Aircastle AYR
February 27, 2008 - 2:55pm EST by
algonquin222
2008 2009
Price: 22.14 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 1,735 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

EXECUTIVE SUMMARY

Aircastle seems to be a proverbial baby that has been thrown out with the credit crisis bathwater. The stock has been cut in half from its July peak, trades around 10x PE and boasts a 12.6% dividend yield. Since its IPO, AYR’s earnings and dividend have doubled, yet it trades below the IPO price from 1 ½ years ago. A dividend yield of the magnitude of Aircastles’ suggests a stock whose earnings and dividend paying ability are in danger of significant impairment. In fact, the stock has sold off in lockstep with other financial companies that accurately fit that description. Paradoxically, Aircastle’s business fundamentals remain very strong and the dividend was just raised in December.

 

Aircastle’s sell-off since the summer is based on uncertainty regarding its funding capacity. Aircraft leasing is a new business for the public markets and I believe that the market is misunderstanding the risk associated with its financing requirements. Even if the capital markets were closed to Aircastle for the next two years, it is highly unlikely they would see any diminution in earnings as their current portfolio of aircraft are on lease and are thus generating stable revenue to fund the dividend. Planes coming off lease are being snapped up quickly by Airlines desperate to get their hands on aircraft in a very tight market. Were Aircastle unable to access the capital markets, the profitability of its incremental growth would be impacted, but its current earnings stream would not. However, Aircastle is priced as if it will never grow again and as if its earnings and dividend are in danger of being cut in the near term.  Not only do current earnings appear secure, but the bank loan market, in point of fact, remains open to Aircastle (See recent Financial Times Article below). Essentially, the holder of Aircastle is being paid a 12.6% dividend yield to wait until the securitization market reopens. Once the credit fears abate, Aircastle should trade at a normalized valuation of a 6% dividend yield which would imply a return would be over 100%.

 

http://www.ft.com/cms/s/436355b6-e345-11dc-803f-0000779fd2ac.html

 

 

DESCRIPTION

Aircastle (AYR) is an aircraft leasing company that was formed by Fortress in late 2004. It has a $5.7bln aircraft portfolio (including commitments) which consists of 157 aircraft leased to 57 lessees in 32 countries. Fortress took AYR public in August 2006 at $23 per share. Since the IPO, AYR has increased its dividend five times and now stands at $2.80 per share or a 12.6% yield. Aircastle’s lessee’s are geographically diversified with only 12% of its lessees located in the US. This is important because I believe there is a misconception that Aircastle is a US focused company with exposure to the domestic air travel market and a US recession. Aircastle is also diversified by segment with almost 30% of aircraft used as freighters, which benefit from longer lease terms, longer lives, and fewer capex requirements as they are more fungible between lessees (no need to format cabin to match the rest of the fleet). Aircastle is also diversified by lease expiration date as well. Importantly, 85% of its aircraft are latest generation technology for their class which ensures their fuel efficient aircraft will stay in demand.

 

The company is structured like a REIT paying out almost of all its economic earnings to equity holders and 70-75% of available cash flow after debt payments. Management described their dividend strategy on the most recent conference call: “our approach on the dividend has been pretty consistent since the beginning. We try to take a best view of the run rate earnings power, the real economic earnings power of the Company, and pay that out as a dividend. Nothing has changed. During the fourth quarter when our Board of Directors got together, we took a look at the market as it existed there, looked at the revenue picture, which I think is in pretty good shape; looked at where we would project the financial markets to be and came to the conclusion that we should pay the dividend we paid. It's a quarter by quarter thing, but our philosophy is the same and we are not holding anything back. It's what we think is a real economic power of the Company.” In order to finance the purchases of new aircraft and grow the business, AYR relies on credit lines, debt securitizations and equity financing. Aircastle’s most recent equity offering was in October 2007 at $31.75 per share.

 

MANAGEMENT

Management, led by CEO Ron Wainshall, is one of the strengths of this company in my opinion. Ron previously ran the asset management group at General Electric Commercial Aviation Service (GECAS) meaning he is extremely familiar not only with the aircraft market, but also various lessees in the market. He is a graduate of Wharton and received an MBA from Chicago Business School. He owns over 300,000 shares of AYR worth approx $6m. As Aircastle must re-lease the same aircraft several times during its useful life, the relationships he and other members of the management team have developed over their careers are essential to placing existing aircraft and also finding the best deals for new acquisitions. Management’s experience allows them buy airplanes wholesale versus competitors who must use sourcing agents. 

 

The management team has proven to be very conservative and methodical. An example is their focus on the freighter market which makes up 30% of their portfolio. They seem alone in focusing in on the freighter market and have mentioned that they do not see anyone else taking commercial aircraft and converting them to freighters. They recognize a situation where the lease rates are equivalent to commercial rates, but the lease terms are longer, the useful life of the asset is extended and most importantly the cost for them to change lessees is minimized. By focusing on freighters with 35 year useful lives as opposed to 25 year useful lives of commercial jets, AYR can purchase older aircraft at lower prices, but lease them at rates equivalent to commercial. This improves the yield of their investments. In addition, the freight market is also a hedge against the commercial market as it is less susceptible to event risk.

 

Management is also very risk averse. On a conference call in March 2007 in response to a question about whether or not they would prefer to lock in current rates as far out as possible or use shorter lease terms to capitalize on potentially higher lease rates in the future, management responded by saying: “our general risk position is to take as little risk as possible, which means that we would lock in lease rates if we thought they were reasonable and we would push out terms to the extent it's available.”  On the most recent conference call this month, management’s comments regarding their belief that they would do very few deals in the first half of 2008 precipitated a large drop in the stock price. What they said, however, would make any value investor smile. They said that they did not think they would be active in the deal market in the near term because prices were too high. Wainshall stated “looking ahead, we will continue to apply the same discipline and investment approach we always have and will only seek to make incremental investments if they are accretive. At the moment, we are not finding many opportunities which we consider to be attractive. As a consequence, we believe our incremental investment activity will be limited during the early part of 2008.”

 

LEASING MARKET FOR AIRCRAFT

Supply of new aircraft is a virtual drip as Boeing and Airbus, the two main suppliers of commercial aircraft, have backlogs ranging from 4 to 6 years. Concurrently, older, less fuel efficient planes are being taken out of service by major operators as the rising cost of fuel makes them uneconomical. This means that the supply of aircraft is fixed at best and is most likely declining. This supply shortage is especially acute for “modern” fuel efficient aircraft in which Aircastle has invested the bulk of their portfolio.

 

Not only is supply extremely tight, but demand for aircraft is strong and growing. Global demand for aircraft is being driven by the growth in China, India and other emerging economies where a burgeoning middle class whose population and wealth are increasing is eschewing traditionally cheaper means of travel and increasing their demand for air travel. One needs only to look at the combined increase in gross orders in 2007 for Airbus and Boeing and see that it was up 53% y/y and 66% YTD in January 2008 to see how strong the underlying demand is. In addition, manufacturers are pushing out delivery commitments as they are unable to live up to their original time frames. The CEO echoed these statements saying in the February 2008 conference call saying “despite the financial market volatility and the present United States slowdown, we continue to see robust lease demand for modern aircraft models around the world. In general we see rental rates for most aircraft types being at least as high as they were last year. In some cases, like for the mid body A330 and the Boeing 767 models, which are in short supply due to relative market growth and new product limitations and delays, the rental increases are pronounced and are at least as much as 10% and even 20% compared to last year. We believe several factors are contributing to the market's continuing strength, including, first, the large and growing new order backlogs at Boeing and Airbus; secondly, the weakness of the U.S. dollar and resulting cheapness of dollar market assets, such as aircraft; thirdly, worldwide travel demand is continuing to grow rapidly and broadly while high fuel costs are exerting continuing pressure on operators to retire less efficient and older technology aircraft.”

 

The supply/demand fundamentals are incredibly favorable for aircraft leasing companies. The current tightness in the aircraft market is allowing Aircastle to lease planes at higher rates (5-10%) and for longer terms (~7yrs). The main risk to Aircastle’s earnings stream and their dividend is whether or not they can profitably re-lease aircraft when they come off their leases. In the current environment there is very little risk here. They have already leased their entire 2008 vintage and are well on their way to placing the 2009s (40% completed). Management is quite confident they will place the rest of the 2009s as they generally do not place leases further out than one year. Management stated in the November 2007 conference call that “having commitments or even serious placement discussions for use of aircraft that far ahead of lease expiration (2009) is really unusual and reflects the tight supply of aircraft in the market right now. Our take on it is that airlines are very concerned about losing their capacity, and they're doing what they can to secure key assets.”  I would argue that based on the backlogs at Boeing and Airbus, the tightness in the leasing market will persist for the next several years. This is a tremendous tailwind at the back of Aircastle. This is a key point and I think where the market is tremendously confused. If the aircraft are leased then the revenue is certain barring a default and in which case they would be able to repossess the aircraft within 60 days and then likely re-lease it. In addition, Aircastle management has said they have no current credit issues as all of their lessees are current and performing. Aircastle’s ability to access the capital markets impacts its growth, but not its current earnings.  

 

BUT THEY HAVE TO GROW, DON’T THEY?

This is not a company for the Buffett schism of the church of value investing. Unlike, land or real estate, aircraft are depreciating assets which means leasing companies must continually replace their assets over time. Over the long term, as aircraft age they are unable to demand the same lease rates they once were and the earnings power of the portfolio will decrease. When this occurs, new aircraft must be acquired to make up the shortfall in order to maintain stable earnings power. I would argue that this impact will not be seen for many years as evidenced by renewal lease rates that are currently RISING for jets that are ~5 years older then when they were previously leased. This is being driven by the tightness in the leasing market which in turn is being driven by the huge backlogs at the manufacturers and the growing global demand for aircraft. As long as these situations persist, the diminution of Aircastle earnings power from its current fleet over time will be minimal. It is most likely that the credit markets will re-open long before the global the aircraft supply and demand imbalance corrects.

 

 In order to remain profitable, aircraft leasing companies must  be run by savvy managers who are able to purchase aircraft at cheap enough prices that allow them to them lease them profitably. There is no moat and prior to the credit crisis, financiers were lining up to get into this business. Economics 101 would suggest that as time progresses and more players enter the business, the spreads will erode and profitability will decline. However, in the near term I have confidence that Aircastle’s model will remain strong as we have good visibility in earnings for the next few years. Paradoxically, the credit crisis has provided a temporary moat for Aircastle as its potential competitors have been unable to enter the business due to the closure of the IPO and securitization markets.

 

The deputy chairmen of Aircastle made the following comments in the August 2007 conference call that exemplifies the situation they are now in: “We are very comfortable where we are today. And I think we're very comfortable with our positions, our liquidity, our funding, and our capital position. Obviously, if things got worse, you would potentially slow down the rate of acquisitions until you had matched up your funding. So we have the ability to do that. If we stop acquiring, we have tremendous cash flow generation. Because as you remember, part of our rent is really return of principal. So if you collect 14% on your portfolio on average, we have tremendous cash-generating capability if we were to stop acquiring assets. And so we're not concerned about it. We're obviously -- to the extent that cost of capital increases for everybody, which is a possibility, you would expect to see asset prices probably come down a little bit. So we are in the business of investing at a margin. And so it's possible that as we go forward, there will be some opportunities that may come up that would not have otherwise been available.”

 

It should be noted that AYR expects to close a financing term facility in the next few months. They expect the all-in (including interest rates hedges) cost to be 7%. This compares to previous securitization all-in cost of 6.2%. Clearly financing costs have risen and the margins on new acquisitions may be affected. However, this should be somewhat offset by higher lease rates. In no way does this potential slight decrease in margins on incremental business justify a 12.6% dividend yield and a halving of the stock price.

 

VALUATION

Clearly a 12.6% dividend yield itself is indicative of a very inexpensive stock. In addition, AYR now trades around 10x ’08 earnings which is about one half of where it has traditionally traded during its short history.  Aircastle’s low valuation implies virtually no growth assumptions. While there may be no growth in the near term, given the strength of the aerospace market and Aircastle’s management, it would be irrational to assume they will never grow again. Therefore the resumption of growth, when it does occur should, act as a catalyst for multiple expansion.

 

 

 

Price

Market Cap

TEV

2008 P/E

Dividend Yield

P/B

Aercap

AER

19.1

1624

4087

7.4

          N/A

1.7

Genesis Lease

GLS

19.57

705.5

1693

14.7

10.1%

1.24

Aircastle

AYR

22.14

1735

3799

10.9

12.6%

1.34

Financial Federal

FIF

23.83

611

2118

11.9

2.6%

1.54

GATX Corp

GMT

38.97

1866

4122

12.10

2.8%

1.62

CAI International

CAP

10.75

184

283.9

9.1

          N/A

1.44

McGrath RentCorp

MGRC

21.3

522

694

12.1

3.5%

2.05

Mobile Mini

MINI

19.57

632

967

12.7

          N/A

1.37

TAL International

TAL

22.27

697

1736

13.1

7.2%

1.75

Textainer Group

TGH

14.28

679

1245

9.2

5.8%

1.69

Average

 

 

 

 

11.32

6.4%

1.57

 

Aircastle trades roughly in-line with its airline leasing peers and other leasing companies based on P/E multiple, but its dividend yield is roughly double the overall peer group average. As Aircastle has indicated many times that their financials are backward looking, but their dividend is forward looking, I feel as it is more appropriate to make a relative valuation call on this company based on their dividend yield rather then its P/E. I believe P/E multiple is an indication of its absolute cheapness and diminished growth expectations.

 

Several indicators point toward a 6% dividend yield as fair value for Aircastle in addition to the peer group average. All three of Aircastle’s equity offerings including its IPO were priced based on a roughly 6% dividend yield. The most recent of these occurred in October 2007. Currently, the REIT index averages 6.2% dividend yield as well. Given the declining asset values and capital issues many of those real estate companies are facing, it seems absurd that Aircastle, whose assets are actually appreciating and remains able to access the capital markets should trade at roughly double the yield of these REITs.  

 

Finally, I believe that there is a good deal of margin of safety in Aircastle beyond the contract based cash flows, strong management and high dividend yield. The CEO made a comment at the Goldman Sachs Finance conference earlier this month that gives me further confidence that there is a large margin of safety based on the asset value inherent in the company. He said “there isn’t anything fundamentally wrong with the company and it is close to trading at NAV as if it is just a repository of airlines.” Aircastle trades at 1.3x book value. However, it is very possible that book value understates the value of its portfolio as Aircastle has been decreasing the carrying value of its fleet based on straight-line depreciation whereas the actual values of the aircraft have been increasing as evidenced by the rising rents. Aercap made a similar claim today during their earnings presentation showing a slide depicting the appraised value of their portfolio to be significantly higher then the carrying value.

 

 

SUMMARY

Aircastle is an interesting play on the global growth of air-travel without risk associated with of individual carriers. The aerospace industry has massive tailwinds and Aircastle is positioned to strongly benefit. Management has indicated that they believe the dividend to be secure and have expressed their confidence by raising it as recently as December. Two insiders bought stock (2,000 shares each) on 2/26/08 further signaling confidence in the story. This stands in stark contrast to the market which has halved the stock on fears that its growth will be less profitable or slowed.  Management has stated that while its financials are backward looking, its dividend is forward looking and reflects their view of future earnings. Given the prodigious yield, it appears that Aircastle shares are a great bargain available because it has been mistakenly tainted by the credit crisis.

Catalyst

Further acquisition of aircraft, continued performance in future quarters, re-opening of securitization market
    sort by    

    Description

    EXECUTIVE SUMMARY

    Aircastle seems to be a proverbial baby that has been thrown out with the credit crisis bathwater. The stock has been cut in half from its July peak, trades around 10x PE and boasts a 12.6% dividend yield. Since its IPO, AYR’s earnings and dividend have doubled, yet it trades below the IPO price from 1 ½ years ago. A dividend yield of the magnitude of Aircastles’ suggests a stock whose earnings and dividend paying ability are in danger of significant impairment. In fact, the stock has sold off in lockstep with other financial companies that accurately fit that description. Paradoxically, Aircastle’s business fundamentals remain very strong and the dividend was just raised in December.

     

    Aircastle’s sell-off since the summer is based on uncertainty regarding its funding capacity. Aircraft leasing is a new business for the public markets and I believe that the market is misunderstanding the risk associated with its financing requirements. Even if the capital markets were closed to Aircastle for the next two years, it is highly unlikely they would see any diminution in earnings as their current portfolio of aircraft are on lease and are thus generating stable revenue to fund the dividend. Planes coming off lease are being snapped up quickly by Airlines desperate to get their hands on aircraft in a very tight market. Were Aircastle unable to access the capital markets, the profitability of its incremental growth would be impacted, but its current earnings stream would not. However, Aircastle is priced as if it will never grow again and as if its earnings and dividend are in danger of being cut in the near term.  Not only do current earnings appear secure, but the bank loan market, in point of fact, remains open to Aircastle (See recent Financial Times Article below). Essentially, the holder of Aircastle is being paid a 12.6% dividend yield to wait until the securitization market reopens. Once the credit fears abate, Aircastle should trade at a normalized valuation of a 6% dividend yield which would imply a return would be over 100%.

     

    http://www.ft.com/cms/s/436355b6-e345-11dc-803f-0000779fd2ac.html

     

     

    DESCRIPTION

    Aircastle (AYR) is an aircraft leasing company that was formed by Fortress in late 2004. It has a $5.7bln aircraft portfolio (including commitments) which consists of 157 aircraft leased to 57 lessees in 32 countries. Fortress took AYR public in August 2006 at $23 per share. Since the IPO, AYR has increased its dividend five times and now stands at $2.80 per share or a 12.6% yield. Aircastle’s lessee’s are geographically diversified with only 12% of its lessees located in the US. This is important because I believe there is a misconception that Aircastle is a US focused company with exposure to the domestic air travel market and a US recession. Aircastle is also diversified by segment with almost 30% of aircraft used as freighters, which benefit from longer lease terms, longer lives, and fewer capex requirements as they are more fungible between lessees (no need to format cabin to match the rest of the fleet). Aircastle is also diversified by lease expiration date as well. Importantly, 85% of its aircraft are latest generation technology for their class which ensures their fuel efficient aircraft will stay in demand.

     

    The company is structured like a REIT paying out almost of all its economic earnings to equity holders and 70-75% of available cash flow after debt payments. Management described their dividend strategy on the most recent conference call: “our approach on the dividend has been pretty consistent since the beginning. We try to take a best view of the run rate earnings power, the real economic earnings power of the Company, and pay that out as a dividend. Nothing has changed. During the fourth quarter when our Board of Directors got together, we took a look at the market as it existed there, looked at the revenue picture, which I think is in pretty good shape; looked at where we would project the financial markets to be and came to the conclusion that we should pay the dividend we paid. It's a quarter by quarter thing, but our philosophy is the same and we are not holding anything back. It's what we think is a real economic power of the Company.” In order to finance the purchases of new aircraft and grow the business, AYR relies on credit lines, debt securitizations and equity financing. Aircastle’s most recent equity offering was in October 2007 at $31.75 per share.

     

    MANAGEMENT

    Management, led by CEO Ron Wainshall, is one of the strengths of this company in my opinion. Ron previously ran the asset management group at General Electric Commercial Aviation Service (GECAS) meaning he is extremely familiar not only with the aircraft market, but also various lessees in the market. He is a graduate of Wharton and received an MBA from Chicago Business School. He owns over 300,000 shares of AYR worth approx $6m. As Aircastle must re-lease the same aircraft several times during its useful life, the relationships he and other members of the management team have developed over their careers are essential to placing existing aircraft and also finding the best deals for new acquisitions. Management’s experience allows them buy airplanes wholesale versus competitors who must use sourcing agents. 

     

    The management team has proven to be very conservative and methodical. An example is their focus on the freighter market which makes up 30% of their portfolio. They seem alone in focusing in on the freighter market and have mentioned that they do not see anyone else taking commercial aircraft and converting them to freighters. They recognize a situation where the lease rates are equivalent to commercial rates, but the lease terms are longer, the useful life of the asset is extended and most importantly the cost for them to change lessees is minimized. By focusing on freighters with 35 year useful lives as opposed to 25 year useful lives of commercial jets, AYR can purchase older aircraft at lower prices, but lease them at rates equivalent to commercial. This improves the yield of their investments. In addition, the freight market is also a hedge against the commercial market as it is less susceptible to event risk.

     

    Management is also very risk averse. On a conference call in March 2007 in response to a question about whether or not they would prefer to lock in current rates as far out as possible or use shorter lease terms to capitalize on potentially higher lease rates in the future, management responded by saying: “our general risk position is to take as little risk as possible, which means that we would lock in lease rates if we thought they were reasonable and we would push out terms to the extent it's available.”  On the most recent conference call this month, management’s comments regarding their belief that they would do very few deals in the first half of 2008 precipitated a large drop in the stock price. What they said, however, would make any value investor smile. They said that they did not think they would be active in the deal market in the near term because prices were too high. Wainshall stated “looking ahead, we will continue to apply the same discipline and investment approach we always have and will only seek to make incremental investments if they are accretive. At the moment, we are not finding many opportunities which we consider to be attractive. As a consequence, we believe our incremental investment activity will be limited during the early part of 2008.”

     

    LEASING MARKET FOR AIRCRAFT

    Supply of new aircraft is a virtual drip as Boeing and Airbus, the two main suppliers of commercial aircraft, have backlogs ranging from 4 to 6 years. Concurrently, older, less fuel efficient planes are being taken out of service by major operators as the rising cost of fuel makes them uneconomical. This means that the supply of aircraft is fixed at best and is most likely declining. This supply shortage is especially acute for “modern” fuel efficient aircraft in which Aircastle has invested the bulk of their portfolio.

     

    Not only is supply extremely tight, but demand for aircraft is strong and growing. Global demand for aircraft is being driven by the growth in China, India and other emerging economies where a burgeoning middle class whose population and wealth are increasing is eschewing traditionally cheaper means of travel and increasing their demand for air travel. One needs only to look at the combined increase in gross orders in 2007 for Airbus and Boeing and see that it was up 53% y/y and 66% YTD in January 2008 to see how strong the underlying demand is. In addition, manufacturers are pushing out delivery commitments as they are unable to live up to their original time frames. The CEO echoed these statements saying in the February 2008 conference call saying “despite the financial market volatility and the present United States slowdown, we continue to see robust lease demand for modern aircraft models around the world. In general we see rental rates for most aircraft types being at least as high as they were last year. In some cases, like for the mid body A330 and the Boeing 767 models, which are in short supply due to relative market growth and new product limitations and delays, the rental increases are pronounced and are at least as much as 10% and even 20% compared to last year. We believe several factors are contributing to the market's continuing strength, including, first, the large and growing new order backlogs at Boeing and Airbus; secondly, the weakness of the U.S. dollar and resulting cheapness of dollar market assets, such as aircraft; thirdly, worldwide travel demand is continuing to grow rapidly and broadly while high fuel costs are exerting continuing pressure on operators to retire less efficient and older technology aircraft.”

     

    The supply/demand fundamentals are incredibly favorable for aircraft leasing companies. The current tightness in the aircraft market is allowing Aircastle to lease planes at higher rates (5-10%) and for longer terms (~7yrs). The main risk to Aircastle’s earnings stream and their dividend is whether or not they can profitably re-lease aircraft when they come off their leases. In the current environment there is very little risk here. They have already leased their entire 2008 vintage and are well on their way to placing the 2009s (40% completed). Management is quite confident they will place the rest of the 2009s as they generally do not place leases further out than one year. Management stated in the November 2007 conference call that “having commitments or even serious placement discussions for use of aircraft that far ahead of lease expiration (2009) is really unusual and reflects the tight supply of aircraft in the market right now. Our take on it is that airlines are very concerned about losing their capacity, and they're doing what they can to secure key assets.”  I would argue that based on the backlogs at Boeing and Airbus, the tightness in the leasing market will persist for the next several years. This is a tremendous tailwind at the back of Aircastle. This is a key point and I think where the market is tremendously confused. If the aircraft are leased then the revenue is certain barring a default and in which case they would be able to repossess the aircraft within 60 days and then likely re-lease it. In addition, Aircastle management has said they have no current credit issues as all of their lessees are current and performing. Aircastle’s ability to access the capital markets impacts its growth, but not its current earnings.  

     

    BUT THEY HAVE TO GROW, DON’T THEY?

    This is not a company for the Buffett schism of the church of value investing. Unlike, land or real estate, aircraft are depreciating assets which means leasing companies must continually replace their assets over time. Over the long term, as aircraft age they are unable to demand the same lease rates they once were and the earnings power of the portfolio will decrease. When this occurs, new aircraft must be acquired to make up the shortfall in order to maintain stable earnings power. I would argue that this impact will not be seen for many years as evidenced by renewal lease rates that are currently RISING for jets that are ~5 years older then when they were previously leased. This is being driven by the tightness in the leasing market which in turn is being driven by the huge backlogs at the manufacturers and the growing global demand for aircraft. As long as these situations persist, the diminution of Aircastle earnings power from its current fleet over time will be minimal. It is most likely that the credit markets will re-open long before the global the aircraft supply and demand imbalance corrects.

     

     In order to remain profitable, aircraft leasing companies must  be run by savvy managers who are able to purchase aircraft at cheap enough prices that allow them to them lease them profitably. There is no moat and prior to the credit crisis, financiers were lining up to get into this business. Economics 101 would suggest that as time progresses and more players enter the business, the spreads will erode and profitability will decline. However, in the near term I have confidence that Aircastle’s model will remain strong as we have good visibility in earnings for the next few years. Paradoxically, the credit crisis has provided a temporary moat for Aircastle as its potential competitors have been unable to enter the business due to the closure of the IPO and securitization markets.

     

    The deputy chairmen of Aircastle made the following comments in the August 2007 conference call that exemplifies the situation they are now in: “We are very comfortable where we are today. And I think we're very comfortable with our positions, our liquidity, our funding, and our capital position. Obviously, if things got worse, you would potentially slow down the rate of acquisitions until you had matched up your funding. So we have the ability to do that. If we stop acquiring, we have tremendous cash flow generation. Because as you remember, part of our rent is really return of principal. So if you collect 14% on your portfolio on average, we have tremendous cash-generating capability if we were to stop acquiring assets. And so we're not concerned about it. We're obviously -- to the extent that cost of capital increases for everybody, which is a possibility, you would expect to see asset prices probably come down a little bit. So we are in the business of investing at a margin. And so it's possible that as we go forward, there will be some opportunities that may come up that would not have otherwise been available.”

     

    It should be noted that AYR expects to close a financing term facility in the next few months. They expect the all-in (including interest rates hedges) cost to be 7%. This compares to previous securitization all-in cost of 6.2%. Clearly financing costs have risen and the margins on new acquisitions may be affected. However, this should be somewhat offset by higher lease rates. In no way does this potential slight decrease in margins on incremental business justify a 12.6% dividend yield and a halving of the stock price.

     

    VALUATION

    Clearly a 12.6% dividend yield itself is indicative of a very inexpensive stock. In addition, AYR now trades around 10x ’08 earnings which is about one half of where it has traditionally traded during its short history.  Aircastle’s low valuation implies virtually no growth assumptions. While there may be no growth in the near term, given the strength of the aerospace market and Aircastle’s management, it would be irrational to assume they will never grow again. Therefore the resumption of growth, when it does occur should, act as a catalyst for multiple expansion.

     

     

     

    Price

    Market Cap

    TEV

    2008 P/E

    Dividend Yield

    P/B

    Aercap

    AER

    19.1

    1624

    4087

    7.4

              N/A

    1.7

    Genesis Lease

    GLS

    19.57

    705.5

    1693

    14.7

    10.1%

    1.24

    Aircastle

    AYR

    22.14

    1735

    3799

    10.9

    12.6%

    1.34

    Financial Federal

    FIF

    23.83

    611

    2118

    11.9

    2.6%

    1.54

    GATX Corp

    GMT

    38.97

    1866

    4122

    12.10

    2.8%

    1.62

    CAI International

    CAP

    10.75

    184

    283.9

    9.1

              N/A

    1.44

    McGrath RentCorp

    MGRC

    21.3

    522

    694

    12.1

    3.5%

    2.05

    Mobile Mini

    MINI

    19.57

    632

    967

    12.7

              N/A

    1.37

    TAL International

    TAL

    22.27

    697

    1736

    13.1

    7.2%

    1.75

    Textainer Group

    TGH

    14.28

    679

    1245

    9.2

    5.8%

    1.69

    Average

     

     

     

     

    11.32

    6.4%

    1.57

     

    Aircastle trades roughly in-line with its airline leasing peers and other leasing companies based on P/E multiple, but its dividend yield is roughly double the overall peer group average. As Aircastle has indicated many times that their financials are backward looking, but their dividend is forward looking, I feel as it is more appropriate to make a relative valuation call on this company based on their dividend yield rather then its P/E. I believe P/E multiple is an indication of its absolute cheapness and diminished growth expectations.

     

    Several indicators point toward a 6% dividend yield as fair value for Aircastle in addition to the peer group average. All three of Aircastle’s equity offerings including its IPO were priced based on a roughly 6% dividend yield. The most recent of these occurred in October 2007. Currently, the REIT index averages 6.2% dividend yield as well. Given the declining asset values and capital issues many of those real estate companies are facing, it seems absurd that Aircastle, whose assets are actually appreciating and remains able to access the capital markets should trade at roughly double the yield of these REITs.  

     

    Finally, I believe that there is a good deal of margin of safety in Aircastle beyond the contract based cash flows, strong management and high dividend yield. The CEO made a comment at the Goldman Sachs Finance conference earlier this month that gives me further confidence that there is a large margin of safety based on the asset value inherent in the company. He said “there isn’t anything fundamentally wrong with the company and it is close to trading at NAV as if it is just a repository of airlines.” Aircastle trades at 1.3x book value. However, it is very possible that book value understates the value of its portfolio as Aircastle has been decreasing the carrying value of its fleet based on straight-line depreciation whereas the actual values of the aircraft have been increasing as evidenced by the rising rents. Aercap made a similar claim today during their earnings presentation showing a slide depicting the appraised value of their portfolio to be significantly higher then the carrying value.

     

     

    SUMMARY

    Aircastle is an interesting play on the global growth of air-travel without risk associated with of individual carriers. The aerospace industry has massive tailwinds and Aircastle is positioned to strongly benefit. Management has indicated that they believe the dividend to be secure and have expressed their confidence by raising it as recently as December. Two insiders bought stock (2,000 shares each) on 2/26/08 further signaling confidence in the story. This stands in stark contrast to the market which has halved the stock on fears that its growth will be less profitable or slowed.  Management has stated that while its financials are backward looking, its dividend is forward looking and reflects their view of future earnings. Given the prodigious yield, it appears that Aircastle shares are a great bargain available because it has been mistakenly tainted by the credit crisis.

    Catalyst

    Further acquisition of aircraft, continued performance in future quarters, re-opening of securitization market

    Messages


    SubjectQuestions
    Entry02/27/2008 04:04 PM
    Memberdavid101
    Algonquin,

    Have some questions:

    1. How much of AYR does Fortress own?

    2. What is the median age of their fleet?

    3. How do their securitizations work? Are they non-recourse and how long is the maturity?

    4. What are the terms of their credit facilities?

    David

    Subjectcomments/questions
    Entry02/27/2008 07:03 PM
    Memberskyhawk887
    Interesting idea, but I am skeptical.

    Do you know what the maturity and terms are on their funding? In general, do they try to secure long-term funding to match the long term nature of the assets?

    I haven’t looked too closely at AYR, but as I understand it, it is like most REITs, essentially a product of financial engineering. As such, I think it should trade close to book value or NAV. What is its franchise value? It looks like it has about 65 people. So it is a handful of people making pretty sizeable bets on airplanes. It is a one trick pony. Sure, things for the aircraft industry look great now, but banks and finance companies have frequently managed to lose big sums of money on aircraft leasing in the past. The mortgage real estate market looked great two years ago. AirCastle has no alternatives if aircraft leasing goes south.

    What if we were to think of AYR as a run-off business? What would it be worth? Present value of future dividends and residual value of the assets right? Have you tried modeling what happens to the dividends in such a scenario? They will inevitably decline, reflecting the depreciating value of the leased assets. I guess I'm trying to isolate the effect of secondary equity offerings that are accretive to book value (because they are done at a premium to book value). Annaly is doing this and to their credit it has worked as the stock keeps moving higher reflecting the accretive book value per share. But NLY operates in the huge GSE MBS market, which investors believe apparently offers high riskless returns. Aircraft leasing is much more volatile.

    What's the deal with taxes? They are not a REIT and based in Connecticut. Perhaps similar to the Bermuda based reinsurance industry, it will manage to maintain this advantage, but if I were a competitor that pays a full tax rate, I'd be complaining to my congressman. Is this a risk, especially with Democrats looking to control the White House and Congress? And with Bush's tax cuts set to expire, do you think high dividend payers like AYR will suffer disproportionately?

    Incidentally, AYR trades at a PE near 11 (based on minimal taxes), putting it in line with many large cap banks that pay taxes and have real franchises (i.e. deposits, branches, lots of people involved in the community, historical relationships, variety of product offerings). Why should AYR trade at a premium? Because it has a 12% dividend yield? That's because it pays out all its earnings. And as I learned in my finance 101 class, a company that pays out all its earnings will see its growth rate slow or turn negative (especially in the case of AYR which has no scaleable patents or intellectual property and has genuinely depreciating assets). This is why most banks and other companies do not pay out 100% of their earnings--because they are reinvesting it in the business. AYR is not. And the only way they can grow the business is by tapping the capital markets and raising equity (incurring hefty underwriting fees). If the market is in the mood to let them raise equity at an accretive value, AYR will do fine, but the market can be very moody for a long time and price the stock at a discount to book. If I were running a business, I would not want to be so vulnerable. But clearly it has worked so far, as AYR has managed to do several offerings in the past year, which has increased book value per share from around $12 to almost $19, despite paying out most of its earnings. I suspect that as AYR continues to raise more equity, investors will continue to compress the valuation of the company to the amount of money that is/was raised, or roughly 1.0 times book. I think book value will be a much more relevant driver of the stock rather than the dividend yield.

    If you want to play the booming aircraft market, why not own Boeing? It trades at only 11.7 consensus EPS for 2009. It operates as part of an oligopoly, pays a real tax rate near 35% (thus not subject to some sort of crackdown), is not dependent on the capital markets for funding, and is a real franchise.

    In the end, I don’t think that this is necessarily a bad idea. I just think that AYR should be prominently recognized as the product of financial engineering that it is. And because it generates a ton of investment banking fees, sell-side research should be approached skeptically.

    SubjectRE: comments/questions
    Entry02/27/2008 08:09 PM
    Membervinlin1060
    Skyhawk, I agree with your sentiments exactly. I think you hit the nail on the head. I did the run off analysis last week and it is near where the stock is trading. The assets are perhaps worth more than book because of the lack of supply. That said, it is complete financial engineering and it is noteworthy one of their biggest competitors is a Cerberus funded entity-Aercap. Competition will set in and it will be difficult to get high returns in the space going forward. At the right price this would be very interesting, but it is not near distressed levels yet. If I were a long, I would also be fearful that they cut the dividend in order to replace their depreciating assets. If this happens, the stock will get whacked and will not be worth 11-12x earnings. Finally, it is noteworthy that Fortress sold a ton of stock at $30 late last year in anticipation of what is happening now...

    SubjectRE: Questions
    Entry02/28/2008 03:28 PM
    Memberalgonquin222
    1. Fortress owns 37% of AYR and sold ~10m shares in the October 2007 secondary. I think that the Fortress overhang is partially responsible for the sell off in the stock. There is a school of thought that they may liquidate the position in order to free up cash. I'm not sure if they will or if they won't, but given the large dividend yield and how much the stock has come down, I'd imagine they’d be comfortable waiting at this point.

    2. The weighted average age of the fleet is 9.6 yrs.

    3. How do securitizations work?
    I will use their second securitization as an example (they have only done two). Their basic strategy is that they use short term credit facilities to finance the purchase of aircraft (usually done in small increments) until they have a sufficient quantity to do a securitization. On June 1 2007, they closed on a $1170m securitization which was secured by 59 of their aircraft and related leases. The securities issued were floating rate at Libor + 0.26. Aircastle immediately hedged the interest rate risk putting their all-in cost at 6.2% fixed. The loan to value was 60.6% based on an appraised value of the 59 aircraft. The covenants require that AYR pay down the principal of the debt during the first five years such that the loan to value remains constant. Therefore the amount of principal paid down over the first five years is equal to the depreciation on the collateral. The lease revenue from the 59 aircraft is used first to pay interest/principal payments and then the balance is available as free cash flow. The maturity date of the notes in June 2037, but AYR has stated they intend to refinance in 2012. I believe the securities are recourse to the collateral.

    4. AYR entered into a credit agreement on Feb 5 2008 so I will use that one as an example since it is quite fresh. This is a short term facility that matures in August 2008 but with an extension option for February 2009. It was done with JPM and Calyon for $300m. The terms allow AYR to use the funding to for up to 65% of the purchase price of 38 specified aircraft which the company either already owns or has committed to but are not part of the two previous securitizations. AYR had originally paid for these aircraft using a $1.3bln warehouse facility of which $900m is outstanding. The addition of the $300m facility will increase their capacity on the warehouse back to $900m. AYR expects to refinance the warehouse in 2Q08 with an all in cost of 7%. This traditionally would have been a done as securitization but as we know that market remains closed.



    SubjectRE: Credit markets
    Entry02/28/2008 03:31 PM
    Memberalgonquin222
    With regard to 2008 commitments, AYR's CFO said on the most recent conference call that they had adequate financing in place already to fund their remaining commitments for 2008. They currently have $43m in unrestricted cash, $6m in letters of credit, and $250m revolving credit facility plus the $300m senior secured facility they did this month with JPM.

    If the credit markets were to completely close or became prohibitively expensive, I think the downside is that AYR would have no growth. They wouldn’t be able to acquire new aircraft and grow their balance sheet. Assuming, they were able to refinance existing warehouses and credit lines, they should be able to maintain their current revenue stream. The fact of the matter is that credit markets are actually open for aircraft lessors, albeit at slightly higher capital costs then they had been previously.

    9/11 was the only time in recent history where passenger traffic declined significantly. In traditional downturns/recessions, passengers still fly, but they downshift. Business travelers fly in coach and coach travelers fly on low cost airlines. In general, the total passenger traffic remains stable. While this turn of events will certainly hurt some of the carriers, the total demand for aircraft won’t really change. In fact, as more traffic shifts to low cost carriers, the demand for leased jets may actually increase as the low cost carriers traditionally are much more likely to lease aircraft versus buying them. The lesson from 9/11 is that there is definitely event risk in this security. Its somewhat protected by its 30% revenue share that comes from freight though.

    SubjectReply to Skyhawk
    Entry02/29/2008 06:38 PM
    Memberalgonquin222
    Thanks for your post. Very interesting and thought provoking. I agree with many of your points. As I mentioned in the write up, this is not a “Buffett” stock. Frankly, I wouldn’t feel comfortable owning this for more than 3-5 years for many of the reasons you mentioned. That time frame being the term of earnings visibility that I feel comfortable with, which is driven by global trends in demand for air travel and the backlog at Boeing/Airbus. I definitely agree with you that AYR is a one-trick pony and needs financing to grow. That being said, I have a few points of contention with your arguments.

    First, barring a massive global recession or another 9/11 event, there is a good deal of earnings certainty here for the next few years. The global demand for air travel and freight is growing and, barring one of the occurrences I mentioned above, this growth should continue. We know supply is more or less fixed because of the backlogs at Boeing and Airbus. As such, I think near term risk to asset values and lease rates is very limited. I think your comparison with the mortgage real estate market is unfair. The key difference is that supply is roughly fixed in this case and it clearly wasn’t in the real estate market. A more apt analogy would be Manhattan real estate where supply is growing very slowly and demand is growing at a much faster pace. Prices have continued to rise there despite what’s happened in the rest of the country. You are correct that Aircastle has no alternative if aircraft leasing goes south, but I believe we have very good visibility for the next few years to confidently say that it won’t. Of course nothing is 100%, but the odds appear to be very good that it won’t be volatile. This earnings visibility is the foundation by which I build my argument on and I’d very much like to hear a contrary take if you or anyone has a bear case.

    I agree with you that in a run-off, the earnings and thus the dividend will eventually decline as the aircraft age and are thus unable to demand the same lease rates. I presume you are using this extreme case to give some sense of margin of safety or bare minimum value of the assets of the company. I haven’t modeled out this scenario to determine a net present value as I feel it would be impossible to be accurate (or even close) given the vast number of variables and different types of aircraft in the fleet (all of which may theoretically depreciate at different rates and have different terminal values). Some of the variables are just unknowable; discount rate, how quickly do lease rates deteriorate (recall they are currently appreciating), terminal value of jets, inflation, supply and demand for aircraft which will impact lease rates and terminal values etc. I’d be very interested to see Vinlin’s work here as the assumptions are key to determining the end value. I grant you that this would be a nice way to get comfortable with the absolute downside, but unfortunately I don’t think there is a way to make an accurate estimation. Luckily, the company is not in a run-off mode and the credit markets remain open for them. Also don’t forget that they already have made deals for aircraft that will be delivered in the next few years and had a few planes undergoing conversion to freighters that will begin earning income in the near future which will boost future income even without any more deals. So the current run rate actually understates future earnings to this extent.

    To get comfortable with the downside risk, I’m using book value. You mentioned that you thought AYR should trade close to book value and it’s actually is quite close to that level already. Book value is ~$16.50 per share and the stock is currently at $20.65 so you are looking at about 20% downside to that level. I’d argue strongly that accounting book value understates actual market price book value. A couple of facts lead me to that conclusion. First, lease rates are currently rising (implying increased market value of the aircraft) at the same time the company is depreciating the assets. Second, Aercap announced earlier this week that the appraised value of their fleet was $1.5bln higher then the $7.5bln net book value it was listed on their balance sheet. This is a 20% undervaluation. It’s actually possible that AYR could have an even greater percentage embedded gain than Aercap as the latter is more of a trading focused firm and has already sold several jets thus recognizing some of their embedded gains already. I don’t have an estimate and we’ll have to wait for Aircastle to have their portfolio appraised until we can get an accurate number, but I am confident in saying that actual book value is higher than accounting book value which further increases our margin of safety here.

    As an aside, I’d just mention that book value would remain flat even with no growth or equity raises. Even though AYR pays out the majority of their net income in dividends, they actually retain about half of their cash earnings as depreciation roughly equals net income. The debt they took on to fund the purchases of aircraft was roughly 60% of the value of the assets. AYR pays down an amount of the principal of their debt each year that is equivalent to ~60% accounting depreciation of their assets to keep the LTV constant. Therefore, 40% of the depreciation is neither paid out as dividends nor used to pay down principal and is reinvested into the business, usually for the equity portion of new aircraft purchases. This is a self sustainable model assuming they can get debt financing.

    So why should AYR trade at a premium? Assuming lease rates stay stable, which I have argued that they will, then AYR should see roughly 14% yields (Rev/NBV of assets). Depreciation is 4-5% and overhead is approximately 1.5%. This results in a ROA of 8-10% and a ROE of 12-16% given AYR’s leverage. That’s on their current portfolio. I’d argue that a double digit ROE like that deserves higher than an 11x P/E. In addition, and you aren’t going to like this part, but if Aircastle is once again able to raise equity and debt and grow their balance sheet, their earnings growth could be quite significant leading to further multiple expansion. Obviously, there is a probability that they won’t be able to raise equity at a price above book value so this is obviously more speculative then the ROE argument.

    Aircastle trades very close to its liquidation value. This provides significant downside protection. In addition, AYR pays a double digit dividend yield that appears very safe based on aerospace trends and management’s comments. The combination of these two factors creates a situation where an investor is paid handsomely to wait for certain catalysts to manifest themselves and should they not appear, the downside is limited. If some of the catalysts occur, then Aircastle could be a big winner. If not, then I don’t see much downside and I also get to pocket a nice yield while I wait.

    The most obvious catalyst is an equity offering at a price above book value. As you mentioned, Aircastle provides a lot of investment banking fees and as such the analysts are going to be working hard to get the stock back up to levels where they can do another offering. I’d rather have a friendly analyst community then not have it and given Wall Streets influence, its more likely than not, they will be able to reflate the stock price once the market settles down. Another potential catalyst is something that I didn’t mention in the write up, which is consolidation. In the most recent conference call, the Aircastle CEO said he thought the aircraft leasing industry would see consolidation in the near future. Aercap’s CEO seconded that statement during his earnings release saying that consolidation was necessary and he thought there would be 2 or 3 deals among the second tier lessors in 2008. Consolidation would reduce competition creating both a more favorable buying environment and a more favorable leasing environment. In addition, many analysts use private market value as a baseline for valuation and M&A activity in this sector could highlight the valuation gap between book value and market value that I mentioned earlier. If Aircastle, isn’t bought out, consolidation of its peers could lead to increased valuation multiples and thus the ability to do further equity offerings. The third potential catalyst is the most likely to occur. If Aircastle makes further aircraft acquisitions, it will be a strong signal to the market that not only is the credit market not affecting their business, but that it is continuing to grow and deserves a higher mutliple.

    With regard to the government changing the tax law on these leasing companies, I’m not going to worry about that until I read about the CEO throwing a lavish birthday party and hiring Rod Stewart to perform. In all seriousness, though, everything I have read suggests that AYR qualifies for the PFIC tax status due to its lack of activity in the US. The vast majority of its leases are done outside of the US. This is certainly a risk, but I don’t assign a high probability to it. Even if the law was changed, the high depreciation charges from the aircraft would limit their tax liability. The expiration of the Bush tax cuts is an issue for this company and something to consider. Given the margin of safety I see here and potential upside, I’m willing to accept that risk.

    SubjectDividend Policy
    Entry03/07/2008 06:41 AM
    Membergary9
    Thanks for the writeup.

    How do they determine the dividend payout?
    Is there a particular payout ratio?
    How often do they reconsider this?
    Do you expect this level of dividend to be maintained or cut or elimiated?

    SubjectRE: Dividend Policy
    Entry03/07/2008 11:53 AM
    Memberalgonquin222
    The dividend is determined by the board each quarter. They don't have an exact payout formula but have said that the dividend is forward looking based on what they expect to earn in the upcoming quarter(s).

    The CEO has said multiple times in the last month that he sees no reason why they would lower the dividend.

    SubjectNAV
    Entry03/11/2008 10:13 AM
    Memberbrook1001
    FYI, Citi is out with a note today saying the fair value of NAV is $26.50 using current appraisal data.

    SubjectRE: Questions
    Entry03/25/2008 01:07 PM
    Memberalgonquin222
    Distributable cash is cash flow after interest payments.

    As I argued in the write up, I think book value is understated as they have been depreciating the assets while the actual jets have been appreciating as lease rates have been rising.

    SubjectRE: Dividend Cut
    Entry03/25/2008 04:49 PM
    Memberalgonquin222
    Yes, definitely unfortunate. Especially considering that management gave every indication that they would not be cutting the dividend.

    I believe that a dividend cut was priced into the stock, but the size of the cut caught the market off guard in this case. The press release stated that the dividend was only 30% of distributable cash flow implying that the earnings power of the company had not been diminished ($3 run rate). Part of the reason for the sell off is a fear that this action portends a liquidity crisis. I do not believe this to be the case as they still have enough financing already in place to fund already agreed upon purchases. In fact, the mere action of cutting the dividend actually, lowers the risk of a liquidity crisis The dividend cut appears to be a conservative decision to enhance their liquidity situation given high uncertainty among financial firms and provide them with dry powder to make accretive acquisitions if they should arise. At the JPM airline conference, several of the lessor's spoke about how they expected to see weak sellers (hedge funds and private equity firms) being forced to sell their jets at presumably attractive prices.

    The stock price has been hurt and may continue to be weak due to a near term absence of catalysts but I still believe the stock will work in the long run as the earnings power still remains undimished.

    The stock remains cheap at 0.8x a likely understated book and 4.6x implied run rate of distributable earnings and 7x PE.

    Given the discount to book value, it is cheaper for a competitor or financial firm looking to enter into this business to purchase AYR and its portfolio then to purchase jets in the open market. Given its recent weakness, I see AYR as a potential target. Note that the CEO of Aercap has said that he expects this industry to consolidate.

    SubjectRE: any thoughts?
    Entry04/01/2008 11:44 AM
    Memberalgonquin222
    Yes the valuation has become ridiculous in my opinion. Fear has taken over. AYR trades at 0.7x book value. This book value is composed of real tangible/fungible assets that are most likely undervalued on stated book as values of jets have been rising during the last several years while the company has been depreciating them. One of the reasons I really liked this name was because of the downside protection that the assets and book value provide. Citi, on March 11th, came out with a research piece that estimated NAV (liquidation value) to be $26.50 per share based on appraisal value of Aircastle’s jets. That is over 2x the current share price.



    In the press release, the company said that the new $0.25 dividend was only 1/3rd of distributable cash flow so we know that their earnings power has not changed over the last few weeks. The stock currently trades at under 4x its run-rate distributable earnings which it says is a proxy for future EPS. It trades at 6x a run rate of last quarters' EPS. This is a very cheap stock no matter how you look at it.



    Here are the comments from the press release:



    CEO Ron Wainshal commented, "We are committed to maximizing shareholder value. The recent volatility in the capital markets creates attractive opportunities for the Company to deploy capital. We generate significant free cash flow and as a result of decreasing our dividend, we will retain additional capital that can be used to increase our liquidity position and make opportunistic investments. More specifically, the $0.25 per share dividend reflects roughly one third of the estimated cash flow available for distribution."



    The dividend cut was clearly a surprise as management had said on multiple occasions that “they had no reason to cut the dividend.” Obviously something changed in the last few weeks for them to make the decision to cut it. The cut was either in response to liquidity issues or the desire to retain cash to make accretive acquisitions. The market has decided it is the former and has punished the stock price. Aircastle’s management is very, very conservative. They are smart and long term focused and the decision, while painful for the stock in the short run, is probably a good one. At the JPM airline conference two weeks ago, executives from Babcock and Brown airline leasing and Aercap said that they were seeing forced sellers of jets in the market. These are hedge funds or PE firms that entered the market and now are having liquidity issues and are being forced to unload the jets at fire sale prices. I believe that AYR had sufficient liquidity to handle their existing purchase obligations, but not enough to be players in the new bargain sales that are starting to occur. Cutting their dividend was the easiest way for them to generate enough cash flow to make these accretive acquisitions. Recall, on the most recent earnings conference call that they said the dividend was safe and they were not seeing opportunities to buy jets at prices they felt would provide them with acceptable returns. A short month later, they have cut the dividend and now are speaking about accretive acquisitions being available. I believe that they cut the dividend, not because of forthcoming liquidity issues, but to enable them be more aggressive buyers right now.



    The stock price has fallen from $40 to the current $11 and there is a tremendous amount of fear/negativity swirling around Aircastle and all of the airline lessors. The bear case is that they are in a perfect storm where credit is unavailable, their airline customers are struggling under high oil prices, and the value of jets in their portfolio are falling as supply is being taken out of the system with legacy carriers parking their oldest, least fuel efficient jets. Clearly this was a falling knife at $20 as I underestimated the continued negative perception on this name and did not believe it would trade so far below its liquidation value. I still stand by the long term thesis though and here is why:



    Credit is available and is actually cheaper then before the subprime crisis began – The capital markets are shut and any securitizations are off the table, but bank loans are still available. At the JPM airline conference both Aercap and Babcock and Brown said that even though spreads have widened for bank debt, their overall cost of debt has fallen due to lower interest rates. Traditionally, airline lessors use bank debt to make original purchases and then when they have a large enough portfolio of jets they use securitizations to refinance at lower rates. Being unable to securitize is not a death blow to these companies as the market seems to be suggesting.


    Despite high oil prices and the current struggles of legacy carriers, global demand for aircraft is not subsiding. The supply and demand framework for jets is very very tight and is not being driven by the US. Global demand for aircraft from China, India, the middle east and other emerging markets is driving prices upwards as supply of jets is pretty much fixed with fixed capacity and delays at Boeing and Airbus. The market sees legacy airlines parking jets and assumes there is going to be a glut of supply which will drive lease rates and residual values downward. What they are missing, however, is that the legacy carriers are parking their oldest and least fuel efficient jets. There are really two supply/demand curves occurring simultaneously as supply is outweighing demand for these older jets, while demand for the newer more fuel efficient aircraft continues to rise while supply is fixed. 85% of AYRs portfolio is composed of the latest generation fuel efficient technology for their class. Again, insiders echoed this at the JPM conference with Babcock and Brown saying that “demand for aircraft remains strong globally and the US is the only place where it has slowed.” The CEO also said that lease rates are continuing to rise and supply of aircraft is very tight. The Aercap CEO said that he still sees robust demand and a very tight supply of airlines and “explosive growth in emerging markets.”


    At the JPM conference and the Aercap earnings release lunch, both CEO's stated how they thought the airline leasing industry was ready to undergo consolidation. Right now, it is cheaper for another leasing company to buy all of AYR for their portfolio of jets then it is to buy jets piece meal in the open market. AYRs low stock price makes it a target and I think that once one of their competitors or a new entrant is able to line up financing, they could be taken out.


    The market psychology around AYR is undeniably negative and it could still trade down further. I can make no assertions that this is the bottom for the price. I do, however, have great confidence that AYR trades below its actual value. In the long run, this value should be recognized by the market. I believe that we could see AYR make an acquisition of an airline portfolio in the near term which should signify to the market that they are not having liquidity problems. I also think that once this crisis has passed, we will see AYR return their dividend to the full distributable earnings which, as the press release indicates, have not been diminished by the credit crisis. I also think that we could see consolidation in this arena of which AYR could be a target or a beneficiary of higher private market values. Given AYRs previously conservative financing (low LTV), strong cash flow from negotiated leases (only 12% are US legacy carriers), ability to access bank credit lines, I do not think this company is at risk of a liquidity crisis. While painful, the dividend cut has also lowered the risk of this problem.

    SubjectRE: purchase commitments
    Entry04/04/2008 12:15 PM
    Memberalgonquin222
    I think the moment you posted your comment about the stock not moving along with the market rally (which it hadn't been), it shot up ~15-20%....

    Roughly speaking, AYR needs $300-400m in the second half of this year, another $200m in 2009 for pre delivery payments (PDPs) on their new Airbus' and then the billion in 2010 to take delivery of the new Airbus'.

    On the Q4 conference call and again in my conversation with IR, they said that they were on track to get a $700m - $1bln term facility done in Q2. They expect the all in cost (including hedges) to have a 7 handle. They wouldn't say whether or not this was a high or a low 7. Previous securitizations were done at 6.2% and 6.6%. After this, they will need to re-negotiate their $1bln warehouse which expires in December of this year. They expect both to be done with the same banks given familiarity. One would expect the warehouse to get done shortly after the term in that case. With cash flow and the money saved from the dividend cut, this should take care of 08 and 09.

    The stock, currently below book value, trades as if they are not going to get that funding at all and, as such, I could see the stock rallying on the news of a completed financing agreement. This is assuming the rate is not higher than a 7 handle as that is what is in the market.

    Assume for a moment that they are able to get the funding and I am comfortable making this assumption based on what Aercap has been able to do, AYR's management comments, news articles about the bank market being open for airline lessors, and analysts comments. If they are able to get the funding, the only negative would be that new growth would be less profitable due to higher funding costs and potentially lower lease rates due to lower interest rates (they tend to move in tandem). The current earnings are not affected at all and looking just at the current run rate of earnings, its clear that the stock is too cheap. Yes, the new stream of earnings will be less profitable, but it will still be accretive. If this is the situation, the stock doesn’t deserve to trade below book value and at such a low multiple.

    Let's indulge the fears and look at what would theoretically happen if AYR could not get funding. This would be a worst case scenario and AYR has several options before defaulting on their obligations. First, they could raise equity. This would be extremely dilutive and depending on how much equity they need to raise, the stock might be fairly valued in the low teens. Hard to make any type of guess here as to where it would trade though. Second, they could sell some of their assets. This would impact current earnings, but wouldn’t be as destructive to shareholder value as an equity raise because they would be replacing the jets they sold with new ones. They may also not get full value as buyers will know they are distressed sales. Third, their slots for the Airbus delivery could potentially be sold for a profit. Aercap recently sold seven slots for what they called the PV of the future earnings they expected to make from those aircraft. I asked AYR about this possibility and they said that had no desire to sell their slots as they were getting the aircraft at a very early delivery date, at a discount to list price, and thought they were a great value which would be very profitable for them. While the market may be looking at the over $1bln in obligations from the Airbus purchase as the Sword of Damocles, it appears that it is actually a valuable asset that could potentially be sold for a profit.

    What is clear is that this isn’t a Bear Stearns or Thornburg situation. The debt markets remain open to their competitors and they are in strong enough financial shape to be as good a credit. In a worst case scenario where they aren’t able to access capital, they have saleable assets, and as a last resort they could raise equity. If they are forced to raise equity, I admit that the current price is probably fair to high. I see the scenario as very unlikely however. As to your question on selling the company at a price below book, management would have no reason to sell the company for a price below their book value when they could just sell pieces of their portfolio to meet obligations at higher prices.

    IR gave some further color on the dividend cut. She said it was an attempt to get some dry powder in this environment. Given rumors that CIT may be forced to sell their portfolio and other hedge funds puking up aircraft assets, it makes sense for them to try to be players in what will most likely be fire sale prices. Second, she said that they wanted to make absolutely certain they had cash to pay this years PDPs in order not to lose the Airbus jets. This underlines how much value they see in the Airbus delivery in that they were willing to torpedo the stock price in order to remove any risk of not having capital in place to make the payment.

    I don't have color on the funding source for the 2010 Airbus delivery. Perhaps the stock price will have rallied so that equity financing becomes the cheapest option. Perhaps the ABS market will have opened or perhaps they will not be able to raise capital and will be forced to sell the slots at a profit and forgo some future earnings. The fact that they are valuable assets alleviates my concern for this obligation.

    SubjectFinancing done
    Entry05/05/2008 09:55 AM
    Memberalgonquin222
    AYR announced a $700m financing on friday evening at Libor +1.75.

    The stock is ripping this morning and as I said in earlier posts, the market had very much discounted AYRs access to funding and especially at a rate like L+1.75.

    I think that once that market realizes that global demand for fuel efficient aircraft is not in free fall and is in fact in tremendous supply shortage, the stock will be again revalued upwards.


    SubjectQ1 Conf Call
    Entry05/14/2008 12:42 PM
    Memberalgonquin222
    If anyone is stillfollowing this name, I call your attention to the Q1 CC as it lays out the bullish thesis quite well. I have pasted some highlights below. Some key points are that it trades at roughly 4x earnings before non cash depreciation, TEV is significantly below NAV according to the CEO, global demand for fuel efficient aircraft remains strong and supply/demand imbalance should continue for some time as older jets are retired, and finally, AYR announced that they are contemplating adding in a asset management component by investing client capital alongside their own for a fee. Asset management, if they can pull it off (which may be reasonable given their long term track record, could significantly enhance their ROE and earnings potential.

    "Annualizing the first quarter (net income before non cash depreciation) would produce a $4.28 per share, or 25% yield on yesterday’s closing price. Obviously we feel that over time there will be depreciation in the value of the assets but even taking this into but even taking this into account, we are earning a very high return on shareholders equity."


    "With regard to the valuation of the portfolio, the 136 aircraft we owned at the quarter end were purchased for about $4.2 billion and had a net book value of approximately $4.0 billion, and we believe they are currently worth more than we paid for them, considerably more"

    "The portfolio has contracted monthly lease revenues of approximately $46 million, with the remaining weighted average lease term of 5.2 years. So on that basis, Aircastle is currently generating over 25% cash return to shareholders and has assets that have appreciated in value, not depreciated."

    "In contrast to the positive worldwide picture, the results in the U.S. were much weaker. The U.S. air transport association showed domestic travel dropping by 2.3% during the first quarter of 2008 versus the year earlier period, though this was offset by a 7.1% increase in international travel. In this regard, I point out that 92% of our portfolio is on lease to airlines outside the U.S., thus limiting our direct exposure."

    "I think the big story in our sector is the high cost of fuel. In U.S. dollar terms, jet fuel costs there are nearly two-thirds higher than a year ago and almost twice the level at the beginning of 2007. This affects airlines all around the world but the U.S. carriers are hurt the most since they don’t have a strong local currency to buffer them from this effect and they are also affected by the slowing U.S. economy."


    "Taking all these factors together, demand for modern fuel efficient aircraft remains strong worldwide, though we are seeing a softening for the less fuel efficient, older technology aircraft."

    "There is a huge base of these approximately 4,000 economically obsolete aircraft still in service around the world and we believe current industry conditions will force many of these to be retired soon. This list includes over 1,000 MD80s, more than 1,000 third generation technology aircraft, such as Boeing 737 200s and DC9s, and approximately 1,300 soviet area units. Also, the average age of the world air freighter fleet is approaching 25 years."


    "Given higher fuel prices, there is growing pressure on airlines to shift to newer generation aircraft. However, given Boeing and Airbus’ being sold out for several years, we believe demand for modern aircraft remains quite tight and if capacity becomes available due to order deferrals or bankruptcies, has been and will be absorbed efficiently. With 86% of our portfolio by value consisting of the most modern generation aircraft currently in production, we believe our portfolio is well-positioned relative to the increasing fuel price environment."

    "We started working on 2010 lease roll-off as well. I expect we will have most of our 2009 placements completed by the end of the summer and overall rental levels for 2009 look comparable to the favorable levels we are achieving this year. "

    "With respect to our dividend, last quarter our board took a difficult but prudent decision to reduce the payout to $0.25 per share by paying out approximately one-third of our cash available for distribution. This action positions the company more conservatively in a still volatile environment. The company’s operating cash flow remains strong and we will seek to deploy it in the most accretive manner possible for shareholders. "


    "In this regard, we continue to look for ways to grow our earnings by leveraging our capabilities, including through managed funds to invest in additional aircraft. A fund structure would allow us to earn money not only through our invested capital but also through management fees and incentive income. "

    "Our all-in cost expectations for our new term facility are consistent with our prior thinking and should be in the low 7% range after factoring in up-front fees and net hedge costs for the new hedges we expect to put in place over the coming weeks."


    Subjectglobal airplane inventory
    Entry06/04/2008 12:06 PM
    Memberfinn520
    Algonquin,

    Do you (or anyone else) know of a good source to get a list of the current global airplane inventory? I am thinking of a database that breaks down the type of aircraft owned by each company.

    It seems like the aircraft lessors are being priced for Armageddon. As you have pointed out, there are a number of factors which would seem to be strongly tempering this outcome:

    a) Most of the demand is international, where demand is much stronger and where the oil price impact isn't nearly as strong as in the U.S. due to currency effects.

    b) AYR's modern fleet is not going to be grounded or lacking demand anytime soon. If you think of the global airline fleet as a capital structure, AYR's planes are senior to several thousand inefficient planes (MD80's, B737-200's, the Soviet fleet).

    Related to b), do you have any numbers on the composition of the planes grounded post 9/11 (roughly 20% of the fleet, I have read anecdotally)?

    Thanks.

    Subjectupdates?
    Entry06/05/2008 10:49 AM
    Memberhkup881
    Any one have any thoughts about the recent decisions by AA and UAUA to retire older aircraft? I'm trying to decide if it's bullish or bearish. On one hand, demand for planes is going down--hence the stock is down. On the other hand, newer planes (basically what AYR leases) should continue to have a premium valuation and lease rate as airlines have a lot of fixed costs and they dont want to shrink themselves out of business. The newer planes are significantly cheaper to operate at these high fuel prices, so the cap rates should increase. Is anyone close to mgmt or the industry who can share some views on what's happening?

    SubjectRE: updates?
    Entry06/05/2008 12:15 PM
    Memberfinn520
    I have little experience in the airplane industry, but have looked at this a little bit in the past few days and come up with the following:

    1) AYR provides the exact composition of it's plane inventory in it's 10-K (pages 138-140), and the numbers appear to reveal a somewhat different story than management says. In the 2008 Q1 conference call: "86% of our portfolio by value consists of the most modern generation aircraft currently in production".

    What does "modern generation" mean? It appears to have more to do with plane type than fleet age. In the 10-k, planes are categorized as either "latest generation" or "classic".

    Composition is as follows:
    Classic
    Age Number of planes
    0-5 years 0
    5-10 years 0
    10-15 years 13
    15+ years 30

    Total 43

    Latest Generation
    Age Number of planes
    0-5 years 6
    5-10 years 53
    10-15 years 13
    15+ years 18

    Total 90

    68% of the planes (90 out of 133) are Latest Generation & 86% of the value is in those planes. That makes sense. 31 of those planes are over 10 years old, and 18 of those planes are over 15 years old. Is it really fair to call those "modern generation"? Is a 1995 Honda Civic "Latest Generation"?

    I don't know enough about the fuel efficiency of various airplanes to know the relative efficiency of the 15 year old plane vs. say, the new Boeing 787's, but I imagine it is material. So to be conservative, knock the number for percentage of value in "modern" planes from management's 86% to something closer to 70% (rough guess based on the numbers above). This relates to the following point that Edward965 made.

    2) What is important to the book value of AYR isn't the current market value of the entire fleet, but the asset value of the planes at the margin. If the value of some of those assets goes from significant to zero in a short period of time due to drastic changes in fuel price, there could be significant impairment in book value in a hurry.

    With a fleet worth $4.0b, total assets of $4.5b, and liabilities of $3.3b, book value is $1.2b. 30% of the assets are non-modern. If the non-modern planes are worth 20% less, than book value is impaired by 23%. If the non-modern planes are worth 50% less, book value is impaired by 56%.

    3) The backlogs for Airbus and Boeing are unprecedented and mind-boggling. Take Boeing's Commercial Airlines segment - after a 15 year period in which the backlog hovered between $65-95b, it has gone up in the past few years from $65b to $124b to $174b to $255b. The demand is very broad-based geographically, and they break it down for you to the individual airline. In addition, it appears to be driven by a growth in airlines in the developing world, what I would assume to be real secular demand.

    If it is true that people are going to continue to fly (historically flight miles have grown at 1.4x rate of global GDP) and there is going to be a premium on the most-recent planes, then Boeing is going to be delivering a lot of planes in the next few years. Historically, even when orders have fallen off dramatically (early 1990's), plane deliveries have risen over the following period, as you would expect. Also, the biggest cancellation rates Boeing has ever seen were 10% in 1993, 11% in 2000, 6% in 2001, and 5% in 2002, so 20% cumulative over the 2000-2002 period.

    Perhaps Boeing will get hurt due to monumental screwups in manufacturing and penalties resulting from delays, but someone in this food chain is going to do well.

    Does anyone with experience in the airline industry have any views on the current backlog? Is there good reason to believe that a lot of it might disappear? If not, how is Boeing (or other players in the segment) possibly not going to make a lot more money in the next 5 years?

    Thanks.

    SubjectRE: RE: updates?
    Entry06/11/2008 02:59 PM
    Memberalgonquin222
    Your analogy between a old honda civic and aircraft is incorrect. The airlines are not redesigned every year it is my understanding that the difference in fuel efficiency between say a 5 year old jet and a 15 year old jet of the same generation is only about 2%. This minimal difference is only due to wear on the engine. The latest generation means that there hasn't been a redesign in the class where the engine, weight, aerodynamics etc are all upgraded. The new Boeing Dreamliner is a new type of plane (787) and definitely is much more efficient then the existing crop of aircraft (different bodies).

    When a new generation of a body aircraft comes out, the values of the previous generation tend to fall because there is a better option out there. Until that new body comes out, the most recent types, even if they are 15 years old, are considered latest generation and are valued as such.

    So to answer your question; yes AYRs jets are on the older side, but no that does not make them less fuel efficient. They own older jets because they are cheaper to purchase and can be leased at roughly the same rates as younger jets creating higher yields. The problem comes from when they pass 20-30 years of age and are no longer appropriate for passenger use. AYR deals with this by converting them to freight and prolonging their useful life.

    Unlike a few months ago when these stocks were sold off because they were "finance" companies, they are now being sold because they are "airline" companies. At the current valuation, the market is suggesting that there will be a rash of global bankruptcies due to the price of oil. AYR has multi-year leases and to justify today's price, many of their disparate global customers would have to default on payments and AYR would then repo the aircraft and be unable to re-lease it at the same rate.




    SubjectLCC
    Entry06/12/2008 08:02 PM
    Memberhkup881
    Any thoughts on LCC's news today that they are going to sideline 10 leased aircraft (6X 737 and 4X A320). These are probably all AYR planes, right? How much longer do they have to make lease payments on them for, can they be re-leased?

    Subjectthoughts
    Entry06/18/2008 07:25 PM
    Memberskyhawk887
    stock is at 50% of NAV. Any thoughts?
    Credit Suisse presentation seemed reassuring. Looks like the USAIR airplanes to be sidelined are not AYR's.

    SubjectRE: LCC
    Entry06/19/2008 01:14 PM
    Memberalgonquin222
    Sorry it took me some time to get back to you. You can see on page six of the presentation linked below that none of the capacity reductions affected AYR's jets

    http://media.corporate-ir.net/media_files/irol/20/200805/CSPresentationJune2008Final.pdf


    SubjectRE: thoughts
    Entry06/19/2008 04:38 PM
    Memberalgonquin222
    Unfortunately I wasn't able to attend the CS meeting (Evidently no spots for us peons). I have read the presentation, but if you have any insights from the Q&A, Iwould very much appreciate seeing them.

    Aircastle is absurdly cheap on whatever metric you wish to use - NAV, PE, dividend yield, distributable earnings etc. For example AYR lists their NAV as $5.6b (of this number only $262 NBV are the older classes of jets) vs a TEV of 3.2b and on their presentation, they list adjusted annualized net income + depreciation as $4.28/share which suggests they believe their stock to trade at 2x cash flow. Mr. Market must believe that earnings/cash flow and asset value will soon decline precipitously.

    Way back when, at the lofty price of $22, when I wrote up this name, the market was discounting this stock because of its financing risk. It discounted it all the way to ~$10 and then, as argued, AYR was able to get their financing at a very favorable rate. Given discussions with management, news reports, competitors ability to finance etc I was quite confident that the market was misunderstanding this situation. They were......on the financing side. On the operations side, I didn't consider the risk of $130+ oil. $130+ oil has introduced new risk into the equation which is the risk that AYRs customers will default on their lease payments forcing AYR to repo the planes. One of the tenets supporting my thesis on AYR was that their cash flows were supported by multi year leases and with a booming aerospace market, it was unlikely that there would be a wave of defaults (recall AYR's customer base is not concentrated so many defaults would have to occur to hurt them).

    The question that needs to be answered is A)will a number of AYRs diverse customers default on their lease obligations and B) will AYR be unable to re-lease the planes in that event.

    Can I answer this as confidently as I was with regards to the financing issues? The answer is no. We are in unprecedented times for the aerospace industry and it is entirely possible that oil could climb to the point that air travel becomes prohibitively expensive for all but the very rich. In that case, AYR would have no business. Do I think that is likely? No. Within the realm of possibility, but not likely in my estimation.

    As argued previously, AYRs fleet is primarily modern generation and thus the most fuel efficient in their class (slide 10 in the most recent slides addresses this point directly). These are not the planes that are being taken out of service. I have argued and continue to believe that the market is not appropriately distinguishing between the modern fuel efficient jets and the older gas guzzlers. Ticket prices are rising which will cause some demand destruction, but the amount of supply that has been taken out of the system (from route/frequency eliminations) should balance that out (at least for the time being). Assuming, oil stays where it is and higher ticket prices do not destroy demand beyond the supply that has been taken out, AYRs customers should survive and AYR will continue to collect their lease payments. If that happens, its valuation should return to normal and you are looking at multiples return on the stock from these levels.

    You'll note that AYR has not been having trouble placing leases for 2008 and 2009. They are basically done for their 2008 leases and 13 out of 20 for 2009 are done. They specifically note that they have placed 9 planes in the last three months which suggests that there is still demand for their planes. If anything is a leading indicator of problems it would be reduced leasing rates or trouble re-leasing planes. We havent seen that yet and AYR says that 2009 lease rates will be flat to + 10%. To justify todays valuation, you would need to see a significant number of AYRs customers default AND trouble re-lease the planes.

    So my thoughts overall - there is increased risk from potential higher oil prices and global wave of defaults. I have trouble handicapping this, but as of right now, this is not ocurring. If we stay at the status quo and AYR continues to perform, the stock could trade at multiples of its current price.
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