AirLease
vs
AerCap
Q2 2020
By Manuel Maurício
October 2, 2020
Introduction
Given that Aercap has been on the Portfolio almost since inception, it’s only logical to be following its peers as well.
AirLease has recently topped Aercap’s market capitalization. In an industry where book value is usually the dictator of price, how can a company with much fewer assets be bought for the same price as a much larger one?
In “normal conditions” these companies should trade at around book-value. Right now, Aercap is trading at 0.35x book-value and Air Lease is trading at 0.6x book-value. Both of them are cheap. But investors are paying more for Air Lease than AerCap. Why? That’s what I’ll be trying to answer today.
*Nerd Warning: I feel I should alert the subscribers that there’s no way to analyze financial companies without getting too technical. I’ll try to keep it as simple as possible, but for the less finance savvy, this might get boring.
Let’s start from the beginning:
If we were to look at the revenue figure alone, no one would say that we’re living in the worst period ever for the air-travel industry.
Here, let me zoom in on the last 10 quarters.
Apart from a slight seasonal decrease in revenue, it’s as if nothing has happened to the aviation industry. How can this be? Shouldn’t we be seeing the revenue plummet?
Actually, no. With almost 100% of its fleet leased, the company must keep recognizing the revenue that it’s owed, even if it isn’t paid. It’s just like your apartment rent. Although your landlord might give you a break and allow you to defer some of your payments to a later date, if he were to record his numbers as a public company, he would have to record revenue coming from you every single month.
Deferrals
But although Air Lease (as well as the other lessors) keeps recognizing revenue, it might not actually be receiving the cash.
Airlease’s management has said that the great majority of its lessees have asked for some type of accommodation. I was listening to the CFO the other day and he mentioned that although everyone is asking to be thrown a bone at, AirLease is obviously not giving the same conditions to all airlines.
He even mentioned that when a state-owned airline (or any other with some type of government backing) comes asking for deferrals, they tell it to go back to their government and ask for cash because the ones preventing the airlines from flying are the governments, not AirLease. It’s an interesting standpoint and it goes to show the powerful terms that these companies have built into their contracts.
It’s important to notice that 75% of the AirLease’s clients are state owned or have some kind of government backing. In Aercap’s case, this number goes down to 25%.
AirLease has worked out deals with approximately 60% of its clients so far this year. The vast majority of the deferrals is short-term, and is expected to be paid in one year or less. On top of that, the company only allows for a part of the owed revenue to be deferred. For instance, if the airline is leasing an airplane for $100 per month, it will only be able to defer, say, $50. Within a few quarters, it will be paying $150 to compensate for that deferral. And of course, Air Lease has also added some interest to those deferred payments and has seized the opportunity to extend those contracts.
A big advantage that AirLease has over Aercap is the considerable lower age of its fleet: 3.9 years vs 6.4 years for Aercap. A young fleet is very important in this industry. Old airplanes are being retired and the demand and rates for younger airplanes is much higher. This is probably the strongest reason for the disparity in the valuation of the two companies.
But I believe it to be only half-truth. What REALLY matters is the number of airplanes that are coming off-lease in the next year or so. You see, for the company to record impairment charges, the estimated future cash-flows coming from a given airplane must decrease drastically. If the company isn’t able to place the airplanes that will come off-lease soon, it will have to record impairment charges. And the older the airplanes, the more difficult it is to place them.
On top of that, the company has very low exposure to the USA and high exposure to Asia where flights are picking up at a higher rate than in the rest of the world.
In the first half of the year, the company had agreed to defer $189.9 Million in lease payments, which represents about 3% of the available liquidity, or 9% of the annual revenue. Aercap agreed to defer $430 Million in lease payments, which represents 4% of the available liquidity, or 9.2% of its annual revenue. Given that both companies have been negotiating similar levels of deferrals, there’s no reason to ascribe different values to the companies based on the deferral agreements.
Bond Market and Liquidity
The air leasing business is founded on the premise of a sound and functioning bond market. As mentioned on my most recent Aercap write-up, there was a fear that the debt markets would dry-up and that these companies wouldn’t be able to refinance their debt. You see, as debt-maturity dates get closer, what these companies typically do is to raise new debt with longer maturity terms to pay for the debt that is maturing soon. This creates a never ending cycle of debt issuance and debt repayment.
What we’ve been seeing recently is that the debt markets are alive and well (for now). Aercap just recently retired $1.5 Billion of debt at 4.4% and raised $1.5 Billion at 3.7%.
In the case of AirLease, in 2020 alone, the company has issued $2.95 Billion at 2.9%. On top of this, the company has also retired $185 Million of senior notes due in 2021 at a discount to par, thus kicking the ball further.
What this means, especially for the subscribers who know little about corporate finance, is that the bond markets have been working properly so far and there are plenty of investors that are willing to lend money to these companies at attractive rates. From the lenders point of view, there has been no suspicious of default either by AirLease or AerCap. Well, to be perfectly honest, it has. For a short period of time when everyone was freaking out there was an irrational fear that sent bond prices down. But not anymore.
Liquidity
Although I’ve previously been taking the company’s figures at face value, I must confess that I should use a little bit more critical thinking.
At the end of the second quarter, AirLease had $6,9 billion in available liquidity and Aercap had $9.6 Billion.
Between debt maturities, airplane purchase commitments and operating cash expenses, I see AirLease needing $9.7 Billion until the end of 2021. That’s a $2.7 Billion in deficit.
For Aercap, I see it needing $12.4 Billion until the end of 2021. That’s a $2.8 Billion in deficit.
In the case of Aercap, the revenue could fall 40% and it would still be OK at the end of 2021. In the case of AirLease, revenue would have to go up 40%. Aercap is much better prepared.
Now, if we pay close attention to the table above, we can see that Aercap’s contractual obligations are more skewed to debt repayments rather than airplane commitments. In the case of AirLease the opposite is true. This bodes well for Airlease given that while Aercap won’t be able to negotiate with the bondholders, AirLease will certainly be able to negotiate with Boeing and Airbus. On the other hand, given its high level of obligations, AirLease is highly dependent on debt refinancing and negotiating with Boeing and Airbus.
Fleet and exposure to the Max
I’ve seen some investors say that the exposure to the Boeing 737 MAX is also a reason for concern. For those of you who don’t remember, the 737 MAX is Boeing’s new airplane model. The one that crashed twice and led to the huge scandal that Boeing is currently trying to fix.
Aercap currently has 5 MAX airplanes and 80 on order whereas AirLease has 15 MAX airplanes and 121 on order, so AirLease is currently more exposed to the MAX.
I’ve mentioned previously that AirLease’s fleet is younger than Aercap’s, but that doesn’t tell the whole story. By looking at the image below we can see that Aercap’s fleet is barbell shaped. Lots of new airplanes and lots of “old” airplanes. Those older airplanes will be harder to place when they come off-lease. That means higher chances for impairment.
The other not-so-good thing we can see from this chart is the large amount of Boeing 787’s on Aercap’s fleet. The 787 is a wide-body, thus harder to place given that the great majority of the routes today are short to medium and wide-bodies are used for longer routes.
But if we look at the airplanes with lease contracts that will be expiring in the near future, we can see that they represent a much lower percentage of the book-value for Aercap than for AirLease. Fly Leasing, a smaller lessor, is in an even worse situation.
Final Thoughts
Summing it up, it’s obvious that both companies need to keep taping the debt market. Without it, they’re toasted. Yes, they still can raise debt against the airplanes, but that wouldn’t be a good outcome.
This massive slump in demand will eventually give birth to a great opportunity for these lessors after this is all over. You see, in recent years the older airplanes were being kept in-service longer than expected due to historic passenger demand. Right now we’re seeing the older airplanes being retired and airlines will want to lease their airplanes rather than buy them in the future. In the meantime, AirLease and Aercap’s weaker competitors will close doors leaving these companies in a good position going forward.
So circling back to that chart at the beginning of this write-up, why is Mr. Market paying more for AirLease than for Aercap?
I would say that he believes that Aercap is more likely to suffer impairment charges than Airlease. That’s a valid concern given that its fleet is older and it has less exposure to flag-carriers. But how far should this be discounted on the price?
At the current prices, Mr. Market is saying that somewhere in the future Aercap will impair its assets by 18% whereas AirLease will impair its assets by 13%. I’ve said it before and I’ll say it again. This to me seems extremely high and very unlikely to happen.
Below I list the good things and the bad things about Airlease when compared to Aercap right now.
- AirLease has a younger fleet.
- On the other hand, it has a greater relative percentage of airplanes coming off-lease in the near future than Aercap.
- AirLease has higher exposure to flag-carriers and state-backed airlines.
- AirLease has higher order-book which has been good for growth but it’s a hindrance right now.
- Airlease’s contractual obligations should be easier to negotiate than Aercap’s bonds, but Aercap is in a much better liquidity position.
- AirLease has higher MAX exposure than Aercap
- AirLease prefers growth over shareholder value
- AirLease is more expensive than Aercap
Conclusion
All in all, I believe that both companies look very interesting right now. Don’t get me wrong. There are many risks here. But I believe they are somewhat baked in the price. I currently prefer Aercap given its much better liquidity position.
Going forward, we can distill the analysis into 3 important metrics to keep an eye on:
1- Deferred payments trend and consequent defaults
2- Access to the unsecured bond market
3- Impairment charges
Just this week Aercap’s share price rose 10% after news came out of another stimulus package for airlines in the USA. Going forward, investors should be expecting high volatility driven by sentiment, not reason. Remember, volatility isn’t risk.
DISCLAIMER
The material contained on this web-page is intended for informational purposes only and is neither an offer nor a recommendation to buy or sell any security. We disclaim any liability for loss, damage, cost or other expense which you might incur as a result of any information provided on this website. Always consult with a registered investment advisor or licensed stockbroker before investing. Please read All in Stock full Disclaimer.