Genesis Lease: Picking Among the Rubble

I've focused the last 3 months writing about stocks that have been unfairly taken apart. First, I chose Apple (AAPL) in January. Next I supported DryShips (DRYS) and (Genco) GNK. I championed McDermott Int'l (MDR) when it fell into disfavor. All have had huge runs since.

Looking at another broken stock, Genesis Lease (GLS), I cannot but help but feel there is tremendous value here.

GLS is an Irish company that came public in December 2006 when General Electric (GE) sold some of its planes to them. GE still owns 11% of the company. GLS leases aircraft - passenger and some cargo - to a wide variety of airlines around the world. It has been acquiring more planes. Currently it has 52.

GLS, like many other leasing companies, pays a huge dividend. It has been paying out 47 cents a quarter right along. When it was trading at $22 - $24, GLS had about a 9% yield. Now its stock price has fallen to $12, delivering now a whopping 15% dividend! As do many leasing companies, whether shipping or aircraft, dividends paid by GLS are greater than their net earnings. This is because the depreciation of their aircraft is so high. For GLS, one needs to especially focus on the EBITDA therefore; their EBITDA rose from $38.6 million to $45.47 million qoq.

GLS's stock has dropped precipitously over the last 9 months from $28 to $12.

Why? First, the Street is worried about the credit crisis. Aircraft leasing companies are on the prowl to buy more planes to rent and therefore need ready financing. GLS has $750 million of financing left on its credit facility, which should be more than adequate. It does not have to renegotiate credit terms until late 2010 ( the credit crisis will have likely been resolved by then). GLS has capital.

Second, its competitor Aircastle Ltd. (AYR) cut its dividend. The market feared GLS would follow suit. AYR, however, was forced to lower its dividend because its lenders required them to do so. Again, GLS has its credit facility in place; its lender cannot force them to decrease their dividend for over 2 years; at that time, they can renegotiate financing.

Lastly, Aloha Airlines, one of the airlines that GLS leases planes to, just went bankrupt and stopped flying altogether. That sent GLS down from over $17 to $12 in less than a month. But GLS only leased 2 planes out of its 52 to Aloha Airlines. That represents 2.9% of its revenues, an amount that comes to $1.65 million dollars a quarter. That lost revenue dropped the stock from $17 to 12, translating into a market cap decrease of $180 million! GLS will most likely take the two planes and release them elsewhere. Moreover, they are secured by deposits per GLS 20F.

Releasing the two planes should not be difficult. As GE said in its last conference call, the demand for leased aircraft is robust and GE has trouble keeping up with the supply. The other aircraft lease companies have said the same. GLS should have no trouble finding new customers. The rest of the fleet is leased to a wide variety of carriers all over the world, mainly ROW airlines, so that further risks are mitigated.

GLS has a young fleet currently valued at $1.55 billion. I think it's worth a lot more. First, its undergone "accelerated depreciation"; under Irish law, GLS has been able to depreciate its fleet 12.5% a year. The average lifespan of its planes is greater than 8 years. Useful depreciation should be more like 5 to 6%. Add some of the accelerated depreciation back and you get more like $1.65 to $1.75 billion. Add in the value of its 5-year leases (average duration) of $500 million (EBITDA minus depreciation and taxes) and it all gets more appealing. They've got $1 billion in debt. Take away the debt and you should be able to sell the company for a conservative net gain of $800 million. Current market cap is $512 million. Not a bad prospect for a company with a product in demand that pays 15%.

GLS is therefore a good growth stock (rising EBITDA) and good value play (even if dividends are cut, they will still be substantial and full of undervalued assets).

Who would buy GLS if investors don't? Private equity? The Arab Emirates? Or closer to home, a company that knows them well, services their aircraft, owns 11% of the company, spun them off at a far higher cost, and, to boot, likes the business and wants to own more aircraft? ....why, none other than General Electric.

Disclosure: Author is long GLS.

Comments

[huskerbob]

How do the fleets of ATA, Aloha, etc. figure into the picture? Do they compete for market share as they are auctioned off? As airlines consolidate and raise prices or reduce service on less profitable routes, does that reduce the need for aircraft? Do any of these factors figure into the reduced share price?

[bschweig]

I am curious about the recent decline. Was any of it caused by the liquidation of Bear Stearns' 1.3 million shares of GLS that they held at year end 2007? (Merrill Lynch also held 1.7 M shares at year end.) If I were JP Morgan and purchased Bear Stearns for a greatly reduced asset value, the sale of GLS stock would be a cash windfall.

[ACapitalist]

I think you should check your calc on the depreciation. I have looked closly at AYR and just did a quick check on GLS and it looks like book deprec is running at about 4% year, or a 20 year life for both. This is still conservative as actual deprec is probably closer to 3%, but not in stright line. Your reference to 8 years may be tax deprec. In the US it is 7 years which creats better cash flow and a large deferred tax liab for plane owners.

[stephenrosenman]

1. ATA and Aloha leased aircraft will go back to leasing companies for releasing. ATA had 29 and Aloha 21 aircraft; I believe, most were leased. The market for leased planes is large and should absorb them easily. Also, as airlines become more troubled financially, they prefer to lease rather than own as requires less committed capital. In 1980, 3% of all planes were leased; in 2003, the number grew to over 30%.
2. Bear has some responsibility for the drop probably.
3. For support of 8 year accelerated depreciation of airlines in Ireland, look at GLS CEO report at JP Morgan conference 3/18/08.

[PsychoRob]

A recent (April 17) report on GLS from Wachovia Securities contains the following surprising sentence:

"We are aware that the financial sector is littered with companies that pledge a commitment to its dividend, only to sharply change course shortly thereafter. We believe that is less likely to occur at Genesis given its high-quality income-generating assets."

*Cough!*

I almost spit my coke onto my computer monitor when I read that one!

Wachovia's slashed dividend aside, the report indicates a belief that GLS's dividend is secure.

I'm a sad owner of WB, and I'm thinking of buying some GLS.

[ACapitalist]

Sorry to nit pic as I think your article is very good and I agree with it but you are wrong on the 8 year depreciation. I did read the 20-F to be sure (page 65,F-9, F-11). You are mixing GAAP and tax information. The 8 year deprec is for tax purposes. For financials, they use US GAAP accounting and the planes are depreciated over 20 years, the book basis you refer to is based on the GAAP numbers. I still agree with you that the value of the planes is greater than book but that is because of the devaluation of the dollar and the the good market for used planes, it does not have anything to do with tax deprecation rates. The 8 year tax life is valuable because it makes the T in EBITDA poistive operating cash flow to the company as the tax is all, or mostly, deferred for many years.