Aercap
Q3 2021
By Manuel Maurício
November 11, 2021
Have you traveled recently?
I mean, by airplane?
I haven’t.
But I’m dying to.
And it looks like I’m not the only one.
The US have re-opened the international market earlier this week. The transatlantic market is the most important in the world and airlines have reported a big surge in demand for this route following the announcement.
This is important, not only by itself, but also because other parts of the world will follow suit.
So how is the increased demand influencing Aercap’s results?
Let’s take a look.
Income statement
If you were to just glance at the revenue figure for the third quarter you’d probably be thinking that we’re not in 2021, there’s no pandemic, and the business is doing just fine.
But if you look carefully you’ll notice that one third of the total revenue came from the sale of unsecured claims in the LATAM restructuring process. Basically, Aercap sold the right to be compensated by LATAM for cash that it was owed.
If we back out both the sale of unsecured claims and the maintenance fees (that increase as airplanes come out of lease), Aercap had the lowest revenue of the past 7 years (when it bought the giant ILFC and became the Aercap that we know today).
This goes in the opposite direction of AirLease which has been seeing its revenue go up. But given the fact that the revenue for both these companies is directly related to the amount of assets (airplanes) that they own, the revenue might be distorted by the changes in the size of each fleet.
I’ve struggled to find a “pure” metric that represents the underlying demand – something akin to the Same-Store-Sales-Growth in retail.
The best metric would probably be the lease rate factors, but the companies don’t disclose them. So, a good proxy could be the Revenue per Average Assets (I could be using the net spread, but I don’t want to consider the difference in cost of debt nor the different D&A schedule assumptions).
By looking at the chart below, we can see that, although AirLease’s revenue has been going up and Aercap’s going down, when we adjust for the size of each fleet (which has been growing in the case of Airlease and steady in the case of Aercap), they’ve been seeing similar trends.
This is a commodity business so it isn’t a big surprise.
With lower revenue – but basically the same costs – the profits went down as well.
The truth is some of the revenue that I removed could/should be added back. I’m erring on the side of caution whereas the company is erring on the side of optimism. As is usually the case with these matters, the truth should lie somewhere in between.
Balance Sheet
If we look at the deferral balance, we see that it has been coming down since the first quarter.
But as a percentage of the total liquidity, Aercap’s deferral balance has been higher than Airlease’s. This might be explained by the fact that AirLease has a much higher exposure to flag carriers which are being supported by their governments.
The important point is that the deferrals are decreasing both on an absolute and relative basis.
On a proforma basis (already accounting for the GECAS acquisition) the company has total sources of liquidity of $18 billion dollars and total uses of $9 billion dollars for the next 12 months.
This means that the sources-to-uses coverage ratio is is now at 2.1x, which is still comfortably above the target of 1.5x.
The combined company will have a leverage ratio of 2.8 times (debt-to-equity), pretty close to the desired 2.7x so the acquisition didn’t turn Aercap into a debt-laden monster (for a financial company).
In order to get below their leverage target, with the business picking up and with lower cash outflows for the purchase of new airplanes (given the OEM’s delays), the management will have more cash than expected. That cash will be used to reduce debt and repurchase shares.
Talking about debt, to fund the GECAS acquisition, Aercap issued $21 billion in unsecured notes. This was a great move as it lowered the cost of debt from ~4% to about ~2.7% while taking the average maturity from 3-4 years to 6-7 years (the longer the better).
Will GE be selling Aercap's shares?
The acquisition of GECAS was finally completed on the 1st of November and we should be seeing the combined financials in the next quarter.
In recent years, GE had been looking to restructure its operations by selling non-core assets and reducing debt.
Interestingly enough, just like what happened with its European peer Siemens, GE announced this week that it’s splitting into 3 public companies: Aviation, Healthcare, and Energy.
As a part of the sale of GECAS, GE got 46% of Aercap. GE’s plans include reducing debt from the current $75 billion to $35 billion by 2023. To do this it will be selling its stakes in Baker Huges and Aercap.
This means that we might be seeing some downward pressure in the share price going forward depending on how and when they sell their stake.
There are good chances that Aercap itself will be a buyer of those shares. I can’t help but to think about the fact that Aercap issued cheap shares only to buy them back later at higher prices.
Hmmm, the way I deal with this bad thought is by thinking that GECAS was bought at 0.5x book value when Aercap itself was trading for 0.65x book value, thus making it a good acquisition.
Airbus is increasing production
I was surprised to know that Airbus plans to increase production of the A320 from the current 40 per month to 64 in 2023. This is bad news for Aercap. So much so that the company sent a letter to Airbus saying that the ramp up in production is bad for business.
The more new airplanes that come into the market the lower the value of the existing (older) airplanes. So it’s in the best interest of the lessors, especially those like Aercap that have a lot of old technology aircraft, to keep supply tight.
Add to that the higher fuel costs (that lead to higher demand for new and more efficient airplanes) and it’s easy to understand why Aercap is asking Airbus to take it easy.
One bright aspect of the recent events is that Aercap had the opportunity to write-off a lot of its older airplanes so the residual risk posed by increased production of airplanes has been diminished.
Conclusion
After looking at AirLease’s results I was expecting much better numbers from Aercap. But it has become apparent that, although the lease rates for new technology narrow-bodies have stayed resilient, the airlines are still hurting.
It’s the management’s opinion that the worst has passed and that we should be seeing the revenue pick up in the next few quarters as travel demand increases and Aercap’s clients come out of cash accounting and power-by-the-hour arrangements.
On a broader perspective of both businesses, the stark contrast between the strategies of these two companies becomes apparent.
Whereas AirLease grows by regular and aggressive purchase of new airplanes directly from Boeing and Airbus, Aercap chooses to acquire big competitors – such as ILFC back in 2014 and GECAS in 2021 – and then digest them over the years by selling older planes at a premium to book value only to use the proceeds to repurchase shares at a discount to book value.
Which of these two strategies is best?
If we look at the book value per share, Aercap has been the best business for the past 10 years…
And if we look at the share price appreciation from 2011 until the beginning of 2020 (before the pandemic hit), Aercap’s share price went up 4.3 times whereas Airlease’s share price went up 1.7 times.
This means that Aercap has been the best bet for the past 10 years.
Having said all of this, and even after Aercap’s share price has gone up to its long term average price/book-value ratio of 0.9x, I still like Aercap’s prospects and superior capital allocation so Aercap will remain in the Portfolio.
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