Aircastle Limited (NYSE:AYR)
J.P. Morgan Aviation, Transportation & Defense Conference
March 14, 2012 10:25 AM ET
Michael Inglese – Chief Financial Officer
Ron Wainshal – Chief Executive Officer
Mark Streeter – JP Morgan
Okay. I have a green light and I think I have a microphone. Again, Mark Streeter here. Jamie Baker ran out, like I just did, but he will be right back. And we're very pleased to have with us Aircastle. We have Mike Inglese, the CFO, we had Ron Wainshal, the CEO. Ron and I share a love of gluten-free food, just an anecdote I will throw out there. But besides that Aircastle, I think transactions over the last couple of days, between ILFC, which is priced to deal right now in the unsecured market, Air Lease having priced an unsecured deal yesterday, I think the writing is on the wall for aircraft leasing companies, as far as I am concerned. And Aircastle was really one of the first to shift gears and sort of pursue a credit rating, which I think is going to pay benefits down the road. So we'll hear from Ron and Mike, an update on the story and on the capital structure.
Thanks everybody, and thanks for the plug on gluten-free. I think most of you guys know a little bit of our company, I’ll just spend a moment talking about us for those who don’t.
Aircastle was formed 7 years ago, as a green field aircraft leasing company by a private equity firm called Fortress. We were basically a build versus buy decision. And we were custom tailored to kind of start fresh with the capital structure, with the portfolio and with the team. And over this last seven years, we built up to being a fairly substantive company. 144 aircrafts with a big spread of business all over the world, we had a different strategy. We kind of view ourselves fundamentally as investor. We don’t really feel like we need to follow the pack as long as we see good value.
We’re relative value players at the end of the day, and so we’re looking for good relative returns, after considering risk. We do focus having said that, on what’s the current technology. Now, current technology changes all the time, but our focus right now is biased in general, towards the front part of a production run. In general, the theory is that last off the line is usually, least likely to host value. And the converse is true.
We finance ourselves and Mike will spend a lot of time talking about that, that’s one of the things that makes us different is that it is a very conservative capital structure, and we see the market today as being particularly interesting, particularly attractive from investment opportunity perspective, it is particularly those areas that we’ve been focusing on.
And what’s kind of unusual is, that usually when you most want money, it’s hardest to get. And that’s probably true for those who are relying on banks for financing. It’s not true in the bond market. So it’s a good set of circumstances, so if we take the step back and look at the investment thesis. It’s a growth industry, positive long term fund rentals. We’re focused on a modern aircraft type. Our portfolio is extremely diverse, a good spread of risk in terms of geography, in terms of customers, in terms end users being cargo and passenger. We’ve got a terrific servicing record, I’ll take you through, and our cash flows and our capital structure are very solid.
So summary on the market, last year we saw a nice recovery from a very deep down turn that we began exiting from a 2010. Growth in our sector is fundamentally GDP driven and what’s helped is that the emerging economies China, Turkey, Brazil, elsewhere are driving, the world economies. They in turn are driving the aircraft leasing space, accounting for bigger share of the pie, and they are also a part of the economy where the aircraft leasing penetration is higher than in the developed world.
The passenger market was actually stronger than the freight market, in fact in my view, kind of surprisingly strong given, the headwinds, in the global economy. So revenue passenger kilometers which I view as a measure of demand or consumption, up almost 6 percent last year. Freight market down a little bit. Truth is when you have adjust for fares and yields, it’s all that worsen that. In terms of freight market, we think that the bottom might have been reached recently, truly I say that for sure, but that sort of what feels like.
I think we’ve got a little bit more of softness in terms of passenger. The supply of parked aircraft and, as a supply and demand equation as always, is a different story depending, on what you’re looking at. As far as narrow bodies, we’re concerned about the production levels going up. There are some short terms effects by bankruptcies and the like, but I think the production levels are longer term which you have to worry about. Different story with wide bodies, where there have been production issues with the new 787, there’s a ramp up to, there’s delays in introduction of new aircraft types and it’s a different story in that market. And we feel more bullish about those as investors as a consequence.
In terms of aircraft finance, just to put in context, we have seen a recovery in rentals that really began in ’10. And it continued for most of 2011 but I think it kind of stalled out for the most part in middle of the year, maybe in August. Relative to the peak, last peak which I think was in late ’07 or early ’08 and the trough which I think was in probably early ’09, or about half way back, this is gross generalization. And we kind of plateaued as a general matter, since the late summer, early fall last year. Different outlooks, again I think the wide bodies have a better picture, long term and more softness on the narrow bodies, particularly in the Airbus side.
So just a few supporting slides here. You can see the projections here show that for the next years to have a nice and steady growth, that’s kind of tied to one’s view of GDP. The emerging economies are going to play a huge role. China, India, Brazil, Turkey and Russia, 30% of the last year’s new deliveries, that’s going to grow. And just as another fact, to an Intra Asia growth was actually bigger than Intra North America growth in 2009. So it shows that the centre of gravity in the world has changed, and the other thing that has changed is the lessors share the pie. It’s a growing pie, but lessors last year, as you know last year owned 37% of the world’s fleet and that’s a big increase over time. And I can see that growing to as much as half, it’s not going to be a straight line but I think that’s still going to grow particularly to the extent that the capital markets access becomes a little more difficult for airlines around the world.
We talked a little bit of the aircraft programs. I think the biggest deal going on right now is the increase in narrow body production rates. The difficult thing about any kind of production process for aircraft, is it’s a long lead time. It’s an 18 to 24 month process. And so even if somebody wants to increase or decrease today, it would take that long to make that change come into effect. So, whether I like there or not, or anybody likes it or not, the production increases we’re seeing today are going to be here for a while, and they are going to be felt for a while.
It’s also pretty sticky with labor to reduce production. So we are as a consequence seeing a first of all, the drop in global economic growth has led to some sort of slowdown in growth rates for air traffic. It’s still not too bad, but I think the confidence from fleet planners is sort of less than what was a year ago, but production is certainly up. That’s a fact. And when you take those two together, trends go down, it’s as simple as that. And it’s the supply and demand today that affects the rents today. It’s not the NEO or the MAX in 6 years or 7 years. It’s the production supply and demand today.
So I’ve said this before, I will say it again. There is a glut of aircraft in terms of production levels. When we look at the NEO and the MAX, it’s hardly a surprise that there is a new technology coming down the road. Anybody investing aircraft expects that there will be something newer and better that eventually comes around. This is certainly the case and typically, you see an aircraft produced for about 15 years, the Boeing new generation family is going to be probably made 20 years or so. The current engine in A320’s is 22-23 years, that’s a long run, that’s all good. And anybody who is not expecting that, is kind of kidding themselves so, we assume our aircraft, we’ve pulled it less every year, that’s the expected.
We like the narrow bodies as an investment, not the new ones. We don’t see there is good value there, we see better value in the mid-aged aircraft where the prices are very depressed. And yes, they’ll be affected by rents, but our paybacks to a part out value is very short. So we don’t think there is a whole lot of downside to us.
On the wide body side we see, a whole different picture. When Boeing decided to re-engine the 737, they basically pushed back the 777 redo. So, that means you’re going to be seeing production of the current technology 777 for a lot longer than, maybe would have been expected a year ago. That’s a good thing for residual values. That’s a good thing for owners of those aircraft, and we’re more constructive on those as an investment, versus the narrow bodies.
So, where are rentals today? Rentals for narrow bodies recovered a bit as I said, but they are still long away from the peak levels. And I am not sure we’re going to be seeing those peak levels in this clinical cycle. The Boeing 737’s are definitely outperforming the A320’s. There’s always an A320 versus 737 difference, the 737-800 premium historically was in the $50,000 a month kind of a territory. I think it’s down by a $100,000 a month, not just for new but also for old. And that’s reflective of the differential in demand and production levels.
Now having said that, there is I think a separate thing going on as far as shrunken version’s of 319’s, the 737-700’s, those aircrafts were in much better demand when there was a premium short haul market. I think the low cost carrier’s proliferation has changed that permanently. In fact, we have shortened our assumed economic life for A319’s. And those are tough place, we don’t see a recovery for the older technology classics. Those are dead. We are 14 years into the new technology 737, so the fact we’re seeing around here, talking about the classics is still a aircraft that is flown, is worth noting in the context of the NEO and the MAX, for all through the current technology.
For wide bodies it’s been a bit of stronger story. That’s the flying demand pictures, the A330’s are slowly faring better than the 767’s than markets have been on the soft side. The 330’s depending on the engine type are reasonably steady as far as levels go, versus last year. The freight market dropped off a lot it’s a more volatile market, but we see as we said before, some signs of recovery. And we’re still very interested in that section, that’s a long term viable space from our perspective.
In terms of our portfolio roughly speaking, a third of our aircraft are in current generation narrow bodies. A third of them are in freight, and a third of them are in current technology wide bodies. That’s a little bit different in most leasing companies. As I said, we’re focused more on the first half of the production run, I suppose that lasts off the line, and the thing that kind of distinguishes us is our freight market penetration. Freight market is a little more volatile than passenger market, but from a credit perspective on average it’s a much better place.
Freight aircraft are a lot easier to redeploy than passenger aircraft, they last longer, low depreciation. We get very good cash yields. We had a customer setback earlier this year with World, when they declared bankruptcy, World was a lessee for two of our 747’s. We’ve submitted a stipulations accord that we’ll keep one of the aircraft there, at a somewhat reduced strength and the other aircraft we signed a letter of intent on.
So we’ve moved quickly, its evidence even in the tough freight market we can move those aircraft. It terms the rest of our book like most leasing companies, a good share of our aircraft is in Europe, that’s traditionally been the home for aircraft leasing. That share has been reducing and I expect it will reduce overtime, reflective of where the distribution of aircraft is. The 41% we have in Europe is largely pretty strong airlines, but we have 41 customers in Europe. So it’s very spread out. Our biggest customers in Europe is, you might be able to see here are Martinair, which is a cargo arm of KLM, it is 100% owned by KLM. Air Bridge Cargo, which is the largest Russian private cargo airline. They are actually quite profitable, Iberia, a part of the British Airways team and actually quite a strong airline, now withstanding their home country weaknesses. I don’t lose sleep on any of these guys, from a credit perspective.
So with that, I’ll turn it over to Mike, and he’ll talk about the highlights and the capital structure.
Thanks Ron. As we reported a couple of weeks ago, 2011 was an excellent year for us. Lease and rental revenues roughed about 9% year-over-year. Our net income basically doubled year-over-year, adjusted net income was up 55%. Maintained strong fleet utilization of 99%, with about a 14% rental yield and we’re very active both buying and selling aircraft last year. Purchased 21 aircraft for almost a billion dollars and we sold 13 aircraft. Somewhere in the neighborhood of half a billion dollars of proceeds with a $39 million gain on the sale of those aircraft.
In addition last year, we instituted a $90 million stock buyback which is about 9.5% of our outstanding float. At about $11.92 per share and we raised our quarterly dividend twice during the year, to its current level of $0.15 per share.
As I mentioned, consistently strong portfolio, utilization to 98 to 99%, since the beginning of our company basically, this chart only goes back to. Beginning of 2007 had that utilization throughout 2011 and in the fourth quarter and with the world, set back that we saw in the first quarter. As Ron mentioned, we should be at about 98 to 99% in Q1, with a similar rental yield for this quarter.
Our lease portfolio with awaited average remaining term of about 5 years is very well dispersed over time. For the remainder of 2012, we have 12 aircraft which represent about 6% of our total net book value left to place it on new leases, in addition to the two World aircraft which Ron, mentioned. We are basically have backed on LOI’s and we’ll have back in service relatively quickly, and as we look out at 2013, 14 and 15, although there is a fair number of aircraft to place in the context of our overall book, its only like 31% in the overall portfolio of value of the company’s. It’s very well dispersed and it provides excellent revenue and earnings visibility cum business.
Ron talked a fair bit about what we’re looking at in terms of our investment strategy and the current deal pipeline. We’ve remain focused on mid-aged narrow bodies, where we do see excellent return opportunities that where we can use our bond market access to secure capital, to pursue those opportunities having gone through the process of getting a credit rating a few years ago, and having tapped the unsecured market.
In addition to leveraging our operating cash flow, it allowed us to pursue excellent investment opportunities over the last year and a half. And we also have done some work in the wide body space for having purchased our first 777 in the fall of last year, on lease to Cathay Pacific. And that deal responded with a mix of equity and commercial bank debt at very attractive rates. And for good assets for good less lease, you can still find bank debt in this market, in spite of everything you read in the headlines. Our asset returns as you see here, from 2007 through ’11 kind of our growth of our average flight equipment held for lease-rental growth and EBITDA growth associated with that over that time. We ended 2011 with an lease-rental run rate of about $610 million.
Our capital structures continues to be relatively conservative on a net debt to book equity basis subdue times, we have accessed capital in the securitization market, the bank debt market, ECA backed market, the unsecured market and at raised both private and public equity over a lifetime and continue to look for new sources of capital. We’ve talked about many times over the past year and continue to see with strength in the high-yield market that has been evidenced in the last two days by some of our competitors that we would expect to be back in that market at some time in the near future to look to pursue additional acquisition opportunities for the business.
We paid dividends for 23 consecutive quarters since our IPO in August of 2006 and had raised it to 50% in the last year as I mentioned and we completed our $90 million stock buyback. In terms of our capital structure, at the end of 2011 we had just under $3 billion of debt outstanding with a weighted average sort of cash pay interest rate at about 5.8% as we look how these financings are expected to perform over the course of the year and we outlined sort of our view on what the expected balances would be on these facilities by the end the year and having recently put in the new swap on our second securitization we’re going to enjoy roughly 400 basis point reduction in cash pay interest rate on that facility starting in June of this year.
And so, on this basis, we would expect our weighted average cost of debt to go down about 110 basis points absent any new financings, which hopefully won’t be the case as this year plays out, but a very strong set of portfolio, some amortizing debts, some bullet maturities, some ECA debt with very low coupons and we think it is a good mix of secured and unsecured. We would expect the unsecured component to become more prominent over the near term in terms of our capital structure. So, sort of sum it off a very modern aircraft portfolio, has a very diverse customer base across end markets, customers, lessees.
Very strong contracted lease revenue stream, excellent liquidity at year end with nearly 300 million unrestricted cash and access to the market. No actual debt maturities until 2015 in our bank facility and no significant purchase commitments outstanding. We could pursue opportunities as we see them and as they make sense from a return perspective and with that we are happy to open up to questions.
Mike, you mentioned that you expect unsecured funding to grow I mean the number one topic, I think, I am talking about and Jamie is talking about with investors is capital strategy here, do you envision borrowing unsecured in the future other than ECA debt where will you secured debt?
I think we’ll use it where we think it makes sense. In the fourth quarter last year we did a few acquisitions, we bought a new 777. We funded with bank debt from DVB and a local Taiwanese bank – , Nord LB for that deal. We bought a few MD11 freighters in the sell-lease transaction with the EVA and did it with a combination of DVB and a local Taiwanese bank. So, where we think it makes sense for the asset and is right for us, secured financing in a context trying to generate stronger ROEs for the business. We’ll look at that in the context of mid-age narrow bodies where the foreseeable future there is effectively nobody lending money to purchase those assets which is one of the reasons we think they are excellent return opportunities when we look at those assets and we think the combination of operating cash flow and the unsecured market over the near term will be licensed sources of funding to pursue those nice things.
And then in terms of asset strategy and portfolio agent so forth. I know you don’t like having a big order book paying PDPs and so forth and I think people understand that, but I was talking to another lessor who was talking about opportunities just to step into sale leasebacks upon delivery and not pay PDPs and so forth and get young new aircraft that way. Is that something that you are interested in pursuing.
I think it is all kind of a risk and return proposition when you do sale-leaseback proposition you don’t have placement risk. Depending on how far out it is, you might have financing risk. So, the way I look at it is if I buy an aircraft today I will know, what it is. What the aircraft is the price, the lease rate and how I am going to pay for it. If I do a speculative order, I am not going to know most of those things and I would want a return premium versus the here-and-now deal for all those incremental risks. If you strip away some of that risk by placement risk I still want a premium over some today. So, that is my kind of value scheme. Having said that as talked about it there are certain aircraft that I have a different perspective on than perhaps others in the market in terms of the – what is an adequate return and how do you even measure that return for the first place. I think depreciation is being a much bigger factor on new narrow bodies and others do and vice versa in regards to wide bodies. So, we are not averse to future capital commitments as we won’t be compensated for it.
You have Ron a mid-life aircraft focus as you’ve talked about and you’ve also at the same time mentioned weakness in the A320 market. Do you think that investors confuse the two issues, it seems like we talk to a lot of investors who are just concerned about mid-life aircraft market is risky and it is under pressure and so forth yet you are generating strong returns off your current strategy and I am just wondering if you have a view as to, is the market analyzing it correctly.
I don’t think so and I have kind of two minds in it. On the one hand, I am very happy from an buyer perspective because I don’t have any competition right, so that is a good thing. If everybody felt the same way I have a lot of competition.
From the stock market perspective I agree with what you are saying. Now, just a couple of comments on the mid-age narrow bodies. In this market, in most facets it’s all punctured price. So, if I say here is a $30 million 737-800, would I do that? In a heartbeat. I haven’t seen any of those. If you say, here is a 10-year-old 737-800 for $20 million; I see a lot of those. That could make sense to me, depends on her ads and everything else. There is no doubt that the supply issues we have today affect the older market, the older aircraft a little bit more, but I don’t need to worry about that for more than another lease or two.
For the guys with the brand new airplanes rolling off at the end of the production line, you’re going to have to live with that for 20 years if you are lucky. So, it is a near-term versus long-term effect and that gets crystallized eventually in price. My contention won’t be provable for years, but again we are investors and we have to make relative value decisions and we don’t feel constrained to any one type or age or anything and we have the capital structure to plan on.
And I think to further illustrate to that question because the A320s gets a lot of talk these days about how it is getting beat up on value and lease rate and most of that is true, but we recently bought a 12-year-old A320 for $15 million on lease to a strong Asian carrier for another 30 months at a very attractable lease rate and so I’ll have $7.5 million of exposure which is about our guess at part-out value and I think I have an 18-year-old plane and I’ll have I think one or two more leases to go on that asset. So, you price those things inappropriately we think you can still make good returns like claiming an assets that don’t have the greatest headline.
Anyone in the room? We can keep going.
Hi, thanks for taking my question. I was wondering over the past year or so and recently we have seen a major sponsor, obviously Fortress in this instance selling down shares of your stock. We have seen over the past two years and obviously I think that would create a concern among some investors in the investor base in general of why should I be buying Aircastle stock as a savvy player like Fortress is selling it. So, I wondered how do you guys really counter that issue and what do you say to that or how do you characterize their particular decision to sell the quantity of stock that they are dealing.
Sure. I think you need to keep in contacts, Fortress started its business with a private equity investment in late 2004 and in 2005. So, 7 or 8 years ago typical private equity funds have a definitive life and at some point private equity needs to return in capital to their investors, that is their business cycle and that is the sate of their business. We don’t control what they do, they don’t share with us their thoughts about when and at what price and how, but practically speaking that is what they are and over time that is their business model. So, we don’t see it as both frankly in either direction about whether I am staying or going. At some point, they go off and they return capital. I think the corollary, there is certainly overhang that exist on the stock from our view over time they are going to go. There is more float in the stock and we think this stock will find a more natural level in the context of what we think the business is actually worth.
Bear in mind that we are not the only company that was started by private equity firm that has substantial holding in. There is a tricky part for those guys is always how do you exit, alright and so some of our other publicly traded brethren have that issue and some of our other brethren who want to be publicly traded one day will have that issue as well, (inaudible).
That is helpful. Do you guys see a turn or I would say in the cycle of the market that we are in right now? Do you think they are kind of tip toping the market? Is that why, because we had an aircraft appraisal session this morning and we were talking about where we are in the current cycle. Do you guys have any views on where we are in the current cycle in terms of aircraft values, lease breaks and how that would be interpreted in terms of the stock performance?
I think the stock is undervalued. Okay? By a lot. And so that is my first comment. I think I talked a little bit about where I think rentals are and the directions. Aircraft prices are function of the specific investment. I think with higher cost of capital you should see aircraft prices feeling pressure downward. So, last year I have a different view about growth than some of my peers do. I don’t believe in hockey stick growth. It is a cyclical business and rather than fight the cycle we embrace it. So, at sometimes in our business in our cycle where you want to be a buyer and at sometimes we want to be a seller and sometimes we do a little bit of both. I think last year was little bit of both. This year to my view is a buy market and so that what comes with that is some pressure downward on aircraft prices. Now, so I can argue that two ways, one is if I am viewing Aircastle or any aircraft leasing company as what Ascend or some other evaluation company says is the value of all the individual aircraft parts minus the debt structure divided by number of shares that is one thing. I actually happen to think that we are worth little bit more simply because the kinds of investments we are able to source. So, I view this as very much as a growing concern.
We do an annual fleet assessment, every company is required to do that. It is part of our kind of accounting cycle. The way we do it is we started out what is like business plan for each airplane that is commercial analysis that we do and it ties in a lot of different people in our business and so we kind of have like a business plan for each airplane or we going to re-invest in this airplane when the lease is over. Is this one potentially a freighter, is it a part out, is it something else.
And in the context of that, we kind of think about, well what is the outlook for this type and that in turn feeds our accounting impairment analysis, it is a nice flow and I think most people actually do that first part by the way and from there comes the, do you have impairments, should you change the book accounting depreciation, should you change residual value assumptions and so, the outcome of that analysis which we completed in our third quarter is quite elaborately discussed was that A319 was not going to last 25 years.
We have six of them, they are all kind of mid-age aircrafts and we kind of shortened the maintenance interval about 22.5 years instead of 25. The expectations we have on rents are also low. The other thing we did by the same token was we took all of our classics and said you know what, it doesn’t matter when that aircraft is made, the residual value is basically the engines for the most part. And so we capped residual values on our classics and this is a generic assumption we got a work in which separately accounted for things like maintenance reserve balances and recurrent condition adjustments, but we capped our classic procedure values to $3.25 million.
Hey Ron, what is the potential to engage in transactions with other lessors at this point, whether it is aircraft coming out of RBS, Jackson Square? – what are your thoughts?
We have always bought aircrafts from every which way. A lot of business we have done has been with a lot of leasing companies. As sellers and as buyers in fact our portfolio of about of 140 somewhat aircrafts was acquired through more than 80 different deals with I think 70 different counterparts. So, it is really the extreme opposite of some models which is – let's just go buy from OEMs. So, it is part of our business and some leasing companies just have the business model to be only in new aircraft and they need an exit. I think they’re going to have a harder time eventually finding that exit for the mid-age aircraft and that’ll be a good thing for us. The motivations for leasing companies all over the map and some are trying to take a booking, some are trying to get out of an aircraft type, some of them lightening up on credits, there is always a good flow.
One more here, we have one more here. (inaudible) you’re saving the good one after that.
Your comment on the differential between new 800s and new A320s at a 100 grand a month, I think it is over cooked price by about 30 to 40. I’ll talk about it later on, but I think a 100 grand I think you had probably taken extremes of an 800 (inaudible) that probably happens close to 400 grand a month and I think it was an A320 flight that might have been done around 300 or just below, but I think if people take that out of the room that is a 100 grand differential I think that will be dangerous data point to take.
Look, whenever you talk about numbers like this I will say it is a little bit dangerous to throw any single data point as a range and the part that you also factor in is okay, well. One, the credits are probably not the same, and two, the lease terms are not the same.
And so in general we’re seeing and I am curious to see what John will have to say about his experience it sound like we had perfect knowledge in the new aircraft market, but we are seeing that there is in general a shorter term on A320s versus 737-800s. So, when you factor that in that is a factor. When you look at the credit quality of the A320 this is another growth generalization you see more of a mix.
I think I am not doing a paid emotional announcement for Boeing, because I certainly have my differences there too. But, I do think that in general, the tone on the 737 and (inaudible) is better, so it is not just the rental you got to look for term, you got to look at the credit quality, you got to look at all the other factors around the lease terms. So, (inaudible).
Okay. Thank you very much.
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