AerCap: Measurement Up As Common Electrical Sells Down

The Setup

AerCap Holdings N.V. (NYSE:AER) is an airplane, engine, and helicopter lessor led by CEO Aengus “Gus” Kelly. AerCap underwent a transformative acquisition when it acquired GECAS (GE Capital Aviation Providers) in This fall 2021. A number of disruptions over the previous three years, together with Covid and the Russia-Ukraine Battle, challenged the enterprise as air journey stopped and airplanes leased to Russian airways couldn’t be seized. Whereas these challenges are comparatively behind the corporate, a big overhang stays. GE owned 14.5% of AER inventory as of 9/21/23, which they may proceed to promote down, making a near-term overhang. As soon as GE exits its stake, AER is way extra compelling. The short-term promoting stress caps near-term upside. GE made intentions identified to exit the place, which ought to occur by Q1 or Q2 of 2024. AerCap’s low cost to BV and mid-single-digit earnings valuation is compelling sufficient to go lengthy in a small starter place, growing the place measurement as GE sells the remaining stake.

Enterprise Description

AerCap is the biggest aviation leasing firm on the earth, with a portfolio of two,323 plane, engines, and helicopters owned, 718 managed, and 426 on order as of June 30, 2023. AerCap supplies a variety of belongings for lease, together with narrow-body and widebody plane, regional jets, freighters, engines, and helicopters, specializing in buying in-demand flight tools at engaging costs, funding them effectively, and hedging rates of interest when prudent. Along with their main enterprise, they’re the world’s largest engine leasing firm, with over 900 owned and managed engines.

AerCap’s mannequin is an expansion enterprise. Borrowing at a less expensive price than airways because of the constant income stream and buying planes cheaper attributable to bulk purchases. The place the price of debt for American Airways in March 2023 was 7.25% for five-year notes, AerCap was in a position to challenge 5-year debt at 5.75%. The chart under depicts AerCap’s high 5 prospects and the geographic area of its income base.

The decrease the credit standing of an airline, the upper the price of financing, and the extra probably they’re to lease fairly than personal. Excessive debt service prices for low credit standing firms impede working a worthwhile enterprise. As an alternative, AerCap’s decrease price of financing permits them to behave as a intermediary, taking an expansion above their financing price and lending it to those riskier prospects. Airways lease a airplane fairly than personal it for just a few causes. The primary ties into the above: airways will need to have entry to capital to buy a airplane. The price of an airplane can run $100m+ (kind of relying on the physique kind); some airways are too small to afford this. Second, a lease doesn’t lock an airline right into a long-term dedication. As an alternative, they’ll lease a airplane for 5-10 years, with the one upfront capital as a safety/upkeep deposit and the primary few months of hire. The upkeep deposit might be refunded on the finish of the lease if the airline returns the airplane in good situation. The delta between a deposit and preliminary hire funds in comparison with the outright possession of a airplane is substantial, giving the airline better flexibility. Lastly, the airline doesn’t bear the residual worth threat when the airplane ends its helpful life. Technological obsolescence could lead to a scrapped airplane.

Moreover, there are dangers if the airplane producer unveils new expertise, resembling better gas effectivity, extra seating, or a greater flying expertise. Airways could change into uncompetitive attributable to a worse flying expertise or competitors providing higher costs. With a lease, as an alternative of the airline bearing this for the lifetime of the airplane, sometimes 25 years, the lessor bears this. The desk under depicts the airplane/tools depreciation schedule and the residual worth assumed. A $50m plane buy has $7.5m of residual worth. The danger of getting an outdated airplane through the early to center of life will increase for airways with little information of future demand developments. AerCap, given its broad buyer base, foresight into leasing/demand developments, and database of transactions, is way extra prone to be the primary to know when demand and expertise adjustments will happen.

Constructing on the final level. Gus usually discusses the worth of the AerCap platform. In the course of the yr ended December 31, 2022, the corporate executed 895 asset transactions (sale, lease, or buy). In earlier years, they accomplished 349, 179, and 349 from 2019 – 2021. AerCap has an unmatched database concerning what airplanes are in demand, slim physique vs. vast physique, Airbus or Boeing, is unparalleled. Probably the most important threat for a lessor is buying an out-of-demand airplane that generates minimal lease income and is probably going out of demand when the lease renewal happens or on the finish of life, having no residual worth. With extra information than anybody else, the informational benefit permits them to lease planes at one of the best risk-adjusted charges, promote planes on the highest value, and buy probably the most in-demand plane.

Thesis

Whereas the above paints a constructive image for AerCap’s enterprise, the promoting stress stemming from the GE selldown has resulted in AER’s inventory declining 2% for the reason that 15-month lockup ended on February 1, 2023, in comparison with the S&P 500, up 6%. A 20% drawdown coincided with GE’s first sale announcement once they filed to promote 23m shares for $58.50, $1.50 under the inventory value. The latest sale announcement occurred on September 11, promoting ~47m shares at $59.00, $2.79 under the present buying and selling value. AerCap repurchased 15.3m, decreasing the shares coming to market. In seven months, the low cost GE is keen to tackle the shares nearly doubled in seven months. GE desires the money and never AER inventory. Under, I’ll stroll via my valuation, which makes AerCap look engaging; till this promoting stress subsides, I battle to see how the valuation hole absolutely closes.

I like to recommend constructing a place as GE continues promoting and reaches 3% or much less of an proprietor. AerCap’s historical past of repurchasing shares ought to speed up the worth realization. My expertise with a number of forms of investments, the place sometimes Personal Fairness or a big shareholder sells down, is extra vital than enterprise outcomes. If outcomes are good, the sell-down continues and will speed up. Poor outcomes trigger additional promoting stress, and a big share sell-down ends in a one-two mixture of promoting stress.

Unit Economics

AerCap’s unfold mannequin is to challenge low-cost debt, buy plane at a sticker value (bulk buy) low cost, and cost lease rents at an expansion over borrowing prices whereas factoring within the credit standing of the top buyer. Its enterprise mannequin is just like a financial institution. Borrow at low charges and lend at larger charges, modify spreads or safety deposit (for a financial institution down cost) for credit score threat. In AerCap’s case, understanding the annualized internet unfold on belongings offers us an concept of the margin they obtain. Calculated by taking fundamental lease rents, subtracting curiosity and depreciation, and dividing by property and tools. The desk under depicts the historical past of this. My estimates for 2024-2026 are primarily based upon the corporate’s order guide, historical past of asset gross sales, and debt schedule (mentioned extra within the steadiness sheet part under)

Enterprise efficiency and, subsequently, the inventory is just like how a financial institution’s enterprise performs. The upper return on belongings (ROA) in AerCap’s case, larger return on plane, the higher enterprise performs. Taking it additional, like a financial institution, AerCap makes use of leverage. On the finish of Q2, that they had internet debt of $45.1B and flight tools of $55.6B. The corporate’s debt/fairness ratio stood at 2.5x, under their goal of two.7x. Using leverage considerably enhances the return on fairness of the corporate. Like a financial institution, the place ROA’s vary from 1-4%, leverage elevates the return on fairness to shareholders to 8-12% on common. AerCap follows the same playbook, with an ROA starting from (0.5%) to three.9% since 2015 and an ROE starting from (3.1%) to 45.8%. (Please notice this calculation is completed as PP&E – debt = fairness in planes).

One other calculation I run to grasp how administration costs leases is trying on the ROA on the price of planes. AerCap has constantly generated a 2.1% – 3% Return on price (excluding 2020), which is nice, in my view.

Lease rents generate 80%+ of income, the remaining coming from upkeep income (supplemental upkeep hire primarily based on plane utilization through the lease time period or end-of-life-compensation primarily based on the plane’s situation), acquire on sale when AerCap sells an plane for greater than its carrying worth, and different earnings generated from claims, curiosity, administration charges, and different miscellaneous earnings.

The corporate’s income per airplane exhibits how lease charges trended. 98.2% of AerCap’s rents are fastened, and the rest are floating charge tied to rates of interest. When AER acquired GECAS, they acquired a portfolio of 300+ helicopters and an engine leasing enterprise proudly owning 450+ engines. One in every of AerCap’s prospects is Bristow. Utilizing Bristow’s leasing prices and the variety of helicopters leased to calculate the leasing price per helicopter, then making use of this determine to AerCap’s helicopter enterprise to estimate the helicopter section income. I used to be unable to discover a comp for the engine leasing enterprise. Since 85% of AerCap’s belongings are plane, I consider together with the engine leasing income however not the variety of engines is sufficient to present how leasing income per airplane has trended.

As proven within the spreadsheet above, within the line Plane lease income/airplane, income per airplane has not recovered to pre-pandemic ranges. As lease modifications roll off and leases signed throughout 0% charges, leasing developments ought to regain and surpass pre-pandemic ranges within the subsequent 2-Three years.

Since AerCap’s price of financing is growing, they need to move on these larger prices to prospects. Listening to Gus on the Deutsche Financial institution Plane Finance and Leasing Convention, he said that new lease charges have moved in lockstep with rates of interest. I estimate lease income/airplane return to 2019 ranges in 2024 and enhance mid-single digits in subsequent years. The rise in rental earnings will partly be offset by larger financing prices (mentioned within the steadiness sheet part).

AerCap has been a internet vendor of plane as a result of they’ve constantly been in a position to promote their planes at a premium to carrying worth whereas the inventory has sometimes traded at or under guide worth. AerCap can promote planes at a premium and purchase the inventory at a reduction. Promoting a airplane for a 10% premium to carrying worth and buying the inventory again at a 10% low cost is a 20% unfold of worth creation (assuming the plane sale and carrying worth are indicative of the remaining guide).

In 2018-2019, AerCap bought ~10% of their fleet every year. In the course of the pandemic, this determine was reduce in half to ~5%, recovering in 2022 to 13%. By means of Q2 23, AerCap bought 39 plane/engines (3.3% of fleet) at unsustainably excessive costs and margins. As proven within the chart under, in Q2, AerCap bought belongings at nearly 2x the carrying worth. Traditionally, 1.1x-1.2x has been the norm. In the course of the Q2 name, Aengus said, “On the gross sales aspect, we proceed to see robust and broad-based demand for our belongings, closing $818 million of transactions within the quarter. This resulted in our highest-ever quarterly acquire on sale of $166 million, representing a 25% margin. Encouragingly, this was not confined to plane belongings. We additionally noticed robust good points in our engine and helicopter gross sales with document volumes in every class. This additional confirms the advantages of the asset diversification AerCap now enjoys.” They acknowledge these margin ranges are unsustainable, so I’ve them returning to historic ranges.

The principle causes AerCap can promote planes at a premium are twofold. First, the price of new construct plane has elevated considerably over the previous a number of years. Plane are depreciated over a 25-year helpful life. Subsequently, if AerCap by no means refurbished or reinvested into the plane, the worth would decline 4% per yr. Over the previous few years, inflation ran north of this determine, so whereas the planes misplaced 4% in worth every year, the price to interchange them elevated at a better charge. Inflation working at 8% and planes shedding 4% of worth ends in a internet 4% enhance in resale worth. Exacerbating this drawback is the uncertainty round Boeing and Airbus deliveries, which places airways in a state of affairs the place they’re not sure what their fleet measurement will likely be in a yr. Paying the premium to have certainty of supply is price it for them, giving AerCap bargaining energy.

Valuation

I used two valuations to develop a good worth of AerCap: a P/B and a P/E. Vital asset writedowns throughout 2020 resulted in a loss. Going ahead, I consider AerCap’s ROE will likely be ~15%, which might sometimes warrant a P/B better than 1x and a mid to excessive double-digit earnings a number of; nevertheless, again and again, like a financial institution goes via a recession and has elevated write-offs, each decade, an surprising occasion appears to happen, inflicting AerCap writedown belongings. With this the case, a 1x P/B and 10x P/E appears affordable. Moreover, given the leverage profile of the enterprise, the potential for a catastrophic occasion is at all times current.

Utilizing the P/E first and primarily based on my evaluation and estimates, my one-year value goal is ~$78 with a draw back of ~$56 for a 2/1 threat reward. If acquire sale margins stay sturdy and leasing charges speed up, I consider there could possibly be upside to estimates and the a number of. My bull case is that the corporate generates ~$8.57 in EPS and, given the robust developments, trades at 12x earnings for a 62% return. With a ~5:1 upside/draw back, the valuation is compelling.

Using a P/B methodology tells the same story.

Below both valuation methodology, the chance/reward is compelling. My common 12-month draw back case is ~$57, base case ~$82, and upside ~$104. With a $63 inventory, the risk-reward skews constructive. The draw back situation would probably take a number of elements, together with softening demand, decrease leasing revenues, decrease acquire on sale margins, and financing prices accelerating to the upside. The bull case entails accelerating lease charges, sustained acquire on sale margins, and internet unfold growth.

Traditionally, acquisitions within the house had been above guide worth, lending additional credence to the above valuation. Fly Leasing is the only real acquisition I might discover accomplished under guide worth. Nevertheless, this was attributable to Fly’s pressured steadiness sheet throughout COVID-19.

Stability Sheet

AerCap, like many financials, runs a levered steadiness sheet. An important objects on AER’s steadiness sheet are Internet Fastened Belongings, that are the carrying worth of plane belongings (price – collected depreciation), Lengthy-Time period debt, and guide fairness. Earlier than the GECAS acquisition, AerCap’s belongings remained comparatively secure because of the continued promoting of older plane and the following buy of latest plane. Debt was additionally comparatively secure at ~$29B. Because the chart under exhibits, AerCap’s fairness in planes (Asset Worth – Debt) elevated since 2016. Whereas this hurts the ROE, because the leverage declines (leverage magnifies returns), monetary stability, flexibility, and draw back safety enhance. Beforehand, a 10% decline in Plane values worn out fairness holders. Whereas the chance of such an occasion is minimal, black swan occasions like COVID-19 and 9/11 underscore these left-tail occasions. On the finish of 2023, I estimate AerCap may have an fairness cushion of ~18%.

Whereas the enterprise economics deteriorate with this larger fairness (i.e., decrease ROE), the catastrophic threat of the enterprise considerably declines. A trade-off of decrease returns however elevated security is one I agree with. Contemplate what might trigger plane values to say no by 18%: authorities mandates a selected gas effectivity, or all planes should be electrical, inflicting AerCap’s planes to change into out of date. A world despair causes air journey to say no, resulting in airline chapter and lease defaults. AerCap’s lack of ability to lease planes might trigger the worth of the planes to say no. A number of different occasions are potential, however contemplating what would occur to the airline trade beneath these conditions, no airline can utterly rework its fleet in a single day. Boeing and Airbus have restricted manufacturing capability. Sooner or later, one might be too pessimistic.

In 2023, AerCap had three bonds mature with rates of interest of 4.5%, 5.8% and 1.15%. In the present day, the corporate’s price of medium-term debt is ~6-6.5%, as mentioned within the subsequent paragraph. The chart exhibits the corporate’s maturity profile and adjustments to its weighted common rate of interest as bonds come due within the subsequent a number of years. I assume the corporate points medium-term debt at 6.2% (which could possibly be low relying on the place rates of interest go). In 2024, the corporate’s common charge goes to 4.56%. In 2025 4.63%, and in 2026 5.09%. Given the low base of three.74% in 2023, the 135 bps charge enhance is a 36% enhance in curiosity expense. Ought to charges proceed to maneuver larger, financing prices will additional enhance.

AerCap just lately issued 6.100% senior notes due in 2027 at 99.540% and $850M at 6.150% in 2030 at 99.371%. The debt issuance was one of many few instances I questioned administration’s motive. Sometimes, when an organization points shorter length debt, they pay decrease curiosity prices for it because of the upward-sloping yield curve, much less uncertainty of a credit score occasion, and decrease rate of interest threat (the chance that charges rise and the investor loses out by not having the ability to put money into the higher-yielding debt). On this case, AerCap issued 2027 2030 debt at roughly the identical rate of interest, probably because of the inverted yield curve. On this situation, firms needing to refinance debt ought to go far out on the yield curve as a result of the market fees them lower than in the event that they went shorter. Why AerCap would challenge 2027 bonds for a similar value as 2030 is puzzling, fairly than issuing all of the bonds in 2030.

Most monetary firms run a laddered bond portfolio, issuing bonds at totally different durations to not have one yr with considerably extra maturities due than one other. Once more, shorter bonds usually have decrease rates of interest than longer. In AerCap’s case, they pressured themselves to refinance debt in 2027. One can envision debt markets being closed then, but AerCap nonetheless must entry the markets by paying a better charge. AerCap might have run the laddered portfolio with these bonds, even when each had 2030 maturities, by forcing or mentally noting that the plan is to refinance a portion of the debt in 2027. If debt markets are closed in 2027, it offers them just a few extra years for markets to normalize. Optionality is commonly underappreciated.

Administration

Aengus has been CEO of AerCap for over 12 years. He grew up within the aviation leasing trade (he is solely 49). I might suggest listening to him discuss. He is trustworthy, simple, and clear. As a earlier shareholder of AER, AerCap was by no means an organization that saved me up. I belief Aengus will make the right choices.

AerCap’s coverage on govt possession is that govt members should personal shares valued at a minimal of 5x their annual base wage; for the CEO, the minimal is 10x. Under particulars administration’s possession stake. The dearth of unrestricted inventory possession is regarding. Most board members personal little inventory and have most of their fairness possession granted via RSU’s.

Administration’s fairness compensation bundle relies on long-term development, worth creation, and EPS development. I’ve no challenge with these efficiency metrics as a result of the corporate ought to change into extra beneficial over time via BV appreciation and growing EPS.

Dangers

Demand for plane relies upon upon the demand for air journey. The principle threat with proudly owning a lessor is that air journey demand falls, leading to much less demand for his or her plane. One of many essential dangers administration discusses is the residual worth, the remaining worth of the plane on the finish of a lease. Decrease demand for plane would lead to AerCap impairing the asset. Impairments decrease the guide worth and, due to this fact, the corporate’s truthful worth.

Alongside these strains, I’ve had the chance to fulfill Aengus and listen to him converse at a number of conferences. He’s by no means shy about sharing his opinion of Airplane producers. Boeing and Airbus care little in regards to the airplane’s worth as soon as they promote it to a lessor or airline. Aengus said a number of instances that the monetary outcomes will likely be poor if an organization buys what Boeing and Airbus wish to promote them. As an alternative, given AerCap’s database, they know what probably the most in-demand plane will probably be at any time, which is usually totally different from what the producer desires to promote. This is smart. For instance, if narrow-body planes are in excessive demand, Boeing is probably going already at max manufacturing capability; they can’t enhance manufacturing in the event that they wish to, so that they don’t have any cause to push gross sales for them. However, vast our bodies are probably in much less demand. With the surplus manufacturing capability, Boeing is out making an attempt to promote these planes to lessors. Equally, buying planes with few potential prospects could possibly be problematic. If the unique lessee doesn’t re-lease the airplane, the potential to lease it to a brand new buyer is difficult because of the lack of potential suitors.

The chart under exhibits that AerCap’s common price of debt in 2022 was 3.1% (totally different from above attributable to floating charge caps and swaps). Given the dramatic rise in rates of interest over the previous yr, we all know that AerCap’s debt price will enhance.

In AerCap’s 20-F, they state, “As our leases are primarily for a number of years with fastened lease charges all through the lease, we usually can not enhance the lease charges with respect to a selected plane till the expiration of the lease, even when the market is ready to bear the elevated lease charges. Because of this, there will likely be a lag in our means to regulate and move on the prices of accelerating rates of interest.” If AerCap is unable to extend lease rents at a charge just like or better than their price of financing enhance, the corporate’s internet unfold will contract, resulting in a decline in profitability.

Lastly, ought to GE speed up the selldown of AER shares, it might enhance stress on shares within the quick time period.

Q2 Outcomes

AerCap reported robust ends in Q2, headlined by a $500m repurchase authorization, guide worth growing 14% y/y, and full-year adj. EPS steering growing to $7.50-$8.00 excluding acquire on sale from $7.00 – $7.50 ($8.50 – $9.00 together with acquire on sale) attributable to robust demand developments and sturdy acquire on sale margins. The corporate recorded its highest-ever acquire on sale in 1 / 4 of $166m, stating gross sales had been robust in all segments. They’ve $809m of belongings held on the market and are on monitor to promote $2.5B of belongings for the yr. In the course of the quarter, they repurchased $300m price of shares.

Subsequent to quarter finish, on September 5, 2023, AerCap acquired money insurance coverage settlement proceeds of $645m from insurance coverage claims because of the 17 plane and 5 spare engines on lease to a Russian service. Unsurprisingly, with the corporate’s proceeds, they elevated the buyback authorization by $650m two days later. As of 9/7, AerCap had $1.3B remaining beneath its repurchase authorization, roughly 10% of at this time’s market cap.

Abstract & Ahead-Trying Objects to Monitor

AerCap is affordable; nevertheless, the GE share sell-down is probably going capping the upside within the quick time period. One of the best sport plan is having a starter place and sizing it up as GE sells down, balancing at this time’s engaging value with the near-term headwinds offered. AerCap’s administration group may be very skilled, demand developments stay robust, and the enterprise generates mid to excessive teenagers return on fairness, which helps a better valuation than at this time’s low cost to BV.

Going ahead, monitor the next metrics:

1. Internet lease spreads
2. Lease income/airplane
3. Acquire on sale margin
4. GE possession stake and AER buyback charge