AER - AerCap Holdings

[marazul]

https://www.dropbox.com/home?preview=Aercap.pdf

 

[jouni1]

https://www.dropbox.com/home?preview=Aercap.pdf

link doesn't work

[Fly]

Widebody bubble:

 

http://www.economist.com/news/finance-and-economics/21723855-airliners-could-be-worlds-next-big-asset-bubble-investors-aircraft-should

[nkp007]

I have been looking at AerCap after following it for a few years. It popped up on my radar while reading through VIC and dove in. I like it given growth trends, valuation, and generous capital allocation policies funded in part by reducing the size their of asset portfolio. I am going in with eyes wide open because 1) This company is very leveraged needs access to capital markets every year (~18 month buffer)  and 2) Declines in residual values / impairments could hurt a lot, but airplane prices have so far been a tailwind on resale.

 

Pros:

 

Valuation - ~8x earnings. Peak earnings, but order book is 95% leased out through 2019 and market is growing.

 

Management - Aengus Kelly has a tight grasp on the business. Read through recent conference call transcripts. He's to the point, shareholder friendly, and understands the nuances of their competitive advantage and fleet. Very, very impressed with his comments.

 

Capital allocation - Using excess cash flow to buy back shares. Bought back like 25% over last couple of years and on pace to buy back 10% this year.

 

Growth industry - Long-term growth of 5%. Air traffic doubles every 15 years. AerCap is positioned with young fleet (between 5-6 years in most popular models) and actually selling off older models to buy back shares.

 

 

Risks:

Hugely leveraged -  Running at liquidity that is 1.5x yearly capex + debt maturities. Could survive lack of access to capital markets for a little while, but share price would take a huge hit if credit markets closed for extended amount of time.

 

Residual value - currently reducing size of portfolio by selling older widebody planes for a gain. But at some point that could shift to a loss. Residual value is key component in book value here, and when you're levered 75%/25% debt to equity, small impairments add up quickly.

 

Buffett - WB called this a scary business that uses short-term money to finance long-term assets. There is a real business underneath here, but ultimately it's a specialty finance company with the associated risks.

 

---

 

Ultimately, I think I am paying a cheap valuation and hoping the global aircraft market does not fall off a cliff. Position size between 5-10%.

[ebdem]

Thanks for the good analysis.

 

I would add as pro, that they are one of the big players with a global presence have scale/plattform advantages.

 

We also have a visibilty, cause above 90% of the planes are already booked for years. This means we have predictable cashflows or at least termination fees.

 

They made it to keep earnings quite stable in the crisis of 2008 - although revenue dropped a lot.

 

Also the industry is controlled by Airbus and Boing, which are producing quite rationally, so that we haven't seen a oversupply for years. But this might change one day.

 

I am using book value as an ample to invest: if it's below 0,8 it's a buy signal, if it is above 1,2 it's a sell signal. As I am investing in the fleet (and also the gains of the trading with it), I think it's a helpful metric.

[rogermunibond]

If you are looking at aircraft lessors - freight is the way to go - ATSG.

[black-dog]

(if an idea hasn't been posted to in ages, do we post it anew?)

 

It's been interesting to follow Aercap these last few years -- they've continued their buyback, they've been selling off a lot of their fleet and buying newer, more efficient aircraft, their management has continued to be excellent (I love reading their earnings presentations and calls -- no "step function change" rhetoric, and they're so insightful analysts seem to throw them airline industry questions only tangentially related to Aercap just to get management's view).

 

What's interesting is while it looks from the outside like the fundamentals of the company's story haven't changed, Q4 saw Pabrai, Einhorn, and Leon Cooperman all substantially trim their positions. If you bought in during the early 2016 dip you've nearly doubled your money, and taking some money off the table would make sense, but they bought and bought when it had hit its current plateau.

 

I'm curious why Pabrai and Einhorn would trim their stakes now, and if there was an upside they saw at $40-$50 when they were buying that went away in the last quarter.

[Lakesider]

I think the sells were to move cash to better ideas. Einhorn still talks about it being one of his largest longs in his latest letter (below). He even states that he thinks the thesis is still good. 

 

https://www.docdroid.net/K95Fju3/greenlight-capital-q1-2018.pdf

 

There was a blip in their fleet on lease when Air Berlin went under in Q4 that may have made them reconsider the risk given the debt.  Also the increasing cost of capital will lower the future spreads.

 

I bought some more as the discount to book value widened and buybacks continue. AER had their aircraft independently valued a couple of years back at a 5-7% premium to book values too. The fleet is set to grow again this year and we should see revenues start to rise again.

[black-dog]

That was an interesting read, thanks. It's interesting, they do put the book value right in the earnings presentation ($57.20!), there's a slide on the spread, a slide on liquidity, and they'll straight up talk about their hedging and how interest rate changes could affect the leases on calls. I dig following them in a way that makes me suspicious.

[CorpRaider]

Heard them mocking Einhorn this morning on Surveillance.  Almost put in an order from some GLRE on the spot, but gold, and the shorts, and the fees...I'm not sure I can.  Definitely tracking this and BHF though.

[mwtorock]

i sold my position in AER in Q4 too after an airplane trade show. it was shocking to me how many people and how easy it was to get into the business of leasing airplanes. i was not sure whether the industry is peaking, but i thought it is closer to the top than the bottom. Maybe a down turn can wash out the new/weak player.

[black-dog]

It might be easy to get into aircraft leasing, but AER's got immense network power that almost no one else does -- last year when someone cancelled a huge order on Boeing, it was AER they called and said "do you want to buy a whole lot of planes cheap?" and AER, knowing they could place them, said yes, and then did.

 

I don't get that as Honest Dog's Rent-an-aircraft.

[Lakesider]

I think you are spot on Black dog, They have showed the advantage again placing the Air Berlin and Monarch planes in Q1.  Angus made a good point stating how they are not at the mercy of the customers when it comes to renewing leases as they can place planes elsewhere at favourable terms, this is something other lessors can not do.

 

Every earnings call I am more and more impressed by Angus Kelly, think I have a bit of a man crush.

 

Will be looking to add to my position if the stock trades down a bit.

 

 

[bizaro86]

I think you are spot on Black dog, They have showed the advantage again placing the Air Berlin and Monarch planes in Q1.  Angus made a good point stating how they are not at the mercy of the customers when it comes to renewing leases as they can place planes elsewhere at favourable terms, this is something other lessors can not do.

 

Every earnings call I am more and more impressed by Angus Kelly, think I have a bit of a man crush.

 

Will be looking to add to my position if the stock trades down a bit.

 

I really want to like this idea. But my question is WHY can they place planes others can't?  Is it a relationship thing? If I owned an airline paying the lowest possible prices for my planes would be pretty high on my list of priorities...

[Lakesider]

 

I really want to like this idea. But my question is WHY can they place planes others can't?  Is it a relationship thing? If I owned an airline paying the lowest possible prices for my planes would be pretty high on my list of priorities...

 

I don't think Aercap is placing planes that smaller lessors cant, I think they are able to place planes far quicker. It seems to me that the is a clear network effect here where as the largest player they now have a great overview of the demand in the market. Demand for leases is currently robust and Aercap seem to have a pretty good picture of who wants what. As an plane is coming off lease and its time to negotiate Aercap likely have 3 other airlines that can take the plane leaving the current customer very little power. A smaller lessor who doesn't have alternatives lined up is not going to risk the asset sitting off lease and will accept less favourable terms.

 

[Scunny Bunny]

There's a lot of funny money in aircraft leasing at present, similar to the stuff that's in reinsurance desperate to find yield. The Big 3 - AER, GECAS (part of GE) and Avolon/CIT (part of HNA the Chinese octopus) - have nearly 40% of the market. If you think it through, the benefits of size & network are immense. Better financing, newer planes, bigger clout and in AER's case, they are one of the few publicly listed. (AL, FLY are quite a bit smaller). The public listing is a big competitive advantage due to capital arbitrage at which AER are masters (latest quarter - sell ~$500m of planes at 13% margin above book and buy back $305m of equity at average 13% BELOW book!). In many ways AER facilitates some of the funny money - see recent quarterlies how they have put together packages for people.  They are not that interested in managing (asset lite idea) as the benefits from owning are much bigger. Aengus (NOT Angus) is spectacular - I'm in the man crush camp - his wide knowledge is immense, but most stunning is the drive to grow book value in every conceivable fashion. I bought its some time back and usually want to see ~ 20% discount to book.  The next few months may be a bit tougher - rising rates, problems with RR Trent for Boeing 777 hampering deliveries and less asset sales. However, with a near fully leased book through 2020, there's better visibility than with most companies. Plus a huge discount valuation. Absolute core holding of mine.

[CLM5]

Can anyone explain this Buffett quote to me:

 

When asked about the aircraft leasing business-

 

"But you will not see us get in, aircraft leasing doesn't interest me in the least. We've looked at that a lot of times, at various aircraft leasing companies offered to us. And that's a scary business. And some people have done well in it by, in recent years, using short-term money to finance longer-term assets which have big residual risks, and that just isn't for us."

 

Can someone explain to me what negative interaction short-term debt could have with the residual risk of aircraft? 

[rogermunibond]

I'm guessing Buffett was offered ILFC during the AIG restructuring.

 

 

Aircraft Lessor Impairments Point to Residual Value Risk

Fitch Ratings-Chicago-13 November 2013: Recent decisions by large aircraft-leasing companies to write down the value of certain older, uncompetitive aircraft fleet types in response to shifting global supply-and-demand fundamentals highlight asset quality risks for some lessors, according to Fitch Ratings.

 

International Lease Finance Corp. (ILFC) took a $1.2 billion noncash impairment charge in the third quarter after determining that future cash flows for 36 four-engine wide-body aircraft in its fleet did not support their previous net book values on the balance sheet. This decision reflected the lessor's view that the holding periods for Airbus A340s and certain Boeing B747-400s would be shorter than 25 years, which is the industry standard. The impairment charge, which comes two years after even larger impairments in 2010 and 2011, represents approximately 3.5% of ILFC's net book value. ILFC's ratings continue to reflect elevated residual value risk, which is driven by the relative size and age of its fleet.

 

The A340 has a very limited global operator base, which contributed to ILFC's decision to reduce useful lives and residual values. The global fleet of A340s has grown to 350 since its initial debut in 1993. Amid increasing fuel prices, Airbus terminated production of A340s in 2011, citing increased competition from twin-engine aircraft. ILFC currently owns 17 A340-300s and 13 of the larger model A340-600s. Other Fitch-rated lessors do not have significant exposure to the A340 family. For many of the A340s it sold to airlines, Airbus provided guarantees that effectively limited the residual risk for owners.

 

Last month, Aircastle also reported a relatively large $98 million impairment charge (roughly 2.0% of net book value). This was driven primarily by a reduction in the useful lives and residual values of six B747-400 converted freighters. Demand in the freighter market has remained stagnant and capacity has been added, resulting in an imbalance. Aircastle's exposure to this segment is unique among the major aircraft lessors, and Fitch does not expect others to be impacted.

 

The supply/demand outlook for select wide-body aircraft, including the A340 and B747-400 fleets, has shifted in recent years as airline demand for these less fuel-efficient four-engine aircraft has slipped. Lessees now have greater opportunities to lower unit costs by adding more competitive twin-engine aircraft, such as the Boeing 787 and Airbus A350, to their fleets. Meanwhile, lessors are finding more value in parting out the aircraft and selling parts, particularly engines, versus putting up significant maintenance expenses required to re-lease the assets at lower lease rates.

 

We believe changes in useful life and residual value assumptions for select older and less fuel-efficient aircraft may remain an issue for lessors as they adapt to changes in global airline fleet-plan priorities over the next few years. We will continue to focus on asset quality risk in this context, while recognizing the potential for technological obsolescence and short production runs to impair expected cash flows and residual values for certain older fleet types, particularly four-engine models.

 

We view increasing exposure to older, uncompetitive aircraft as a longer-term risk facing the aircraft leasing industry, which will play out over a number of years. If we see global capacity grow fast enough to absorb the growing number of aging aircraft in lessor fleets, the ratings impact across the industry will be limited. However, if the secondary market continues to narrow, then ratings of some lessors with greater exposure to older fleets may be pressured.

[brycepeterson]

Hi CLM5,

 

Not sure I'm correct - here's what I think - hope it helps:

 

(A) There's long-term risk in buying an airplane, which is pretty easy to imagine (Buffett's term is "residual risk").  Usually tied to advances in technology.  It's a huge cost to buy an airplane, thus better to lease than own (let someone else take the ownership / residual risk). 

 

(B) Using short-term debt to buy a long-term asset can be risky if interest rates rise (you have to refi at higher costs).  Worse, if the asset you purchased is depreciating in value, your cost went up while your asset value went down ("residual risk").

 

Kind of a secondary "risk" using ST debt is it usually costs much less than long-term debt, thus you can fool yourself into thinking you're getting a decent deal on a high quality plane.  So using ST debt, while looking good on paper assuming ST rates never move, can act like a bad drug (similar to an adjustable rate home mortgage).  Just not a real healthy biz model to practice given the asset you're buying.

 

Bryce

[Spekulatius]

Why wouldn’t you match your financing with the duration of the typical 10 year lease? A straight 10 year loan would probably be a decent match for an asset with a 20 year life.

 

If you don’t do that, you just gamble on interest rates.

[CLM5]

Hi CLM5,

 

Not sure I'm correct - here's what I think - hope it helps:

 

(A) There's long-term risk in buying an airplane, which is pretty easy to imagine (Buffett's term is "residual risk").  Usually tied to advances in technology.  It's a huge cost to buy an airplane, thus better to lease than own (let someone else take the ownership / residual risk). 

 

(B) Using short-term debt to buy a long-term asset can be risky if interest rates rise (you have to refi at higher costs).  Worse, if the asset you purchased is depreciating in value, your cost went up while your asset value went down ("residual risk").

 

Kind of a secondary "risk" using ST debt is it usually costs much less than long-term debt, thus you can fool yourself into thinking you're getting a decent deal on a high quality plane.  So using ST debt, while looking good on paper assuming ST rates never move, can act like a bad drug (similar to an adjustable rate home mortgage).  Just not a real healthy biz model to practice given the asset you're buying.

 

Bryce

 

Yeah, I think you're spot on. Makes sense, thanks for the answer.

 

Seems to me though, that it's less of an interaction with the ST debt and residual risk, as it is that he just doesn't like the residual risk at all? Even if rates go up, your margin between the ST rate and the lease rate should always be positive, and AERs was even through the great recession. From just a quick look at the B/S and income statement, it looks like they get around 13% annually from leases, which they're locked into for long-term. Even in down cycles like that, only a small percentage of planes actually come off lease and need to be placed elsewhere. And when they do (in the great recession), management was able to place these planes on short term leases at bad prices rather than sell or lock in long term leases at the bottom of prices. When the cycle stabilized, they were able to then place those planes at better terms. The lowest their ROE ever hit in those bad times was over 10%.

 

If you're making 13% annually from leases, that margin is never gonna turn negative unless his point about the residual risk is realized. Even then, a significant chunk of your portfolio of planes would need to be defunct to create losses. Aer has a diverse portfolio of planes, made up of the 2 manufacturers that have essentially a duopoly manufacturing planes. I just fail to see what makes this so dangerous. It would take an extreme outlier event to put aer in trouble, and that could be said of any company... and worst case scenario, in an extreme situation where interest rates rise rapidly, I don't see why they couldn't cease the purchase of new planes, and operate on what would then be significant amounts of operating cash flow the company generates.

 

 

[CLM5]

Why wouldn’t you match your financing with the duration of the typical 10 year lease? A straight 10 year loan would probably be a decent match for an asset with a 20 year life.

 

If you don’t do that, you just gamble on interest rates.

 

This is also a fair point.... I don't know. They're just capitalizing on the lower interest rates in the short-term. I guess it's too much to ask of most public companies to think of the long-term.

 

With that being said, they do utilize interest rate caps/swaps to hedge that risk. But it seems to me that in the long-run, it would still be much cheaper and easier to match their debt maturity with that of their assets.

[marazul]

The issue here is that Aercap, and all large lessors, have huge backlogs. These deliveries can´t be paid with just cash flow generation, they need to tap the debt markets. Risk here is that each year you need to issue new debt to finance these deliveries, and the market is not always open. Aercap has availability on a large credit line, huge cash flow generation and proven ability to sell planes...but this might not be enough in a financial crisis....Buffett won´t take this economic and reputational risk at probably any price but small investors (like me) might be willing to do it if the expected return is there. I think an investment in Aercap at current prices is a decent bet, but I know this will trade like crap (and probably deservedly so) in a downturn.

[bizaro86]

His aversion to having Berkshire enter seems surprising to me. This seems like a place he could probably get a deal based on a "seal of approval." Berkshire ownership would lower finance costs and guarantee the market would be open, even without an actual guarantee, I suspect.

 

He might even be able to get a deal on purchase prices. 200 c-series to Berkshire aviation probably goes at a huge discount, and they could probably "relationship" place them with an airline they own a big chunk of.

[mwtorock]

His aversion to having Berkshire enter seems surprising to me. This seems like a place he could probably get a deal based on a "seal of approval." Berkshire ownership would lower finance costs and guarantee the market would be open, even without an actual guarantee, I suspect.

 

He might even be able to get a deal on purchase prices. 200 c-series to Berkshire aviation probably goes at a huge discount, and they could probably "relationship" place them with an airline they own a big chunk of.

 

Everything could change if there be another downturn and he could get AER for pennies on the dollar. He used to hate airlines, but now he owns four. He used to avoid tech, but now he owns apple. Just saying.