|Shares Out. (in M):||213||P/E||6.9x||0.0x|
|Market Cap (in $M):||7,500||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||28,000||EBIT||0||0|
We believe AerCap Holdings NV (NYSE: AER) represents a compelling long investment over the next 24 months with upside catalysts driven by their transformative acquisition of competitor ILFC from AIG announced in late 2013. We see limited downside from the current stock price with the stock currently trading at ~1.2x PF Book Value on the combined business (expected close in mid Q2 2014) which is set to earn 15-17% ROEs and continue to grow organically.
Over time we have found many examples where a transformative and highly accretive M&A transaction is not properly discounted by the market leading to a time-arbitrage opportunity. We believe these opportunities exist because: (i) management is not inclined to set the bar high for these already attractive deals, (ii) the sell-side is not incented to look out 2+ years in a transformative acquisition or (iii) investors are unwilling to wait for the longer dated benefits of the acquisition.
We believe AerCap (AER) represents just such an opportunity with EPS power of ~$5.50 by 2016 for patient investors.
AerCap operates in an easy to understand and easy to model business, aircraft leasing. Prior to the announced transaction, the three largest players in the global aircraft leasing industry were: (i) GE Aircraft Leasing (GECAS) with 1,670 aircraft, (ii) ILFC (owned by AIG) with 1,002 aircraft and (iii) AerCap (AER) with 327 aircraft. The AER acquisition of ILFC will create the second largest player with similar scale to GECAS.
The business model is fairly simple with aircraft leasing companies purchasing planes from Airbus / Boeing directly or engaging in sale-leaseback transaction with global airlines on existing fleet assets. The lessors receive monthly rent with the major cost items being depreciation, SG&A overhead and financing costs. AER / ILFC have 80% of their expected lease revenues for the next three years already contracted showing the long term nature of these contracts.
We believe the aircraft leasing industry has positive industry fundamentals driven by secular growth in air travel globally and aircraft leasing gaining share as a percentage of aircraft purchased.
Global air travel is growing 3-4% with faster growth coming from emerging markets. AerCap has shown a focus on newer aircraft and emerging markets with APAC, Latin America and Africa / Middle East representing >40% of lease revenues prior to the ILFC transaction.
Aircraft lessors have also grown their share of aircraft finance (vs. airlines and other financing sources). According to Ascend Fleets Database, lessors now account for ~40% aircraft finance today up from ~25% 15 years ago. We expect this trend to continue driven in part by new sale-leaseback transactions.
We believe the AER / ILFC transaction will be even better than management is leading investors to believe leading to >$5 per share in EPS power today, growing organically from there.
Here is how we get there:
We would also note that management guided to a 5.5 debt-to-equity ratio when the transaction was announced and committed to de-lever to 4.0 within 24 months. This was based on a $22-23 stock price prior to announcement and with the stock now at ~$35, the transaction would be roughly 5.0 debt-to-equity improving the leverage optics out of the gate.
We also believe management has somewhat of an incentive to “keep the stock price down” prior to close because the higher the stock price, the larger the accounting purchase price which could lead to higher depreciation or higher goodwill at close. This could be the reason that management is guiding to Run-Rate EPS of “$4.00+” vs. our expectation of >$5.00.
Finally, we see longer term upside as AER is able to refinance ILFC’s debt to a lower rate. While we are getting some benefit of that (roughly ~100 bps) in the purchase accounting adjustments, we think there could be further savings in the future as the business is integrated and modestly de-levers. Another 50 bps savings on ILFC debt would equate to ~$0.45 of incremental EPS power.
Valuation / Price Target
AerCap, pro forma for ILFC will have approximately $6B of equity and generate $1B+ of run-rate net income at close for an ROE of ~17%. We think it would be fair to capitalize AER’s growing EPS at a 10-12x P/E given the favorable growth profile of the business and the solid ROE.
We also believe that AER could garner a higher multiple than it has in years past due to its larger scale and market capitalization (~$7.5B today) relative to the smaller and mid-cap peers in the industry. AER’s larger size could generate more interest from institutional investors and move aircraft leasing businesses toward the mainstream from their current niche, small/mid-cap market.
There are three public comparables that inform our view on valuation: (i) Aircastle (AYR), (ii) Air Lease Corp (AL) and (iii) Fly Leasing (FLY). The comps have market caps of $650M to $3.2B, Cash ROEs of 7-13.5% and 2014 P/Es of 10.6-14.3x (12.3x on average).
As another comparison, United Rentals (URI) is an unrelated leasing business generating ~23% ROEs and trading for 13.2x 2014 EPS estimates today.
If we give AER 11x ~$5.50 in 2016 EPS we get a target price of $60.50 per share, up 70%+ from the current price or a ~30% compounded return over the next two years.
For downside, we expect AER will have nearly $28 per share of book value at closing in Q2. If AER were to trade down to book value we would see ~20% downside from current prices. Given that AER will be generating teens ROEs, growing low single digits organically and will have a $25B order book of new high demand planes from ILFC, we don’t believe AER should trade for book value or below for a sustained period of time.
We view the 70%+ upside over 2 years and 20% downside as a favorable risk / reward in the current environment.
Closing and integration of the ILFC deal
Management better highlighting the longer-term EPS power after deal closing
Management delivering on potential upside scenarios including higher synergies, lower cost of ILFC debt or incremental sale-lease-back transactions with global airlines