Checking in on AerCap – March 19, 2019

Checking in on AerCap – Couldn’t look more attractive at this juncture, confluence of two major events creates better backdrop and tremendous buying opportunity in AerCap shares.


“There is no new aircraft purchase that can provide a better return than buying back AerCap’s stock.”  {Source that will go unacknowledged}


I’m overdue in providing an update on AerCap.  This update is going to cover the following:


How the problems with the 737 Max create a number of compelling value creation opportunities for AerCap.
Waha’s activities – both near-term impact of sales activityand opportunity it creates for those interested in increasing exposure to AerCap and AerCap’s stock repurchase program.
An updated analysis of AerCap on both an intrinsic value basis (assuming a liquidation of the assets) or as a going concern.
What are the likely forces that have been constraining the company’s valuation, particularly over the last couple quarters?
737 Max implications for AerCap


As I want to keep this update somewhat succinct, I’m not going to go through a long overview on all the potential reasons for what’s happened with the 737 Max, I’m going to focus on what this means for AerCap, to a lesser extent Air Lease, and potential outcomes.


Big picture, there are two primary components to the groundings of the Boeing 737 Max jets when it comes to AerCap:  1) what this means for the existing planes in AerCap’s portfolio and 2) what this means to AerCap due to the forward order book.  In terms of existing 737 Max’s in AerCap’s portfolio (which are only 5 of AerCap’s ~1,000 planes), this is very simple. The groundings have no impact on AerCap’s cash flows.  There are “hell or high water” provisions in the lease agreements and the lessees must pay AerCap their lease payments regardless of whether the aircrafts are flying or not.  Now from a practical perspective, what this means is that the lessees are paying AerCap and Boeing is paying those companies that have leased the planes their lease payments.  I have had this verified by multiple parties within the industry and I understand the circulation of cash flows is already happening.  In fact, one needs to appreciate that AerCap is obtaining payments that cover depreciation on the planes and the planes aren’t event flying. So,if one thinks about it, the longer this delay goes on the better for the lessors.  It’s like leasing out a new Lamborghini with the car going directly to a garage for a good portion of the time on the lease – that can’t be bad for wear and tear on the car!  On the margin, the grounding is a good thing for the lessors of those planes.


The bigger issue is what does this mean to the forward order book and how does this both impact revenues/cash flows and open up value creation opportunities for AerCap?


In terms of impact to revenues and cash flows, there are two countervailing forces at play.  From a macro level, one has to appreciate that AerCap is one of the biggest owners of commercial aircraft in the world and depending on how you measure it either the number 1 or 2 aircraft lessors in the world.  With the 737 Max grounded and the airline industry going through strong secular growth, available aircraft that can fill the void for the 737 Max’s that are not being flown or delivered are now in significantly higher demand.  While AerCap is always busy buying, selling and leasing out aircraft, it’s probably fair to assume that AerCap’s phones are currently ringing off the hook with airlines looking to source aircraft.


Despite AerCap being leased out on all new aircraft through 2020, AerCap will benefit from:


Heightened demand for leases of their unleased, new (non-737Max) aircraft due for 2021 delivery and later.
Demand for aircraft coming off lease in 2019 and 2020 should be elevated given these issues with the 737 Max which should be positive for lease rates and for sales prices. 76% of the 198 planes that AerCap has coming off lease in 2019 & 2020 are A320 family aircraft or 737 NG aircraft which would be the obvious substitute mid-life aircraft for the 737 Max.
The secondary market value of all of AerCap’s A320 aircraft and 737 NGs are presumably going to be pushing higher (whether they are coming off lease or not). Those type of aircraft represent over 70% of AerCap’s portfolio (676 of AerCap’s 962 owned aircraft).
On the flip-side, neither AerCap nor its lessees of 737 Max aircraft are going to be taking receipt of any new 737 Maxs until that plane is certified to fly again.  That means that the lease revenue stream on those aircraft will be deferred and that will impact AerCap’s revenue and operating cash flow growth in the near term relative to the Company’s internal forecasts.  Now this is where things get interesting.  This being the leasing industry, when lessors are in higher growth mode (buying in more equipment), that’s typically when they are the most free cash flow negative. By not having to close on 737 Max purchases for the time being and being in a position to book some highly attractive mid-life aircraft sales, that frees up a lot of cash.  Frankly, this dynamic couldn’t be coming at a better time given AerCap’s ridiculously inexpensive stock.  AerCap has been hyper focused on how much value can be created for long-term investors in AerCap through share repurchase at bargain-basement prices.


AerCap’s CEO has repeated on every earnings call or investor event that I can recall that they are not interested in growth for growth’s sake. They are interested in maximizing value for shareholders and if buying in their stock (effectively buying their existing aircraft portfolio) provides a meaningfully higher return than purchasing and leasing out new aircraft, that they will favor buybacks.  I believe that AerCap is viewing the current environment as a tremendous opportunity to create value by buying-in undervalued shares with the capital that is being freed up by the deferral of 737 Max purchases and the cash generated by attractive sales of aircraft.


Before going through the math, it’s worth highlighting AerCap’s buyback activity over the last four plus years:


The Company has reduced its net share count by over 1/3 (net of stock-based compensation) and has repurchased on average ~$900mm of stock per year or about 11% of its stock annually (on average).  The average repurchase price has been ~$45.50 over this period (vs. $44.20 current).  What’s especially worth recognizing is at the current price, AerCap is able to buy back stock at a ~29% discount to book value – which is highly accretive to book value per share growth.  Even more importantly, AerCap’s “intrinsic” book value per share is materially higher than its GAAP book value per share.  Buying in stock at these levels is buying in AerCap at a 50% to its intrinsic book value per share (calculation of AerCap’s intrinsic book value to follow later in this update).


So,reverting back to the 737 Max issues, how could it impact AerCap’s ability to maintain high levels of share repurchase activity and maximize value for long-term shareholders?


There are two, broad schools of thought on how long it will take to recertify the 737 Max for flying:


That this is going to be a 3-6 month grounding. That this is primarily an issue of implementing a software upgrade, putting pilots through significant training and providing the NTSB sufficient time to investigate and then recertify the airplanes.
That this will take considerably longer than 3-6 months because there are so many countries that need to sign off and the FAA is not going to sign-off until they are 110% comfortable that the likelihood of another 737 MAX suffering the fate of the Lion Air or EthiopianAir airplanes is diminimus.
The longer AerCap expects it to take to have the 737 Max flying again, the more likely AerCap will re-accelerate share repurchases.  Best case theoretical scenario, which is highly unlikely in this authors opinion, is Boeing is forced to scrap the 737 Max, refund AerCap its deposits and AerCap uses all the cash to buy back stock. This just isn’t going to happen, but I am trying to drive home the point.


How this whole set up differs for AerCap vs. Air Lease is the following:


Most investors attracted to Air Lease over AerCap have been attracted to Air Lease because of its forecast growth profile.With the 737 Max representing 41% of Air Lease’s order book (vs. 26% for AerCap) and 26% of Air Lease’s pro forma (existing fleet plus planes on order) fleet vs. 7.5% of AerCap’s pro forma fleet, the 737 Max is a much more integral component of Air Lease’s growth profile.
Air Lease has shown no real, historical inclination to repurchase stock and focused its capital allocation on growth of its fleet and to a modest extent dividend payouts.
Given that Air Lease has committed to a more exacting credit profile (no higher than 2.7:1 debt to equity) and Air Lease has a less sizable, younger fleet of aircraft from which to harvest sales, it is not clear how much share repurchase capacity Air Lease could practically implement?
Air Lease’s near-term EPS forecasts are going to need to come down for the period over which Air Lease is going to be unable to take delivery of 737 Max planes. If AerCap repurchases sufficient stock, that won’t be the case for AER.
Upshot is this, to the extent that AerCap comes to the conclusion that the 737 Max’s re-certification is going to take a while, they will undoubtedly deploy excess capital to more aggressive buyback activity than previously anticipated.   And for anyone with a long-term view on the opportunity in AerCap shares, there’s no better way for AerCap to drive more shareholder value.


Waha Capital’s Disposition of its AerCap Shares


Waha is a Dubai based private equity firm that has been the biggest owner of AerCap since late 2010.  Waha purchased its original 29.8mm shares of stock for consideration valued at $380mm ($12.73 per share) which represented 26.3% of AerCap’s shares outstanding at the time.  While Waha remains AerCap’s largest current holder with 15.6mm shares as of its most recent filing, Waha appears to be selling down its remaining ownership over defined periods that sync up with the funded collar transactions it entered into years ago with four investment banks (Citibank, Deutche, Nomura and UBS).  Being aware of those periods can be advantageous for those looking to accumulate shares in AerCap.  It is also helpful to know about these periods if one is wondering why volume has picked up so appreciably in AerCap stock or if you’re wondering about curious trading during those periods. Yesterday, happens to have been the last day of the most recent period.


The next five periods where Waha has funded collar expirations:


5/15/19 – 6/12/19 – 150k shares per day or 3mm shares in total
8/19/19 – 9/16/19 – 150k shares per day or 3mm shares in total
11/18/19 – 12/6/19 – 150k shares per day or 3mm shares in total
2/18/20 – 3/16/20 – 150k shares per day or 3mm shares in total
5/18/20 – 6/15/20 – 96.2k shares per day or 1.9mm shares in total
As Waha has sold a number of shares that almost precisely lined-up with the amount covered during each collar period (even if neither the puts or calls were triggered), I think it’s safe to assume Waha is on a defined path to sell the rest of its holdings.  Given its low basis in AerCap shares, it’s hard to begrudge the sales.  That said, one can be particularly opportunistic if one recognizes that these sales come during a period when another exogenous event is impacting market liquidity.  The most recent collar expiry period had the Boeing 737 max news hit right in the middle of it.  The prior period happened during the December market swoon.  Given that this most recent period ended on March 18, I will be little surprised if we witness strength in AerCap’s stock in the coming days/weeks.


Calculating AerCap’s Intrinsic Value


While it is very easy to calculate AerCap’s fully diluted book value per share ($61.88 as of YE 2018), I submit that that is a poor indicator of AerCap’s “intrinsic” book value (or liquidation value) per share.  Simply put, AerCap owns a fleet of aircraft that are overly, conservatively depreciated and worth more than the stated value on their books.  This has been proved time and again over recent years with sales of mid-life aircraft at 108%+ of book value and based on periodic appraisals of AerCap’s fleet that suggest a similarly higher market value for the planes than stated book value.


Additionally, by the nature of the way AerCap operates its business and negotiates new aircraft purchases with Boeing, Airbus and Embraer, all of the new aircraft that AerCap has on order are being purchased at a discount to their fair market value.  So,there are really three elements to AerCap’s appreciably higher intrinsic value relative to its book value:


A current fleet that’s too conservatively valued on AerCap’s balance sheet.
A forward order book that is worth a lot more than AerCap is paying for it.
Analmost 3:1 debt to equity on AerCap’s books, basically all that unrecognized value should be falling to the book value per share.
I submit that this is how to calculate AerCap’s real “intrinsic” book value per share.


Taking a middle of the road estimate, that AerCap’s existing fleet is worth 8% more than its current book value (in-line with 2018 sales activity and in line with the last fleet appraisals that I’m aware of) and then also assuming that the forward order book for everything but the 737 Max should also trade at a 8% premium to the prices AerCap negotiated, then the NPV of AerCap’s current and forward order book comes to ~$88 per share or double the current stock price.  This is basically the liquidation value of the business.  That value is providing no operating or going concern premium to the company and the company is a company that is a) the best lessor in the industry and b) consistently putting up ROEs in the low double digits.


Point is this, I submit that AerCap’s intrinsic value is at least $88 per share which is considerably more than its current book value of ~$63. With that kind of intrinsic book value per share and the ability to buy back stock at half the price, the Company should be, and I believe is, warmly embracing this 737 Max grounding.  It not only frees up capital for more share repurchase activity at this abjectly low stock price, it pushes up the value of AerCap’s existing portfolio – which allows for sales of mid-life aircraft at higher prices to re-invest in share repurchase.  It’s a great value creation cycle!


As a going concern, I don’t see why AerCap shouldn’t trade at 15x earnings.    The stock traded at that level or higher pre-the 2008-2009 financial crisis and AerCap is a much better company today.  15x is also the level at which railcar lessors (GATX) trade at and in many ways railcar and commercial aircraft are similar industries (long lived assets, long lease terms, high utilization rates of their assets).  At 15x forward earnings, AerCap is worth over $105 per share.


So,when one compares share repurchase at current prices vs. purchasing new aircraft at a discount, consider the following math.  Keeping it very simple, assume that AerCap can purchase new aircraft now at a discount such that an 8% pretax return can be achieved the day the plane is due for delivery.  Tax effect that return at 13% and that pulls it down to a 6.96% after tax gain.  Given that AerCap is effectively leveraged 2.8:1 that makes the after-tax return on equity ~26%.  Investing in your fleet (i.e. buying back stock) when its intrinsic and going concern value is 100%+ greater than the current market price suggest that there isn’t much of a choice between the two.  At these prices, AerCap should be buying back as much stock as it possibly can.


Likely Forces Currently Constraining AerCap’s Valuation


Concern over late cycle– investors concerned about the near-term likelihood of global recession are going to give the aircraft lessors a wide berth.  While secondary markets for aircraft are currently robust, if we go into an abrupt global slowdown, concern will be how quickly aircraft values will decline and because AerCap is leveraged, how that will impact the equity. I’d highlight that value of AerCap’s fleet of aircraft would have to decline almost 15% from current prices to justify the current stock price let alone justify something lower.  Further, as can be witnessed in most presentations from either AerCap or Air Lease, the growth over the last 40+ years in passenger miles flown has continued, virtually, unabated and is expected to continue to grow in the mid-single digits for the foreseeable future.  The secular growth in air travel as well as in commercial airlines leasing vs. buying planes continues unabated.


Waha putting periodic pressure on shares–  Waha is approximately half way through exiting its position and AerCap’s stock seems to be being sold during defined periods.  Waha’s sales should be anticipated and given that it is up ~3x on its investments in less than a decade (and Waha Capital being a PE firm), the sell down of shares should not be interpreted as anything more than Waha exiting a great investment.


Aircraft Leasing sector being a niche sector– this is not something that is likely to change absent GECAS coming public (which would make a lot of sense butis nothing I’ve heard any rumors about).  And even then, we’d have to wait and see.  There are only four public aircraft lessors in the Western Hemisphere (AerCap, Air Lease, Aircastle and Fly Leasing).  And only AerCap and Air Lease are true comparables as the other two only traffic in used aircraft (they don’t buy new from the OEMs).


Concern over how the Boeing 737 Max problems could impact the sector– as emphasized in this update, the Boeing 737 Max grounding could be one of the greatest value creation opportunities that AerCap has experienced in years.  That said, as discussed,the impact to Air Lease appears more complicated and there are undoubtedly monies that trade the sector that trade both stocks within a relative valuation band.  That could be impacting the trading in AerCap’s stock.


Constant concerns over competition– this issue is unlikely to go away until we go through the next real downturn.  There are constant rumblings about how a lot of money coming out of the East is chasing sales leaseback deals at very unattractive (to the lessor) rates.  As of the last update, AerCap hasn’t done a sale leaseback deal in years. AerCap is fully leased on all deliveries through 2020 and has a very high % of its 2021 planes contracted as well.  Most importantly, AerCap has been able to maintain its net spread (inclusive of depreciation) very consistentlyfor years now.  The Company is incredibly well run and benefitting from having made aircraft purchase commitments years ago for the bulk of its current forward order book.  Further, with AerCap’s leading scale and platform, it has unmatched market knowledge of what’s needed and desired in the market place.  It’s willingness to not chase leasing deals on uneconomic terms has been a real asset for shareholders.




AerCap is trading at 70% of estimated Q1 2019 book value and approximately 50% of estimated intrinsic value.  AerCap also trades at 6x 2020 IBES consensus EPS.  While Boeing is facing real near-term disruptions in its business with over 25% of its forward order book 737 Max planes, AerCap doesn’t even need a forward order book to still have tremendous intrinsic value in its existing fleet of ~1,000 commercial aircraft.  And on a pro forma basis for the filling of all aircraft orders and taking account of AerCap’s current fleet, the Boeing 737 Max would still represent <8% total fleet (currently the 737 Max represents about 0.5% of its fleet).


Given its abject low valuation and how the 737 Max’s grounding should both highlight the value of AerCap’s existing fleet as well as create an opportunity to re-accelerateshare repurchase, AerCap is a tremendous buying opportunity at these levels.  AerCap represents a superior investment opportunity for the investor with a multi-year outlook.


Kudos to all the others on SZ (like Jim Kopans, Tom Kerr, Hugo Roque and Sarah Johnson) that have also been highlighting the opportunity to SZ members.