Aircastle Limited (NYSE:AYR)
Citi 2011 North American Credit Conference Call
November 15, 2011 10:45 AM EST
Michael Inglese – CFO
Unidentified Company Participant
[Starts Abruptly] and specialty finance within Citi’s Credit Trading and Analysis Group. It’s our pleasure to welcome Aircastle to the conference this year. CFO, Michael Inglese, is here to talk about the company and give us an update on the current business conditions, and perhaps an outlook for 2011.
With that, let me turn it over to Mike.
Thank you, Ryan [ph]. Good morning, everyone. For those of you who don’t know Aircastle, we’re one of the leading commercial jet aircraft leasing companies in the world, 138 aircrafts and 61 customers in 34 countries around the world. We have a slightly differentiated business model and growth strategy than some of our peers, and I’ll elaborate on that in the course of the next 15 minutes or so. We have a modern fleet of commercial jet aircraft, both passenger and cargo, financed in a conservative capital structure. And I think we’re well positioned to capitalize on the resumed growth trends in both passenger and cargo markets in the industry over the long-term.
From our perspective, key investment highlights with our business model. Very long-term good growth market expanding at a multiple of global GDP historically and it seems to be headed back on that trend through the recent cycle. And we’ve seen a very dramatic increase in a number of aircraft lease versus owned by airlines around the world over time. Our aircraft portfolio is very moderate. 93% of it is latest generation technology. And we also focus, as I mentioned, on the cargo sector of the air market, as well as the passenger sector.
We have a very strong servicing and origination track record over a 145 leases done in our six years of existence and we’ve acquired our fleet via 79 transactions with 60 different counterparties over time. We focus on finding value in each investment and have done one significant portfolio acquisition in our history. But institutionally [ph] find in our view and in evaluating our own portfolio that the best value is done on sort of a stone-by-stone basis is now [ph] finding value in many different transactions.
Our management team comes from a lot of industry players. The business was started in 2005 as a Greenfield business, and Fortress Investment Group who started the business recruited experienced managers from around the business. As the CFO, I’m the only one in the senior management team who doesn’t come from the aircraft leasing industry. I’ve been here for about 4.5 years and previously spent about 13 years in the satellite services business.
Business model; we have very stable cash flow. Last 12 months EBITDA was up $569 million, ended the third quarter with $266 million of unrestricted cash, operated about 60% net debt to net book value our flight equipments, and have demonstrated access to many different market capitals over our five or six-year history.
A couple of industry slides just to give you some context, 2010 passenger and freight traffic was up dramatically over the dismal 2009, comps that were out there given the financial crisis. Through the first nine months of 2011, we’ve continued to see strong passenger traffic growth and we see freight growth was actually basically flat with the prior year which is pretty impressive given what we’ve seen in the marketplace.
Freight recently has shown some modest downtick on a sequential basis. And I think people are just taking a more conservative view as are we in terms of adding capacity on an un-leased basis and looking for investment opportunities in both of those segments. We expect to see, as I add a statistic show here in the right on the top graph, about 5% plus growth in each of the passenger and freight markets, given the normalized GDP growth forecast around the world.
The global fleet is expected to grow substantially over the next 12 years whether it’s Boeing or Airbus who put out there projections here, Airbus in blue and Boeing in the silver color. We’re going to see a lot more passenger and freight airplanes flying around the world. A lot of that growth will be driven by the emerging economies, but there is also substantial re-fleeting activity that needs to be done, particularly in the North America and some of the European carriers over that timeframe.
As I mentioned, the rest of our markets here has increased steadily from the early 70s when the first business started to where we are in 2011 of somewhere north of 35% of the global fleet is operated by lessors. It provides an attractive value proposition for airlines 100% off-balance sheet financing, although that concept may change as accounting rules change, most importantly transfer of residual risk and management of fleet capacity.
And finally, lessors historically have had much more stable business operations margins compared to the airline. As you can see in the bottom chart here, even through the financial crisis, aircraft lessors continued to remain very substantial high revenue utilization and very strong operating performance through the recent downturn.
Our fleet looking back to the beginning of 2007, we’ve consistently maintained about 98% to 99% revenue utilization which is basically days that aircraft are available for lease and how many days of those they’re actually generating revenue for us. And our rental yield which is our basic lease rentals received over the net book value of our carrying value of our equipment has averaged around 14% over that timeframe. You can see one modest dip in utilization in the first quarter of 2009. Late in 2004, we had our number four customer go bankrupt. And taking back those aircraft and getting them back on lease in about a five months timeframe put a little dent in utilization and revenue yields in that quarter. But we’ve consistently been driving it back up from that point.
Our lease expiry profile is very well diverse across the coming years. We have two aircrafts left in 2011 that we’re actively remarketing for sale or lease in our 2012 placement profile. We had about 24 aircraft that needed to be re-leased. We’ve done about 13 of those aircrafts or about 9% of our net book value which leaves us at about 11 aircrafts to go that represent about 6% of the net book value of flight equipment.
Looking out at ‘13, ‘14, and ‘15, you could see a larger number of expirees, but in fact not a very significant difference in the net book value of flight equipment. So a lot of smaller sort of carrying value assets that will need to be re-leased over time as we march forward here. But it gives us a pretty good visibility on a revenue performance and EBITDA performance given the lease expiry profile.
Our portfolio, as I mentioned 93% by net book value. We do have a few classics less in the fleet, but fundamentally very strong focused in A330s, the narrow bodies both Boeing and Airbus, and also in the freight segment. About 30% of our net book value by portfolio, by net book value is cargo aircraft, so 747 freighters which is the predominant sort of value and counter those as well as some A330 freighters which are on lease to Hong Kong Airlines.
We like freight market. It gives us good head market diversification against passenger. And we’ve seen excellent lessee performance over time from those cargo capacity customers. Typically those leases are longer-term than passenger. And generally speaking, the credit quality of our cargo customers has been stronger than the passenger set as well. Our overall portfolio had about a five-year remaining lease term at the end of the third quarter. Freighter lease term is running at just about seven years. And the overall average – weighted average days of our fleet was about 10.8 years at the end of September.
Our customer base is spread across a variety of carriers around the world as I mentioned. Our top three customers, South African Airways has taken delivery of four new A330 or passenger configuration aircrafts in our fleet this year to become our largest customer. The HNA Group, the Hainan Group out of China, our second largest, they’re a subsidiary of Hong Kong Airlines operates those three A330 freighters I mentioned. Emirates Airways, one of the more profitable airlines in the industry operates two 747 freighter aircrafts from our fleet. And then further down, Martinair, which is a wholly-owned subsidiary of KLM-Air France is also a big freight operator that operates five of our aircraft 4747 as well as 1 MD-11. And then further down, maybe the names you don’t recognize, Air Bridge Cargo in Russia is the largest scheduled freight operator in Russia and enjoys certain advantageous route rights. They also leased two 747s from us. So good diversity across the world.
Our geographic mix is probably close to most lessors, somewhat less than half in Europe, about a quarter in Asia, an uptick for us in Africa as a result of South African Airways coming on line, and then the balance is spread between North America and Latin America.
Over the last four years, we’ve continued to modestly grow the fleet. We stopped investing basically at the end of 2007 when we saw the markets peaking, added capacity early in 2008 from commitments that we made during 2007, and have been focused on running the fleet and generating cash from the fleet over time. Since that period, we began investing again in middle of 2010 and have been investing in assets as well as selling assets to realize value during 2011. So for the last 12 months, September 30 this year had about $4.1 billion of average aircraft assets which generated about $569 million with LTM EBITDA in that period.
Conservative capital structure, we’ve accessed capital in the asset-backed securities market, the bank debt market, ECA supported debt for our Airbus order. We went to the unsecured market last year for the first time as well as the private public equity markets over our history. Had net debt to book equity about 1.66-to-1 at the end of the third quarter. We have been a dividend payer since our inception and IPO in August of 2006 and have paid – and declared dividends for 22 quarters, and recently completed a $90 million stock buyback program in 2011, where we took in about 9.5% of our outstanding shares for about $11.92.
Liquidity and long-term debt outlook, we ended the quarter with $266 million of unrestricted cash, a $196 million of restricted cash. We have no scheduled debt maturities until June of 2015. And recently, in the third quarter, we entered into a new swap for one of our securitizations which will bring us new swap plus spread interest rate down to 1.58% from its current 5.53% effective in June of next year. And we looked at the sort of historic low levels of interest rate and thought it would be prudent to lock-in and forward for that deal which will give us more time to evaluate it as it rolls forward. And as it starts to delever more rapidly next year, it will give us I think more flexibility to look into refinancing as we move forward.
Our current investment focus has been fundamentally in three areas over the last few years and currently continued to look at mid-aged narrow bodies. Our sort of sweet spot has been in sort of the eight to 12-year old aircraft sector. That’s the part of a market where there is not very much of any bank debt available and none of that has come back since the financial crisis, which is one of the reasons we accessed the unsecured market last year. We saw very good investment opportunities and we think the – having a credit rating and the ability to access the unsecured market gives us the ability to source capital and pursue those investments.
Similarly in the freight market, this year we purchased three 747 passenger aircrafts which we’ll be converting into freighters at a very good all-in costs and putting out on lease. The first two will be going on lease to Southern Air, when they’re finishing the conversion process in the first quarter of next year. And again having the ability to access the unsecured market gave us the opportunity to pursue those high-value propositions, because the bank market is not there for freight conversion as well as those mid-aged narrow body.
By contrast, also after the end of the third quarter, we purchased a recent vintage 777-300ER passenger aircraft which is on lease to Cathy Pacific. That’s a market where with the right asset like a recent vintage 777 and the strong credit like Cathy, you can access the bank market even in today’s conditions. And we did so with NordLB out of Germany who provided financing for that aircraft purchased in the business. So that’s where our focus is, playing fundamentally in segments of the market where we have not seen tremendous competition from many of the new entrants who focused a lot of their investment efforts and time in pursuing new order deliveries or sale lease backs of brand new narrow body fundamentally, because that’s where the banking sector moved in terms of providing capacity since the financial crisis.
Quick sort of run through of what we’ve done so far this year; as I mentioned, delivered new A330 to South Africa, also just did a final delivery to the Hainan Group during the first half of the year, purchased a 777 with Cathay recently, have acquired some additional mid-aged narrow body.
And so far, this year, we’ve sold a number of aircrafts capturing value from activities we’ve done in the past. We’ve sold four 737-400 freighters. Those aircrafts when we originally purchased were on passenger leases to an Indian airline. At expiry, we made the decision to pursue a freighter conversion program for those aircrafts and placed them on long-term leased with the Chinese post office affiliate and subsequently sold those aircrafts for roughly $10 million gain early this year.
We sold one of our A330 order positions on lease to Avianca to one of our competitors in the second quarter. And then during the third quarter, we sold a 747 freighter that we bought out of the DAL bankruptcy in December of last year placed on a long-term lease and realized a very nice gain on that asset during this quarter. So we continue to focus on realizing value where we can and where that segment of the market works in the context of our portfolio and adding and recycling capital into new high yielding assets.
So with that, I’ll be happy to open up the floor for questions.
Unidentified Company Participant
[Inaudible – Microphone Inaccessible] impacting your business right now as far as leasing rates and also at looking growth opportunities in the future and how you maybe considering funding those.
Sure. In terms of the portfolio and customer performance, yes obviously we can re-monitor customers on a very rigorous basis. I wouldn’t say today that we have anybody who is on our watch list that wasn’t there 12 months ago, so we haven’t seen any significant change in customer performance or activities manifest itself in our portfolio today.
How we think about the business and where we think we’re taking it, looking at some of the sort of caution in the marketplace and the headlines, I think – as we think about investing, where last year we may have been willing to buy planes that had no customer and take that risk of finding a new customer, we’re probably a little more cautious on that front today, and I don’t think we’d be doing those sort of [inaudible] buys with an expectation of strong placement.
With respect to demand and lease rates, I think what we’re seeing in the market is that lease rates have sort of plateaued. We did see a very nice pickup from the trough in the market for both mid-age and new narrow bodies, as well as the wide bodies in our fleets. But I think we are seeing some caution emerge in the customer set about making commitments too far out of the future and then we are seeing some sort of flattening of lease rates across those sectors of assets at the moment.
And then in terms of how might we fund, I think we’re trying to align how we fund with what we think we’re buying and making sure whatever we’re paying for our financing gives us an adequate spread based on what we’re putting our money into. And so to the extent we continue to see mid-aged narrow bodies as an attractive asset segment. I think we would consider being back to the unsecured market to raise capital to produce those kinds of acquisitions over the near term. I think if we continued and to see good values in wide bodies like a 777 or perhaps a A330, it’s more likely we would look to the secured markets to fund those assets. But our funding mix and our investment sort of philosophy will be tied together and we’ll – in our view try to match that yield spread to the plate where we think we’re going to be raised in capital to investment that money.
Unidentified Company Participant
Okay. Just a question, I guess, with everything going on in the markets and also management is looking to try and basically see round corners. I was wondering maybe if you can talk to us maybe about any potential scenario now sort of things like that’s how you conduct core things perhaps around the areas of like an oil spike or further European downgrades and how that may affect with your counterparties?
I mean we look at it in a couple of different layers. Obviously, we’re all over accounts receivable. At the end of the third quarter, we had accounts past 30 days due of $500,000 on roughly $47 million a month revenue roll. So we are very focused on collections and making sure we keep our assets flying, keep rents coming in and make sure we’re getting adequate maintenance, reserve cover out of customers, and always thinking about people on our watch list around where might we put these assets if things don’t workout here.
From an exposure standpoint, some customers post LCs that we’re always evaluating who are the counterparties on these things, how is that progressing in time, what can we do to make those changes and make sure we don’t get blind sighted by any of that. But fundamentally in our six years of existence, as I mentioned, our largest sort of customer default was our number four customer in the fourth quarter of 2008. It was a Danish airline, Sterling, they had seven aircrafts, 737-700s. We were working with them as they were headed to bankruptcy to try to get flamed out early. As it turned out, we were rather unsuccessful. Denmark is a very clean bankruptcy jurisdictions, so we literally had the planes out within 30 days, had them all back on lease within about a five-month timeframe on average, took a little bit of a hit in sort of rental run rate by re-leasing things into a crappy market in the winter, but the maintenance reserves we collected from them covered most of the costs of getting the planes ready for redeployment. So it’s really staying on top of your customers and the things that can affect them to sort of prevent and protect yourself as best as you can in those instances.
Similarly, this year we had an instance in Egypt which no one saw coming where we had a customer who had four A320s, they were in both the charter flying service business as well as the hotel business, it was a Kuwaiti funded company who had lots of tourism in Egypt which suddenly stopped, the airline was shutdown. We still were able to get our aircraft out of the country in about a 45-day timeframe at a time when people were very uncomfortable with what the law was anymore. And we’ve gotten three of those four back on lease already. We have one aircraft that’s still part of our 2011 list that we’re out marketing. But we’re seeing particular softness in the A320 and A319 markets in the recent months in terms of demand as well as the lease rates.
Unidentified Company Participant
Okay. And, I guess, you were highlighting some of the financings that were done recently. And when you’re just looking at your capital structure right now, I guess is there a particular optical mist of the financing that you would like to have in the future? Or can you give us any sort of direction about where potentially you may see heading in terms of your capital structure and also maybe items on target leverage, or ratings, and things of that nature?
Yes, as we look at ourselves in the context of the business model, we’re executing it we as a standalone lessor sort of midscale, we think conservative leverage is important to withstand the shocks that your customer set is going to go through and it proves to be very resilient model during the financial crisis. So I think we’re most comfortable somewhere within fitting distance of 2-to-1 debt-to-total capital. We have used secured financings historically and have evolved our financing as the markets have evolved. We went to the unsecured markets in the first time last year. I would expect us to go back to that market. But I think over time, we will always maintain some mix of both secured financing as well as unsecured financing, because I think it’s very important to be able to access the markets that are open when they’re open to continue to fund the business model as it flows forward.
Unidentified Company Participant
We will see if the audience has any questions. If we get a microphone around, that would be great.
Two questions if I can. So the first one would be around the sort of changes in dynamics for export-import banks, a lot of the OEs are looking for the leasing community to step-up and fill some gaps there I think. What’s your view on that? And then secondly, have you all considered the Embraer E-jet for your portfolio and what do you think about that aircraft’s viability for lessors?
So first the XM or ECA-backed marketplace, over the last three years they’ve probably financed about a third of the deliveries in the marketplace, which has probably doubled their historical average. And frankly, the manufacturers who both manage their order books kind of brilliantly through that timeframe shouldn’t have to provide much in the way of customer finance.
About this time last year, the XM and ECA regime implemented some cost increases to upfront fees on a sort of sliding scale based on ratings or how they would charge people to access those guarantees in an effort to try to drive stronger credits back into the commercial marketplace. That may have worked reasonably well had we not been watching the grueling [ph] headlines of Greece and Italy over the last six months and what you’ve seen – and I think what we’ve seen in our lot of European banks have pulled back somewhat, some of them have decided to exit the aviation finance business and other related businesses not particularly related to the performance of their aircraft portfolio.
So I think what – I think we’re going to see the ECAs and the XM continue to support a very large volume of the order book over the near future, because both Boeing and Airbus are such huge exporters in both the economic blocks, and I don’t see any other way or any one else is going to step in a big way in the near term to fill those gaps, even with more expensive pricing.
With respect to the e-Jet it’s something we have started to look at. We haven’t made any decisions about making a step into that play. We’ve spent sometime with the folks there and looked at other asset classes. I think the e-Jet has achieved a pretty significant sort of penetration in the marketplace in terms of number of aircrafts and service, number of operators that they’re operating with, and those are two really important parameters for a lessor to be comfortable with when you’re thinking about investing in a particular aircraft out that you really want to have a good feel where the plane is going next and have a broad operator based around moving those assets when that time comes. So we haven’t made that step yet, but I wouldn’t rule it out in the future as we continue to look at different assets in the mix of the portfolio.
Is there a particular region that’s easiest to remarket planes to?
I mean generally speaking, we cover in Europe and it’s a more lot appealing in Asia for moving aircrafts these days. It’s just the economic activity in the particular region, which is one of – the fundamental beauty of this business model is these models are portable and you can take a plane out of Southern Europe and you can paint a new color on it and put some seat covers on and it and take it and least it into Thailand or into the Philippines, or anywhere in the world where demand is for that kind of aircraft.
So there is no red tape in one region versus another that makes it more of a hurdle or –?
Certain countries and certain jurisdictions or places we’re not entirely comfortable of doing business unless it’s kind of really at the end of something blight and it’s a low-value asset. Indonesia as an example, it’s the easiest jurisdiction if things don’t go well with your lessee. And we recently took an aircraft out of there which is the very old 737 classic in sort of the last part of its life. So at some point you’ll take a little more risk around a small value asset. But typical 12-year old 737 narrow body, I don’t think we’ll be comfortable putting higher value assets in the jurisdictions that have – that don’t have the track record of sort of cooperative negotiated in parting other way.
And you mentioned five months a couple of times, I’m sure if there is [inaudible] average, how long it takes to remarket the plan?
Our history through our scheduled expirees has probably been less than a month of downtime. Between lessees over our six years to the unexpected ones typically take a little bit longer. But our sort of two worst cases were the ’08 incident and what we’ve dealt with this year, the aircraft coming out Egypt.
Reportedly about 25% of global aircraft leasing is up for sale right now. That’s the figure that I’ve kind of seen it thrown out there. And with the – I don’t know where it goes. And then with bunch of European banks looking to dispose of assets, how do you kind of see the supply/demand dynamics? I thought you’re slightly [ph] quoting to a lot of demand for these assets, et cetera, but these statistics and the thought process of disposition from banks makes us sound like there could be a lot of supply coming on line.
I mean, I think, I’m not sure about your 25% statistic, but there are a number of portfolios and/or companies who are for sale, who are reportedly for sale, the RBS, the aviation business is in the press, and I can’t speak specifically about what will – how correct any of that is. But there are certainly people who have decided they’re not a natural long-term owner for this asset for whatever reason, and we’ll see who steps in to take that place if anyone. But the sort of sale of portfolios or the sale of businesses in our view doesn’t typically affect the supply demand dynamic of the end customer base.
That will happen more if an airline with a bunch of A319s goes out of business or like Veneros [ph], not Air Mexico the other one. When Mexicana went under – you had a bunch of planes that suddenly came into the market and so you had sort of a short-term disruption of more of certain things seeking a home in the near-term than you typically have in any particular year. And so the industry activity, how that will play out, how people will swap and/or change ownership, I don’t think we’ll have a dramatic effect on the real “who needs a plane for their airline operation in the near-term.”
Without naming names, where do you see the most risk to the airlines regionally, LCCs, freight carriers? I mean is there real viability risk emerging from some of these businesses that you’re all depending?
I think, we see – so maybe the periphery in Europe, in Southern Europe. And parts of Northern Eastern Europe you have sort of charter operators and some other smaller carriers who have had a lot of disruption because of what happened in North Africa and what has been historically a very large sort of vacation destination for lots of Europeans. So we don’t have a lot of exposure in any of those places. We have a couple of aircrafts left un-leased in Italy, we have six aircrafts in Spain which is with Iberia, so we don’t particularly lose any fleet over that.
But I would say some of the periphery of Europe, there is probably pressure on some of the smaller carriers that we continue to watch. This is keeping on top of what’s happening with potential lessees and what it might mean for other aircraft coming into the marketplace.
Maybe if you could highlight some of the trends you’re seeing within cargo versus passenger lines, and basically what are your thoughts on that and how potentially you maybe looking to shift business in the future to meet emerging demand in one of those particular areas.
I think – as I mentioned, I think near-term there is a lot of caution in terms of end user in both segments. And as a result we’ve – we’re not getting out ahead of ourselves in terms of investing in assets that don’t have cargo lessees at the moment. We continue to like the freight sector, we’re comfortable where that is as a percentage of our business today. But we are – as we look at each incremental investment, we keep an eye on overall diversity, but we’ve not had some hard target that says, “I want to be 70/30 or 60.40.” We’ll continue to do it on a what do we think – how do we like this asset, how do we like the going in price and what do we think the prospects are for lease collection and sort of residual value for that asset as it moves to its lifecycle. So you’ve certainly seen a heightened level of caution in both segments today in terms of people thinking too far out in advance and making longer-term commitments about fleets, configuration or capacity.
In the freight segment, during the crisis you saw a lot of older 747-200 aircraft getting parked that probably will never return to service. There is good sort of seems to – there is good balance today in supply and demand with the 747-400 freighter fleet in the world. And it will take quite a bit of time before the new 747-800 variant which is almost 30% larger capacity than the 747 will come into the market and sort of I think create any kind of supply/demand imbalance, it’s not a big ramp-up in production or where delivery schedules that we think will impact that.
And, in fact, the 777 aircraft both as a passenger and as a freighter aircraft, we think we’ll be one of the few things that’s being produced today that’s probably still rolling off the production line in 10 to 12 years. We think Boeing’s decision to go with the MAX Engine on the 737, and get 787 and 747-800 production sort of on track and stabilize, takes some of the focus away from replacing a 777. And in its freighter capacity, the 777 is not quite as big, but almost enough to replace the 747-400 freighter fleet over time in terms of capacity and range, and sort of mission capability.
In terms of contracts coming to leases and things of that nature, how are you evaluating the market conditions now, given the potential for re-leased or looking for a sale and things of that nature, how is the current environment shifting? Any of your thoughts –?
I think it’s – as I said, it feels like lease rates have plateaued for a number of assets, and so we’re very focused on trying to get future placements in a normal cycle sort of locked in, and we’re not trying to get too acute to try to get a maybe a few more points on the outside. If the wind blows our way we’d rather get things put away, know what it’s going to be, and sort of manage the business around that. So that is our focus and continues to be our focus as we’re heading into 2012.
Unidentified Company Participant
Is there any other questions in the audience? Okay, great. Thank you.
Thank you very much.