Description

FTAI - LONG

Current price: $20

Price Target $94 (4-year time horizon)

Market Cap $2.1b / Enterprise Value $4.2b

Overview

FTAI has been written up before on VIC, but I believe now is a perfect time to revisit the stock.  My price target is $94 over the next 4 years.  Yes, you read that correctly--$94.  In this write-up, I will try to explain why my assumptions are reasonable and why the stock has a wide margin of safety. For those with a short attention span, my thesis is quite simple. FTAI has gone through a major transformation from a complex “mess” of assets to a pureplay aviation company.  The company is on the cusp of seeing substantial growth in its parts & service business and that will translate into a higher multiple. I see EBITDA growing from $423m in 2022 to $1b in 2026 and see the multiple expanding from 9.7x today to 12x.  Also, the company has a 6.3% dividend yield, which limits the downside. 

Some Historical Highlights/Lowlights

FTAI has gone through significant turmoil and change the past three years. The first major setback was in March of 2020 when COVID caused everyone to stay home--not exactly an ideal scenario for a company whose dominant business is related to air travel. What is important to recognize is that while earnings declined, they were still reasonably healthy as lease payments for engines/ aircraft need to be made regardless of whether planes are flying.  Also, the travel industry, and specifically aircraft maintenance, is still in the process of healing after the global pandemic and has a positive outlook for many years. The second major setback was the Russian/Ukraine war in February 2022.  FTAI had several aircraft that were abandoned, blown up or not retrievable.  This resulted in a $122m charge and reduced the size of the fleet, which hurt near-term earnings power.  All of these assets were insured, and the negotiations with the insurers are ongoing, so stay tuned.  The next major event was management’s decision to spin out the infrastructure assets.  FIP, as it is now affectionately called, is a collection of businesses that include rail, energy storage, ports and terminals.  Separating these assets simplifies the FTAI story as these are complicated assets in various stages of early development (code for they don’t all make money yet). Also, as part of the spin, FIP took on debt and returned $700m of cash back to FTAI, which improved the balance sheet.  Lastly, after the separation, FTAI changed its tax status to eliminate its K-1, so now a wider group of investors can own the stock.  What is absolutely mind-boggling is that prior to last week the stock price was near the lows, despite all of these events that de-risked the FTAI story and cleared the “runway” for significant growth.

Description

FTAI has two main businesses: leasing and products/service. The leasing business has decent visibility because most of the leases are for 36 months. The biggest variability is when new assets are purchased and the gain on sale when assets are sold.  As of the end of 3Q22, FTAI had 229 engines and 96 aircraft on lease.  Most of the engines are CFM56 which is the most popular engine in the world and commonly found on the A320 and BA737. FTAI’s second business is aerospace products/service.  This is relatively new and has grown from basically zero in 2020 to $74m/yr ebitda run-rate in 3Q22.  This is an attractive business because the FAA mandates that airplanes are required to get regular service and parts used in this service must be formally approved.  This creates steady demand and significant entry barriers.  FTAI has a few key partnerships that make this possible.  They have a 7-year contract with Lockheed for maintenance shop capacity and labor.  They have an exclusive JV agreement with Chromalloy for aerospace parts.  FTAI and Chromalloy are in the process of getting approval for 4 additional parts.  The process typically takes 3-5 years to get FAA approval, which is either viewed as painstakingly long or a wonderful barrier to entry.

Thesis Key – Grow the Products/Service Business

In 3Q22, this business generated $18.6m ebitda, which annualizes to $74.4m.  Management has guided to $500m in long-term ebitda for this segment.  This is how we get there:

1)      The key assumption in the table is that FTAI will grow its market share to 10% over time.  This is credible because of their significant value proposition.  They provide parts that are approximately 50% cheaper and their modular factory provides flexibility customers want. A typical major maintenance overhaul costs $5m-$6m every 5 years.  FTAI should be able to cut that cost in half.

2)      The modular factory allows FTAI to service an engine in phases.  This saves the customer time and money.  This can reduce service visits from 3 months to as little as 7 days in some cases. 

3)      Engine maintenance is typically up for bid after the first 10 years in flight.  Of the 22k CFM56 engines in circulation, 50% were covered by original service contracts in 2018, 38% were covered in 2022 and only 5% will be covered in 2028.  This is a huge opportunity for FTAI to take over those maintenance contracts.

4)      FTAI can grow their business without significant capital.  The products/service business is very complementary to their legacy leasing business. FTAI can retain service contracts even after they sell an asset. This is a replicable situation that requires no additional capital and supports the ramp of the service business.

5)      FTAI expects approval of four additional engine parts.  This should happen by the end of 2023, but even if this bleeds into 2024, it is still a highly likely outcome.  FTAI’s partner Chromalloy has never had a part turned down for approval, so it is more a question of when, not if.

6)      The price of an engine typically goes up mid-single digits every year.  This translates into a price increase for FTAI.

7)      Air travel will continue to grow.  It is one of the few positive secular trends that have held up the past 50 years and should hold up the next 50 (see charts below).

The Aviation sector has positive growth and has proven resilient over and over again.

 Source: Boeing 9/22.

Valuation & Target

            The current valuation is attractive and provides limited downside.  The stock trades at 7.9x my ’23 EBITDA estimate and 4.2x my ’26 estimate.  Free cash flow is also substantial with a 14% free cash yield on ’23.  Nearly half of the free cash will go towards the dividend, so that leaves half for potentially accretive actions.  CAPX is unusually low because the products division is asset light as FTAI’s partners shoulder the majority of CAPX requirements.

My price target is $94 or 12x my 2026 ebitda of $1b.  This does NOT incorporate any of the free cash which means I’m ignoring the 6.3% annual dividend and potential uses of cash for buybacks or acquisitions.  Also, it is noteworthy that management expects ebitda of $1b in 2025, so one year earlier than I have assumed.

Balance Sheet

            Leverage ratio appears elevated at 4.6x as of 3Q22, but this should decline to 2.9x by end of 2023, and 2.2x by end of 2024.  Net debt as of 3Q22 was $1.95b and should decline to $1.25b in 2 years, due to free cash after paying the dividend, $200m in insurance proceeds and $150m in non-core asset sales.

Peers and Valuation

            Here is a list of who I view as the best comps.  Notice that the blended multiple is 12.7x.  My target multiple is 12x.  Over time the earnings contribution will increasingly come from products/service, so I expect the multiple to gradually migrate towards the product comps.

Risks

            There are always macro risks to air travel, but I view the long-term trajectory of this company as difficult to derail.  Even if the world enters a significant recession, it will not have as big an impact on FTAI as the Covid lockdowns.  Another risk is that the products business could ramp more gradually than expected, but this stock is not valued like a company expected to grow earnings 20%+ per yr.  I think earnings could grow 10%/yr (half as much as I expect) and the stock can still outperform especially when you add in the dividend.  In the past, management has given guidance that was too optimistic, but I would argue that it was very difficult to predict Covid or the Ukrainian war.  While the timing of their forecasts have been off, they have executed on key items like the FIP spin and the K-1 elimination. 

Catalyst

1) Insurance Proceeds. No one from the sell-side has incorporated any insurance proceeds from the planes lost in the Ukraine/Russia conflict. The book value of planes lost is $125m, but they were insured for replacement value. The likely recovery should be $150m-$300m. Timing is uncertain, but I expect half in 2023 and half in 2024.

2) Non-Core Asset Sale. FTAI owns 3 ships they are looking to sell for $125m-$175m. This is likely to happen in 2023 as they already have been contacted by interested buyers.

3) Passive Index Adds: There are three likely index adds. The MSCI index in February will create 2m shares of passive buying. The Russell add will be in the summer and will create 8.5m shares of passive buying. And, after reporting 4 quarters of profit, the S&P 600 add will create 11m shares of passive buying. In total this is 21.5m shares of additional buying pressure.

4) Acquisitions: On 1/4/23, FTAI made a small acquisition into the emergency aircraft maintenance market. This is likely to become another growth business (called QuickTurn) for the products division.