|Shares Out. (in M):||240||P/E||0||0|
|Market Cap (in $M):||14,996||P/FCF||0||0|
|Net Debt (in $M):||0||EBIT||0||0|
|TEV (in $M):||0||TEV/EBIT||0||0|
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We wrote up AerCap (“AER” or “the Company”) three years ago and believe that the shares today offer a compelling value proposition at $63. While AER has been written up a handful of times in the past, quite a bit has happened along the way and so we will try to focus our thoughts here on the most recent developments and investment considerations. At a price of $63 per share, AER offers an opportunity to buy a well-managed aircraft leasing business capable of low double-digit ROEs at just under 8x normalized earnings and an approximately 25% discount to book value. As conditions continue to stabilize and with minimal leverage added to acquire GECAS, we expect AER will be able to repurchase roughly 10% of its outstanding shares per annum in the coming years.
AerCap, like other large publicly-traded aircraft lessors, has historically traded at a meaningful discount to book value despite a long history of earning double-digit ROEs, disciplined capital allocation and prudent growth. We believe this is in large part due to the perception that AER is a highly cyclical business, vulnerable in a downturn as a result of its leverage and exposure to the volatile airline industry. As we reach the other side of the pandemic, we expect these perceptions to change based on the Company’s performance over the last 2 years. At the end of 2019, AerCap had book value per share of just under $74 which, before accounting for the GECAS transaction, had grown to nearly $77 in the third quarter of last year despite the largest impairment in the Company’s history and a historically unprecedented downturn.
Based on Company disclosures, we believe that book value will further increase to $84 as a result of the GECAS transaction, meaning that the Company will have grown book value by just over 13% during the course of the pandemic, the single greatest challenge that the business has ever faced. While we will be the first to acknowledge that AerCap is not the greatest business nor does it have the deepest moat we have come across in our careers, in our view shares should trade closer to book value where they would still offer prospective purchasers a low double-digit return, implying a roughly 33% return for today’s purchasers.
AerCap has capitalized on market dislocations and its competitors repositioning efforts in the past, most notably with its acquisition of ILFC from AIG in 2013. The pandemic provided another opportunity for an accretive acquisition. In the early stages of the downturn while uncertainty was at its height, AER prudently focused on maintaining liquidity and managing its existing book. With the rollout of the vaccine and increased clarity on the longer-term outlook, AER was turned its attention to negotiating an acquisition of GECAS, a transformative deal that would make AerCap the largest lessor in the world. Importantly, on a combined basis 60% of the Company’s fleet consists of benchmark new-technology aircraft and management estimates this share will rise to 75% by 2024.
Based on disclosures and commentary from the Company, we believe that AER acquired approximately $34.0 billion of assets in exchange for approximately $24.0 billion in cash consideration and $6.6 billion in equity (111.5 million shares issued at a price of just over $59 per share as of the date of the acquisition). On a levered basis, this acquisition represented a roughly 35% discount. During its third quarter call, management noted that they are still working through the accounting related to the acquisition and plan to provides more information in connection with its upcoming fourth quarter call. For those that followed AerCap’s acquisition of ILFC, you will be familiar with some of the accounting issues. AER has indicated that its purchase accounting requires the value of the assets acquired to reflect the price paid by AerCap, which does not capture the discount AER received. As a consequence, AER’s preliminary pro forma information shows accounting book equity of $16.5 billion ($69 per share) rather than $20.0 billion ($84 per share), understating the discount at which shares trade today.
On the earnings side, considerable noise remains as a result of the pandemic. In recent quarters, the company has recognized significant one-time gains from the sale of trade claims received from bankrupt lessees and one-time expenses related to the GECAS acquisition. Maintenance revenue remains elevated as a result of lease transitions while top-line is understated as a result of assets in transition to new lease counterparties and assets on cash accounting as a result of collections uncertainty related to bankruptcy or restructuring, both of which will ultimately earn income. Sorting through these various effects, we estimate normalized in-place earnings of just over $8 per share, though expect some continued volatility over the next several quarters. On a combined basis, the Company also has an order book of 436 aircraft, the vast majority of which consist of benchmark new-technology assets, which should provide a foundation for growth in the coming years. It is worth highlighting that management has stated that the overwhelming majority of the order book has been placed through the end of 2023 and that many of the orders placed years ago were done so at attractive pricing.
A key difference between the GECAS and ILFC transactions is that this most recent deal was considerably less leveraging than ILFC. Covenant leverage, AerCap’s preferred metric, stood at just 2.8x pro forma for GECAS compared to its target of 2.7x. As the post-pandemic recovery continues, this has two benefits. First, the Company has not overextended its financial position and will not find itself in a situation where it must sell assets to retire debt in a market where asset pricing may not be ideal. Second, if the secondary market for aircraft continues to strengthen alongside traffic, as it has in recent quarters, we expect that AerCap will sell considerably more aircraft than it has suggested both to optimize the portfolio and to fund either growth at attractive economics or share repurchases. The Company repurchased nearly 35% of its outstanding shares between 2015 and the start of the pandemic, a time during which opportunities to grow the business organically via new OEM orders or sale/leaseback transactions were scant. As the company begins to generate significant excess cash flow, we expect that AER will continue to repurchase significant amounts of its stock provided higher return alternatives are unavailable.
While the air travel industry is still undeniably dealing with significant ongoing effects from the COVID-19 pandemic, the environment improved markedly in 2021 as measured by passenger kilometers, seat capacity and load factors. Per IATA, global RPKs were down 58% in 2021 compared to 2019 but with much of the drag continuing to come from international (down 75.5% in 2021 compared to 2019), which has been much slower to recover than domestic (down 28.2% in 2021 compared to 2019). While Omicron may end up putting a small dent into the recovery, the available data suggest that the effect was not as significant as may have been feared. In December, domestic RPKs were down just 22% compared with 2019 and international RPKs were down only 58%.
The consensus view remains that, absent a material new development, air traffic will have broadly recovered by 2023 and we do not have a strong view that this timeline is either too short or long. In terms of secondary market asset values and lease rates, we expect these to recover alongside or even ahead of traffic, particularly for the liquid, in-demand benchmark assets that comprise the majority of AerCap’s fleet. Rates for the A320/21neo, for example, have already begun to exceed pre-pandemic levels in anticipation of a recovery in short-haul routes as Air Lease CEO John Plueger noted on their third quarter call:
“I don’t think the MAX is quite yet to the pre-pandemic level, but it’s climbing nicely, and I expect it to be back that way very, very soon. And I think on the – certainly on the 321, 21neo, yes, I think that’s the case. I think we’re probably above pre-pandemic levels in lease rates as we sit here today.”
This is consistent with what we’ve heard from other market participants and what other major lessors have said in their public comments and makes sense to us generally. Older/less-liquid variants and certain widebodies will be more challenging, but directionally should improve as well. It is worth noting that the majority of the leases in the book did not require restructuring and continue to pay at the originally-agreed lease rates and in those instances where assets needed to be transitioned over the last year or two, concessions that were made were generally short-term in nature.
A related point worth mentioning is the significant decline in OEM production relative to baseline expectations heading into the pandemic. Airbus deliveries, for example, declined by nearly 35% in 2020 and fell even further behind pre-pandemic forecasts. 2021 and 2022 will also likely come in below pre-pandemic forecast levels and with the well-publicized issues with the MAX, it is likely that more than a full year’s worth of production will have been lost in the aggregate. With total global traffic still well off of 2019 levels, the supply shortfall has not yet been fully felt but as traffic begins to normalize over the next 12-18 months, we expect that the lack of these aircraft that would have otherwise found their way into global airline fleets will provide a strong demand tailwind.
Although AerCap was regarded by many as an over-levered and vulnerable company in the early stages of the pandemic, we believe the last two years have demonstrated the resilience of the Company’s balance sheet and the prudence of the management team. AerCap reported positive operating cash flow throughout the pandemic and enjoyed a comfortable liquidity position even at the depths of the crisis. Its longstanding relationships with the OEMs further allowed it to restructure its orderbook and conserve liquidity when uncertainty was at a peak. We believe that its handling of the crisis to date reflects well on the Company and its disciplined culture of risk management. Today, AerCap continues to enjoy a strong liquidity position which would provide the Company with the wherewithal to withstand another prolonged period of turbulence, with $13 billion in available liquidity (excluding operating cash flow from the business) compared to $9 billion in projected outlays (debt maturities and capital expenditures) over the next twelve months.
A final note worth addressing is recent concerns regarding aircraft lease rates and interest rates. We do not have a strong view as to whether or when interest rates will begin to rise or to what extent, but do not believe that rising rates represent a material risk to AerCap. Placements out of the orderbook contain escalators tied to a benchmark, providing a degree of embedded protection on future deliveries. Existing leases, with an average remaining life of approximately 7 years, generally do not adjust for changes in interest rates. Having said that, the lessors generally finance their book with only slightly-shorter dated debt and so if lease rates broadly track interest rates as they have historically, any mismatch should not put significant pressure on margins. The GECAS financing, by way of example, had a weighted average maturity of just over 7 years at a cost of roughly 2.5% based on current benchmarks for the small floating rate piece of the deal.
In sum, we believe that AER is a resilient, high quality aircraft lessor that trades at an attractive discount to book value. The GECAS transaction makes AerCap the largest lessor in the world in an industry in which scale is valuable in all aspects of the business ranging from negotiating large orders with OEMs at discounted pricing or positioning large portfolios of assets for lessees. The order book provides a foundation for growth going forward and the combined fleet predominantly consists of benchmark assets with a heavy tilt toward new-technology aircraft. The Company also has a long track record of disciplined capital allocation and we expect they will be able to repurchase a significant number of the outstanding shares even without significant asset sales.
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