I was researching an aircraft leasing company called Air Lease (AL) over Christmas and early new year. I did a fair bit of reading (10K, recent earnings, some related articles) but the work was incomplete in the sense that I didn’t really arrive at a conclusion with respect to buying or not. I got this idea from the “Better Investing” magazine; some Better Investing investment clubs have purchased AL.
What I like about it?
o Led by industry veteran credited with getting this industry going
o Decent PE for a growth company
o Interesting business model with respect to aircraft purchase, lease, and sell
o Provides exposure to growing air travel without having single airliner risk (airlines generally have been poor businesses but air travel continues to grow)
o Exposure to emerging markets
What I don’t like about it?
o Debt + emerging market exposure; in the event of an economic slow down, this company might suffer
Anyways, if there’s interest let’s discuss this idea. Please note that the numbers on these notes were last updated Jan 6th, 2015.
Company, industry, and sector
Company: Air Lease (NYSE: AL)
Sector: Rental & Leasing services
Air Lease Corp is an aircraft leasing company, engaged in purchasing commercial aircraft & leasing to airlines. It operates on a global basis, providing aircraft to airline customers in Asia, Pacific Rim, Latin America, Middle East and Eastern Europe. In addition, Air Lease sells aircraft from their lease portfolio to third parties, including other leasing companies, financial services companies and airlines. Further, they also provide fleet management services to investors and owners of aircraft portfolios for a management fee.
Air Lease maintains a strong credit profile, which allows the company to access the capital markets and obtain unsecured debt at low interest rates. Air Lease is targeting 10% secured debt to total assets and 70% fixed rate debt. The company targets debt to equity ratio of 2.5 to 1. Using its low cost funds, Air Lease buys new aircrafts in bulk from the manufacturers, and then places these aircrafts at attractive lease terms at airlines that are growing but either don’t have affordable access to capital for purchasing aircrafts or can’t access aircrafts soon enough because of backlog at manufacturers. Aircrafts are leased in what the company calls the sweat spot of 18 - 36 months ahead of delivery, i.e., this provides certainty that purchased aircrafts will generate cash inflows and allows airlines access to aircrafts ahead of manufacturers. Air Lease sells aircrafts once they become 7 to 8 years old.
Recently, Air Lease announced partnering in a new aircraft leasing joint venture called Blackbird Capital I, which aims to manage aircrafts worth $2B by 2016. Air Lease owns 9.5% of this joint venture, with the rest owned by institutional investors arranged by Napier Park Global Capital. AL will provide management services over a 12 year period to the joint venture for a servicing fee based upon AUM. AL also expects to sell aircraft from its portfolio to the joint venture with an aggregate value of approximately $500 million by year-end 2016. This is a good way for AL to maintain its credit profile while supplant its income with high-margin management fees. Further details here:
Company strengths, advantages, and strategy
o Founded and led by Steven F. Udvár-Hazy, who’s widely regarded as the aircraft leasing industry pioneer.
o Diversified geographically and across various carriers (77 airlines in 47 countries). They do focus a fair bit in markets that are experiencing rapid growth, and these markets have pent-up demand for modern jets which will be replacing ageing fuel-inefficient older jets. AL refers to these as the “replacement” market and many of these markets don’t have well established financing alternatives to stoke the growth demand.
o Diversification of lease portfolio reduces the risks associated with individual lessee defaults and adverse geopolitical and regional economic events.
o Air Lease mitigates the risks associated with cyclical variations in the airline industry by managing customer concentrations and lease maturities in the operating lease portfolio to minimize periods of concentrated lease expirations. (I.e., diversification over time and geography)
o As of 30 Sep 2014 (Q3 2014), AL has 212 aircrafts (161 narrow body, 34 wide body, remainder turboprop), with weighted average fleet age of 3.5 years. The weighted average remaining lease term on their aircrafts is 7.3 years.The aggregate net BV of the fleet is $8.9B. Their general strategy is to maximise value by owing aircrafts over the first 8 to 9 years of an aircrafts lifetime, which is normally 25-30 years.
o Regional distribution based on book value: Asia~ 41.6%, Europe ~ 34.2%, LATAM & Mexico ~ 8.3%, US & Canada ~ 4.7%, Middle East & Africa ~ 5.9%, Pacific & ANZ ~ 5.3%
o As of 30 Sep 2014 (Q3 2014), they have over 372 aircrafts on order, with 363 being ordered from Boeing and Airbus making them one of the largest customers of these airplane manufacturers (i.e., AL should be able to eek out good deals that the airline upstarts won’t be able to manage)
Aircraft acquisition strategy.
Air Lease orders aircrafts in bulk directly from manufacturers to minimise acquisition cost. They acquire based on demand, targeting the replacement of aging aircraft with modern technology aircraft, aided by industry specific knowledge and relationships with airlines. Often, as a cost saving strategy, Air Lease sources many components separately, such as seats, safety equipment, avionics, galleys, cabin finishes, engines and other equipments, directly from third-parties and has these installed during the final assembly process at the aircraft manufacturers facilities.
The economics of scale allows Air Lease to buy aircrafts at good prices and also allows thereto re-price purchases when upsizing their orders (e.g., they did this with A321/A320 NEOs and A330s). Steven Hazy said the following in Q2 2014 conference call:
The type of customer that Airbus and Boeing respond to are the customers that, A, show up at every delivery, never cancel an order and are able to redistribute these airplanes through the leasing medium, to airlines all over the world, bringing in lots of new customers that heretofore did not operate those type of aircraft either Boeing or Airbus. So I do believe we get special treatment. We deserve it and we’re there in hard times and good times.
Aircraft acquisition financing.
AL finances the purchase of aircrafts primarily through unsecured debt financing, but also using free cash flow and available cash balance. Air Lease has received two investment grade corporate credit ratings, which has lowered its cost of funds. It has also developed a 43 member, globally diversified banking group, which provides funding (e.g., banking group has provided around $4.2 billion in financing), and also facilitates raising monies in the capital markets (e.g., $4.8B in unsecured debt).
The company ended Q3 2014 with total debt outstanding of $6.6 billion, of which 76.3% was at a fixed rate and 81.8% was unsecured, with a composite cost of funds of 3.67%. Total unsecured debt outstanding was $5.5B compared to $4.3B as of December 31, 2013, increasing the Company’s unsecured debt as a percentage of total debt to 81.8% as of September 30, 2014 compared to 73.4% as of December 31, 2013. The company’s fixed rate debt as a percentage of total debt also increased up from 61.9% in Dec 31, 2013 to 76.3% in Q3 2014.
Air Lease works closely with their existing customers and potential lessees to develop customized lease structures that address customer’s specific needs. Lease agreements are enters into between 18 and 36 months prior to aircrafts delivery to Air Lease. Typically,
- they look to negotiate a new lease 6 to 12 months prior to lease expiry
- leases are generally for fixed rates and terms (hence attractive to airlines but does pose interest risk to AL)
- payments in US dollars, which reduces currency risk for AL
- leases require cash security deposit and maintenance reserve payments.
- closely monitor the operating and financial performance of the lessee
Lease schedule for 2015 and beyond
+++++++++++++++++++++++++++++++++++++++++++ Year # ordered # leased +++++++++++++++++++++++++++++++++++++++++++ 2015 39 39 2016 29 19 2017 27 16 2018 33 11 2019 - 235 5 +++++++++++++++++++++++++++++++++++++++++++
Their basic strategy is to maintain a portfolio of young aircraft with a widely diversified customer base. They achieve this goal by ordering new planes directly from the manufacturers, place them on long term leases, and selling the aircraft when these are 8 to 10 years old (A typical aircraft is used for 25 to 30 years.). They sell aircraft that are currently operated by an airline with multiple years of lease term remaining on the contract, in order to achieve the maximum disposition value of the aircraft. Buyers of the aircraft may include leasing companies, financial institutions and airlines
Air Lease finances aircraft purchases with available cash balances, internally generated funds, including aircraft sales and trading activity, and debt financings. Since inception in 2010, Air Lease as a company is structured to be an investment grade company and their debt financing strategy has focused on funding on an unsecured basis. Unsecured financing provides flexibility when selling or transitioning aircraft from one airline to another.
The Company received a corporate credit rating of A- from Kroll Bond Ratings in May 2013, followed by a second investment grade corporate credit rating of BBB- from S&P in August 2013. Investment grade credit ratings lowers cost of funds and broadened access to attractively priced capital. The overall strategy is to increase the unsecured debt as a percentage of total debt.
From Yahoo & Google Finance:
o AerCap Holdings N.V. (AER) - $8.24B market cap with TTM of $2.6B
This one is probably the biggest fish in the pond. From their website:
“AerCap is the global leader in aircraft leasing with 1,300 owned and managed aircraft in its current fleet and a highly attractive portfolio of 400 high-demand, fuel-efficient aircraft on order. AerCap serves over 200 customers in 90 countries with comprehensive fleet solutions and provides part-out and engine leasing services through its subsidiary AeroTurbine. AerCap is listed on the New York Stock Exchange (AER)."
AER now owns ILFC - the company started by Steven Hazy which was subsequently sold to AIG. [Note, the numbers will change and AER should be a 30 to 40B company following merger completion with ILFC.]
o Avolon Holdings Ltd (AVOL) - $1.6B market cap
Dec 2014 IPO; didn’t see much details on their financing costs but this company doesn’t appear to have an investment grade rating; weighted average age of fleet was 8+ years; 140 aircrafts in fleet with a book value around $5.4B.
“Total revenues for the third quarter were $177.6 million, an increase of $7.5 million, or 4% above the previous year.”
o Aircastle Limited (AYR) - $1.73B market cap; still working towards getting an investment grade rating based on its Q3 2014 release. More about AYR in the TMF article linked below.
o FLY Leasing Limited (FLY) - $544M market cap with TTM of $370M
o GATX Corp (GMT) - ???
o GE Capital Aviation Services LLC (private) - ???
- Economic slowdown, which will affect air travel and demand for new aircrafts; also more risk because of significant exposure to emerging markets.
- Lease defaults can have significant costs with respect to recovering the aircraft.
- Lower fuel costs are generally favourable,
- Interest rate risk as described in the 2013 10-K annual filing:
We finance many of the aircraft in our fleet through a combination of short- and long-term debt financings. As these debt financings mature, we may have to refinance these existing commitments by entering into new financings, which could result in higher borrowing costs, or repay them by using cash on hand or cash from the sale of our assets. Moreover, an increase in interest rates under the various debt financing facilities we have in place would have a negative effect on our earnings and could make our aircraft leasing contracts unprofitable.
Some of our debt financings bear interest at a floating rate, such that our interest expense would vary with changes in the applicable reference rate. As a result, our inability to sufficiently protect ourselves from changes in our cost of borrowing, as reflected in our composite interest rate, may have a direct, negative impact on our net income. Our lease rental stream is generally fixed over the life of our leases, whereas we have used floating-rate debt to finance a significant portion of our aircraft acquisitions. As of December 31, 2013, we had $2.23 billion in floating-rate debt. If interest rates increase, we would be obligated to make higher interest payments to our lenders. If we incur significant fixed-rate debt in the future, increased interest rates prevailing in the market at the time of the incurrence of such debt would also increase our interest expense. If our composite interest rate were to increase by 1.0%, we would expect to incur additional interest expense on our existing indebtedness as of December 31, 2013, of approximately $22.3 million on an annualized basis, which would negatively affect our financial condition, cash flow and results of operations.
The interest rates that we obtain on our debt financings have several components, including credit spreads, swap spreads, duration, and new issue premiums. These are all incremental to the underlying risk-free rates, as applicable. Volatility in our perceived risk of default or in a market sector’s risk of default will negatively impact our cost of funds.
We currently are not involved in any interest rate hedging activities, but we are contemplating engaging in hedging activities in the future. Any such hedging activities will require us to incur additional costs, and there can be no assurance that we will be able to successfully protect ourselves from any or all negative interest rate fluctuations at a reasonable cost.
- Ongoing litigation with AIG/ILFC (ILFC is the aircraft leasing company that was founded by Steven F. Udvár-Hazy and was subsequently sold to AIG)
Financials and Other Notes
o Note: The company’s earnings release has stopped provided adjusted EPS in recent quarters. Previously, they were providing adjusted net income which primarily added back stock based compensation. In the most recent quarter, if we added back stock-based compensation then the earnings would be up by another $0.035.
+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ Fiscal Year 2011 2012 2013 ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ Sales (M) 336.7 655.7 858.7 Pre-Tax Profit (M) 82.8 204.0 293.4 Net Income (M) 53.2 131.9 190.4 EPS (GAAP, $) 0.59 1.23 1.75 ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
o Strong revenue and earnings growth.
o In 2011, AL has traded between a PE of 30 and 50
o In 2012, AL has traded between a PE of 15 and 22
o In 2013, AL has traded between a PE of 12 and 19
+++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ Quarter Rev(M) Pretax Profit(M) Net Income(M) EPS($) +++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ 09/14 261.9 96.3 62.4 0.58 06/14 256.3 95.7 62.0 0.58 03/14 246.3 94.7 61.4 0.57 12/13 242.9 90.6 58.8 0.55 09/13 215.9 74.9 48.6 0.46 06/13 207.9 66.3 43.0 0.41 03/13 192.0 61.7 40.0 0.38 12/12 190.1 61.3 39.8 0.38 09/12 174.9 57.2 37.0 0.36 06/12 158.2 43.9 28.2 0.28 03/12 132.6 41.6 26.9 0.26 12/11 115.1 38.7 24.8 0.24 09/11 92.1 28.3 18.3 0.18 +++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++
In Q2 2014 conference call, there was a question regarding dividend policy & share buys: Steven (CEO) noted that they initiated a small dividend policy to bring institutional and retail investors who would not buy the share if there was no dividend. The dividend is expected to grow as the cash flow from the business grows. With respect to share buy backs, they think the best use of capital is to buy new planes and they expect to double the size of the company within the next 5 to 6 years. He noted that for every dollar of revenue they generate about $0.35 in pretax profit, i.e., 35% profit margin, so capital is scare and best used for aircraft purchases. He also noted the following bit which I think is important:
“What I can say in a positive way and we’ve already articulated this on Wall Street is we have no plans, at this time, to issue any equity in the public markets or in a private placement other than through the current management stock plans and potentially exercise of stock options.”
o See this article on the TMF site for another perspective on the industry and alternatives