AerCap Holdings (AER) and Air Lease Corporation (AL) are two of the largest publicly traded aircraft leasing companies (~$3B market capitalization, respectively). Both have been significantly impacted by COVID in the past six months, with shares of each business diving up to 80% in the first days of the panic. Since then, each has focused on liquidity and taking a long view of the return of air travel.
As you can see below, they rate very similarly on Seeking Alpha’s ratings system and quantitative factors, and both have significantly underperformed the S&P over the last five years, even prior to COVID:
(Source: Seeking Alpha)
(Source: Seeking Alpha)
Business Model Overview
The marketplace role of aircraft lessors is ordering large numbers of aircraft from manufacturers (Boeings (BA) and Airbuses (OTCPK:EADSF) (OTCPK:EADSY) – “OEMs”) many years in advance. Because of their purchasing scale, lessors can often negotiate significant discounts compared to airlines that might order the planes directly in smaller quantities. They can then in advance negotiate leases with various airlines, often for 10 years or more, to provide the aircraft for operation by the airlines. This benefits the OEMs by concentrating their sales and making their orders more predictable, while also making it easier for airlines to secure planes on shorter notice via leases instead of ordering from the OEMs years in advance. It also removes the responsibility to retire the aircraft from the airlines.
For these two lessors, a high-level overview of their aircraft is as follows:
- AER: As of June 30, 2020, they owned 931 aircraft (all but 41 were leased) with an average age of 6.4 years. They managed an additional 104 aircraft, and had outstanding orders for 322 more (over 50% leased). 20 of the off-lease aircraft are designated for sale. Some find AER’s widebody exposure concerning.
- AL: By comparison, as of June 30, they owned 301 aircraft with an average age of 3.9 years. They manage an additional 81 aircraft, and have outstanding orders for 393 (181 already leased) and purchase options for an additional 25. One owned aircraft is currently held for sale.
In terms of 737 MAX exposure, AER owns 5 and has outstanding orders for 80, while AL owns 15 and has outstanding orders for 121.
Given the focus on liquidity, I’ll turn first to the balance sheets:
|June 30 Balance Sheet (Thousands)||AL||AER|
|Net Flight Equipment||19,108,073||35,356,328|
(Source: Company filings)
So, despite having similar market capitalization, AER has about twice the book value of AL. Part of this is tied to the nature of their fleets – AER has an older fleet and hasn’t seen much growth over the past few years, while AL has been growing revenues by double digits. This is also evident from AL’s larger and more aggressive order book. Both companies also have a low average cost of debt, 3.2% at AL and 4.1% at AER.
With regards to liquidity, on their conference call, AL noted:
“In mid-June, you saw us access the investment grade unsecured bond market raising $850 million to five-year notes. Now at the end of the first quarter, we had ample liquidity of more than $6 billion.
Yet, we chose to take additional advantage of a favorable bond market for ALC, and this transaction further strengthened our liquidity position, which is now $6.9 billion at the end of the second quarter.”
Similarly, AER has proportional liquidity to their book value. From their call:
“We continue to maintain a very strong liquidity position. We’re currently holding a record level of liquidity with $12 billion in total sources of liquidity as of June 30. Against that amount, we had $5 billion of debt maturing over the next 12 months, and expected CapEx of $0.5 billion for total uses of $5.5 billion. So we currently have a record level of liquidity equal to 2.2 times our cash needs over the next 12 months, and excess cash coverage of around $6.4 billion.”
AER also just announced an additional offering of $1.5B in unsecured notes, due in 2024 and 2027, used to tender outstanding notes and for general corporate purposes.
In short, neither lessor is on the brink of collapse. Their respective debt/purchase obligations are similar in aggregate, with AL strongly tilted towards future purchases as one might expect from the above:
|Interest on debt||226||444||387||316||239||475||2,087|
(Source: June 2020 SEC filings)
Both airlines have the liquidity to continue operations for years at reduced revenues. Both have continued to make money during the pandemic, not burn it. Neither has had any issues tapping the credit markets for further liquidity since the crisis began, and both have a large base of unsecured debt.
AER: “We have customer relationships with approximately 200 airlines in approximately 80 countries.” Top five customers are as follows:
(Source – Annual Report)
AL: Top five not disclosed, but “[we] have a globally diversified customer base comprised of 106 airlines in 59 countries.”
Both businesses have historically traded at very attractive earnings multiples (~7x price to earnings and ~.8x book). Deals in the space have (pre-pandemic) been done at about 1.2x book, and that was for a lower-quality asset than AER or AL.
- AER, with a $3.0B market cap, trades at about 3x TTM and FWD earnings, and 0.3x book.
- AL, with a $3.2B market cap, trades at 4x TTM earnings and 5x FWD earnings, and 0.5x book.
These metrics are particularly intriguing given peer BOC Aviation (OTC:BCVVF) trades at book value and 7x TTM earnings.
AL and AER have differing approaches on returning capital to shareholders; AER has bought back $607.3m of shares in FY18 and 19, further sweeting their low P/B multiple, while AL has paid an attractive dividend even through this crisis (current 2.2% yield, very low 13% payout ratio, 33% 5-year CAGR). On an absolute basis, the AER payback has been higher, but some investors may be more oriented toward dividend growth and find AL’s future payout growth prospects more attractive.
As a senior creditor to airlines, investments in an air lessor can be thought of similarly to an investment in an ETF of secured airline bonds. The comparison isn’t perfect, but for lessors to make money, they don’t need airlines to make lots of money, but rather to stay solvent. Even in the event of bankruptcy, an important fact stands out:
- There were 23 airline defaults in 2019 (Jet, WOW, etc.) and the net impact to AER was a gain – they made more on corresponding lease cancellation security deposits and maintenance revenue than they lost on the defaults. This has held true even during the financial crisis, when they never reported an annual loss.
AER’s current deferral situation:
“At the end of June, our deferral balance was $430 million, which is equivalent to roughly 9% of our annual revenues. Against this amount, we’ve over $1 billion of security. The level of requests for deferrals has slowed down as traffic has begun to recover. Obviously, there are some customers who have filed for bankruptcy in the last number of months, which should be no surprise to anyone, given the level of disruption in the industry. But that doesn’t automatically mean we will have the aircraft returned. And in many cases, we expect the aircraft to stay in place after the airlines emerge from bankruptcy. In other cases, we will take aircraft back, but I expect this to be manageable for a platform of AerCap size.”
“And if I look at, where is that balance going to go to overtime? Where do we expect it to go to based on what we’ve talked to customers about and what we foresee? I expect that that balance on the balance sheet should grow to around $700 million to $800 million over the next couple of quarters.”
And for AL:
“To date in total, we have agreed to accommodations with 59% of our lessees to defer approximately $190 million in lease payments. The lower level deferrals granted over the past three months speaks to the slower pace at which we receive additional requests and reflects the amount of time we spent to diligence each request and understand which customers really need our help.
As I shared last quarter, most of our deferrals are partial lease deferrals for payments due in the first and second quarter 2020, typically with a short repayment period. In fact, the majority of those we granted will be repaid over the next 12 months.”
“Our airline customers are largely abiding by the deferral arrangements in place. As such, our collection rate for the second quarter and month of July were at 91% and 89% respectively, compared to the first quarter in month of April for which our collection rate was 90% and 86% respectively.”
Significant as these deferral amounts are for each lessor, they essentially represent one lost year of earnings for each business, some or all of which may be recovered through associated security held and repayment plans. Even through the worst days of this crisis, they have avoided the type of impairment that might throw into question the viability of their businesses.
- AER is exposed to Norwegian Air (OTCPK:NWARF) due to a recent debt-for-equity swap they performed that made them the largest airline shareholder. The carrying value of this investment at the end of Q2-20 was $199.6m, which has since dropped by over half due to bankruptcy concerns.
- Transactions during the pandemic have continued to show the underlying value and strength of demand for aircraft.
- A secondary benefit in the recent MAX delays – by the anticipated planes being behind schedule, there was an undersupply of aircraft in the market going into COVID. With the further manufacturing cuts since, the market isn’t as oversupplied as it would be otherwise.
- Timing of vaccines, rapid testing, and further global aid to airlines will all be short-term drivers of volatility in these stocks. I will not be that surprised to see a temporary 50% drop again from current prices before the crisis is over.
I see both AER and AL as very intriguing investments at their current price levels. The share price destruction that has taken place over the past year seems disproportionate to the safety each maintains as a senior creditor to quasi-government entities. I personally prefer AER for the following reasons:
- Lower price/book and higher earnings provide stronger margin of safety given comparable equity values.
- Future order book for AER has higher coverage of leases already executed.
- Growth “premium” currently attributed to AL may evaporate if pandemic drags on.
- More focused returns of capital to shareholders than AL.
- Broader customer base and lower MAX exposure.
- If Norwegian recovers, high optionality for AER to participate in upside, perhaps a spin-off of holdings? (Unlikely)
Disclosure: I am/we are long AER. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.