the industry, is reaching a stage that beggars belief. The market is treating this asset base like a mall REIT, yet air traffic doubles every 15yrs like clockwork, RPKs are growing at 7% pa and even if that rate slows it is hard to see how it doesn't keep outpacing global GDP growth, let alone turn negative. Frankly the market perception of this industry is bewildering - this is not a micro-cap; this is not a complex business model; this is not under-covered; and this has been going on now for a very long period of time (>10yrs as a listed company).
If this were some structurally challenged industry, where there was some doubt that the business would exist in its current form in some reasonable timeframe (eg auto OEMs), I could at least understand a persistent, long-term discount. But this is not really a debatable point (there is simply no alternative to modern fixed-wing aircraft for long-range human transportation) so is not relevant...meaning I cannot fathom what is causing the persistent inability to value this name (and sector, I guess) at anything close to fair value.
Furthermore I could make the argument that a mild recessionary scenario, with higher/normalized interest rates but persistently lower oil prices, is actually a much better one for the leading lessor companies. For starters, it makes airline profitability much more sustainable (lower fuel costs, assuming no ramp in capacity), and at the same time it seems likely that many of the new entrants to the market would retreat (meaning yields on new leases would start expanding again, after years of contraction). In fact, this seems to be starting to happen (eg Avolon's rapid growth has clearly slowed and I would think a lot of the China money that rapidly entered the industry will not stick around through the next recession).
Ok rant over. I have been adding (all the way down) and think this is trading at near-firesale prices, but frankly I don't understand why Gus + team don't shop this company. It seems clear by now that the market will never give them the credit they deserve so they should sell this to a Japanese bank with permanently low cost of capital at a solid premium to book value, in my view.
Any comments/thoughts on what I could be missing, please chime in. Maybe its as simple as Greenlight et al getting massive redemptions into year end.
|Subject||Re: the most frustrating stock i have ever owned/covered|
|Entry||12/22/2018 02:14 PM|
My guess is that the market doesn't know much more than you do. The share price is just a number now. When the dust settles, it will represent partial ownership in a great business with a great moat and a great management team again, and it will be offered at a great price, but for now it's just a number.
|Subject||Re: the most frustrating stock i have ever owned/covered|
|Entry||12/22/2018 02:18 PM|
Agree they have executed very well. Not involved but why is P/E the right metric to value a business with that balance sheet?
|Subject||Re: the most frustrating stock i have ever owned/covered|
|Entry||12/22/2018 03:51 PM|
This has been a frustrating name. I agree with you that results have been stellar for a long time. The market does not feel comfortable with the business model, given the (small) possibility of a donut.
Think the idea that Aercap and other lessors can go to 0 in a terrible scenario is always present. That is why this stock gets killed once spreads widen, volatility, etc...and might the reason why this has always traded at a discount. Even Buffett mentioned he does not like the business given the leverage and risk of asset values declining sharply.
Another reason the market might be nervous right now, is that a huge portion of their new planes are delivered in the next year or so. So there might be some fears that they are getting into this capex boom in a period of global slowdown. Also, there is always a dependency on capital markets. They will need to issue debt relatively soon to finance a portion of the deliveries. The debt of air lessors has been trading like crap and spread have widened significantly.
Having said that, this is a great company managed by an incredible CEO. At .65x understated BV and 6x earnings, I think investors are getting a great deal. There is a very high probability of great returns from this point.
At these prices, seems like results are: 1) shit hits the fan and this stock trades like shit (continues to) with no correlation with results or valuation. Total collapse if debt markets shut air lessors and company can't finance the deliveries. (Very low probability); 2) there is no epic recession/crisis/slowdown and this thing doubles in a year (high probability).
So I would be a buyer of Aercap here, but always knowing that the possibility of a donut is always there.
|Subject||Re: Re: Re: the most frustrating stock i have ever owned/covered|
|Entry||12/22/2018 10:08 PM|
thanks for all the feedback. agree with much of that as potential explanatories for the move (even if i disagree with most of the bearish rejoinders).
tharp - P/E is just a way to show the derating, i wasn't necessarily saying this is the way to value these things (although actually i don't think its a terrible metric for this kind of business given the leverage is really pretty manageable).
agree with the points re holder base, and v small possibility of zero (although frankly if they didnt go in 08-09, i think this is almost inconceivable). the points re competition and losing your advantage to cheaper capital i think are actually not right, and provable (given how much they have outperformed other lessors during various customer bankruptcies over the last few years).
|Subject||Re: Re: Re: Re: the most frustrating stock i have ever owned/covered|
|Entry||12/25/2018 05:34 PM|
not that this is a particularly noteworthy transaction, but it proves a few things:
- narrowbody aircraft remain in demand from institutional investors at high prices (relative to what the market perceives)
- these planes are still getting moved at reasonable premiums to book value (though we don't know the age of the planes/engines, etc)
if AirAsia can do these kinds of portfolio transactions, you can bet AER mgmt sees them and the more the stock falls will simply pursue these kinds of deals to free up capital to buy back stock at a 40%+ discount to NAV
|Subject||KKR Commits to Invest $1 Billion with Altavair|
|Entry||01/03/2019 02:59 PM|
I'm uite new to the space, but does this have any read through to AER? Seems a positive that a sophisticated investor is looking into space and maybe suggests AER could be a PE target? On other hand, more capital coming into space.
Bloomberg story on deal below
By Julie Johnsson
KKR & Co. is investing $1 billion in aircraft lessor Altavair AirFinance in a bet that jet freighters will turn out to be a profit bright-spot amid global trade turmoil.
The New York-based investment firm is acquiring a 50 percent stake in Altavair, which was formerly owned by Guggenheim Partners, along with six cargo aircraft. That initial commitment may be expanded by additional commercial aircraft purchases and leasing investments over the next several years, the companies said in a statement Thursday.
The timing for the deal is surprising, coming as gloomy 2019 revenue forecasts from Delta Air Lines Inc. and FedEx Corp. heighten fears that political instability and trade wars may lead to a global economic slowdown. Delta shares plunged the most in more than three years after the Atlanta-based passenger carrier trimmed its revenue forecast for the second time in two months.
But Altavair Chief Executive Officer Steve Rimmer sees a chance to capitalize on the uncertainty as it drives more blue-chip airlines to lease rather than take on additional debt to own jetliners. Though aircraft financing has been awash in liquidity, bumpy equity markets could also drive some competitors to the sidelines.
“It’s been challenging the last five years to find deals that made a lot of sense in terms of risk and returns to us,” Rimmer said by phone. “But we saw opportunities arising in 2019 and 2020.”
Rimmer has been seeking a deep-pocketed backer since parting ways with Guggenheim through a management buyout in October 2016. KKR, meanwhile, had been looking to expand the investment firm’s three-year-old foray into the aircraft sector in the face of “increasing demand for both passenger and freighter aircraft,” said Dan Pietrzak, a managing director with the firm.
The partnership plans to mull new aircraft orders, used planes and converting passenger jets into cargo-haulers. Altavair also sees growing demand for leasing large cargo-haulers like Boeing Co.’s 777 and jumbo 747 aircraft, particularly as the McDonnell Douglas MD-11s favored by FedEx and United Parcel Service Inc. approach the end of their commercial lives.
Rimmer wouldn’t discuss the initial freighter purchase, other than to say the aircraft are larger than the used Boeing 767 jetliners being snapped up for Amazon.com Inc.’s cargo fleet.
“They’re in the wide-body space,” he said. “We know the 777 market very well. We know the 747 market very well.”
|Subject||Re: KKR Commits to Invest $1 Billion with Altavair|
|Entry||01/03/2019 03:44 PM|
hey Ray - not sure it's that relevant to AER (or the other large lessors):
- reading the article, these guys sound pretty much cargo focused, at least for now (only AYR of the major lessors has residual cargo/freighter exposure, it is a v different market to passenger aircraft)
- $1bn of investment, even levered say 3x, is pretty small (AER portfolio is ~$32bn today, for example), especially if a decent chunk of this is going towards freighters to start
I guess its marginally positive that new money continues to come in - but this is not something I have really been remotely worried about. To your concern, new money has the potential to lower go-forward returns, but at the same time raises prices on legacy asset sales. Since AER is trading at such a deep discount to book, I believe the main market concern is impairment of existing book value rather than long-term returns on capital for this asset class.
You may take a look at the recent AER press release where they essentially signposted (at least to me) that not only has there been no change in underlying demand for aircraft but they actually see increased demand (they sold 36 planes in the Q, and have now leased basically all their Embraer E-2s, a new mid-size aircraft that some thought would find uncertain demand in the market). Business as usual, I expect them to keep hoovering up stock at big discounts to B/V (just like in 2016)...just going to have to wait for the market to care...
|Subject||Re: Re: KKR Commits to Invest $1 Billion with Altavair|
|Entry||01/03/2019 04:15 PM|
Aircraft leasing is a very large and fragmented business with many PE firms involved in one way or another. I know this isn't their mandate, but it's hard for me to believe that they will earn superior returns investing at book versus buying AER at under 2/3 of a book value that may well be understated.
|Subject||Re: Re: Re: KKR Commits to Invest $1 Billion with Altavair|
|Entry||01/06/2019 12:23 AM|
Agreed Nassau. Additionally, there are now rumours KKR is looking at taking out GECAS - AER’s main competitor - at around book value. I am not as familiar with the composition of GECAS’ fleet but based on the reports it looks to be 3x levered (ie more than AER) and generating around a 10% RoE (again worse than AER) - this is probably due to a higher concentration of junkier assets like helicopters and freighters (which AER has zero of). If sophisticated buyers are willing to pay book value for an inferior, more levered business from an obviously distressed seller, then it is quite clear AER is at the very least worth book value even in today’s market and in a real sale scenario (ie 50% upside to current) I would argue at least a 10-15% premium to this. In other words if true, this is quite good news for other listed lessors, and AER specifically.
|Subject||yet another junky lessor taken out at least at book value...|
|Entry||03/01/2019 05:24 AM|
DZ Bank's Aviation finance unit seems a bit of a hodge podge (narrowbodies, widebodies, freighters, cargo, etc). We know nothing about how levered the portfolio is or the quality of the assets. Also it seems not just pure leasing but also bridge financing and structured finance. What is not debatable is that it is a) of significantly smaller scale/platform capability than the larger lessors like AER/GECAS; and b) the sale price, though unconfirmed, looks to be around asset book value (FT article says a $6.3bn transaction, MUFG press release says 5.6bn EUR portfolio as of Jun'18).
Still find it really hard to believe how significant strategic transactions like this, the KKR deal, and maybe a GECAS transaction can occur while much better public comps (better performance, scale, management, assets, etc) trade 35%+ lower. Ok frustrated long rant over.
|Subject||another boringly profitable quarter where they say and do all the right things|
|Entry||05/02/2019 04:24 AM|
yet another quarter, they keep putting up the numbers. they have compounded book at 14% the last 5yrs; they have not lost money in their entire listed history; and they once again demonstrated there is a real value to the platform (getting their planes out of Jet Airways weeks in advance of everyone else, and redeployed faster). the 737 MAX risk is essentially de minimis (1% of book today) and they highlighted - repeatedly - that buying back stock is the best and only use of their excess capital. they have essentially placed their entire fleet and order book through 2021 (well, 95%) and the average lease term keeps going up (now >7yrs) so its unlikely the record of value creation breaks anytime soon.
the stock has clearly bounced since the swoon last Q but it is crazy to me that a financial asset with such a long, consistent and not-volatile history of value creation through the cycle, moderately levered (relative to other financials) and a clear leader in its field, is available at 75% of book while generating consistent and sustainable mid-teens % returns on equity. If this was called 'JPMorgan AerCap' it would trade at close to 2x book and be considered not unreasonable value.
one day this space will re-rate to where it belongs; until then its an ongoing anomaly - a wildly cheap stock (and space) in an overheated expensive market.
|Subject||Re: another boringly profitable quarter where they say and do all the right things|
|Entry||05/02/2019 09:56 AM|
I think it was nice to see management providing a new overview of the overall de-risking of the company on slide 11. Haven't seen this emphasized, but it seems AER has never been "safer" than it is today (although pre-ILFC takeover closing was similar in terms of asset age & D/E, but that is not a fair comparison as the company knew when doing the deal it would close on ILFC which was much larger )
Some perspective on how opportunistic AER could get in the next downturn: going into the GFC, AER had lower asset quality (higher avg age of fleet, lower diversification by virtue of being much smaller), higher D/E (>3X) than today but still managed to double in size opportunistically throughout (and do a large SLB deal a bit later with American).
Also nice was more confirmation on continued asset sale & buyback arbitrage for 2019
On the call, CEO laid out AER's "barbell strategy" more clearly than ever (?) before in calls:
The average age of our fleet continue to decrease and we are now operating in the low 6s. Average age was 6.2 years at the end of March. We've reduced the age of our fleet in the right way by buying new technology aircraft that will be in demand for the next 25 years.
The average age of our new technology fleet was only 1.9 years at the end of March while the average age of our current technology fleet was 10.8 years and we believe this barbell approach is the correct way to manage the portfolio. [..] And over the last 5 years, we've been very consistent and deliberate in creating a barbell in our portfolio regarding age. [..] And look, it's been very enticing to purchase new 777s (old tech) to boost near-term growth in earnings and reduce average age of fleet. But this is where residual value risk lies, because these planes have declining user bases.
Tech obsolescence risk is lower for old model if it's an old plane as competition is more indirect because of age difference.
Both the fact that small lessor entrants can show paper profits by undercutting competition & using aggressive residual values AND the financial trade-off of using barbell approach for risk reasons vs showing immediate profits now by buying deeply discounted new end-of-model aircraft remind me of W.B.'s older annual letters on how to win in the reinsurance business: for through-cycle economic profits you need countercyclical behaviour because it is so easy to show near-term paper profits in both sectors.
AER's actions (shunning top line growth at times, barbell) speak louder than words.
.. But unlike in reinsurance, AER's size is actually an advantage because
* operational capabilities
* lessors act a bit like brokers, balancing supply/demand throughout the world (small network effect: large lessors are able to earn more "bid-ask spreads" by solving the local imbalances puzzle: efficiently reallocating planes from one client to another as their uncorrelated/local needs change)
|Subject||Re: Re: another boringly profitable quarter where they say and do all the right things|
|Entry||05/11/2019 10:55 AM|
punchcard - thanks for your comments, i am in complete agreement. having thought about this more over the last few days, the messaging from the co definitely changed with this report, and for the better: as you said, more discrete disclosure re the barbell strategy; more pushing the track record of value creation through the cycles; more pushing the differentiation between AER now and pre-ILFC; and particularly, more pushing the difference b/w AER and its competitors (willingness to completely eschew easy growth for disciplined, slower returns).
I thought the part of the call where Aengus explained the merits of the barbell strategy in terms of residual value was instructive. I don't have the exact quote in front of me, but he essentially said he wanted to own either very young new technology planes (ie ones on first leases but with 20+ yrs of life left); or, CG planes on their last lease - in other words not taking residual value risk on CG planes post their last lease.
at this point there isn't any real questioning AER's execution nor the dexterity of this particular management team (Gus is a huge asset, I hope he never leaves). It is much more about when the market will value this appropriately for the consistent and sustainable value generation they produce. that is a much more difficult question to answer but I guess it would be some combination of:
- more aggressive signposting/engagement by management in marketing the company (seems like this may have started this quarter with the increased disclosures)
- further upgrade to credit ratings (likely imo)
- further rotation out of growth/momentum and towards value (maybe this happens post SV unicorn puke, who knows, but we can dream)
- passage of time/ongoing solid performance
this is still very much a core holding for me, I simply have to stop myself buying more and more as the mkt periodically gives you chances to buy it at silly prices like in Dec.