Aircastle In Fine Shape; Fears Appear Unfounded

A couple of days ago Aircastle Ltd. (AYR) gave a presentation at the Credit Suisse Capital Goods Finance Symposium and it has posted the slide show to its website. The link above is a PDF presentation of the slide show.

Going through the slides, it is apparent that Aircastle is in fine shape with its leased aircraft. From what information I could find about the recent share price drop, there are two fears driving investors away from AYR. First, the general profitability problems for airlines with the recent fuel price increases and indication by many airlines to reduce flights. Second, a specific claim by one of Aircastle’s customers, US Airways (LCC), to turn in some leased aircraft. From the presentation it appears that the company will not have a problem keeping its aircraft leased and the US Airways jets are on uncancelable leases.

The financials for Aircastle appear strong. Its debt load is less than 75% of the book value of its jets and the book value understates the market value. It is able to get its aircraft that are coming off lease released at higher rates and already has over half of the jets coming off in 2009 committed with letters of intent. Finally, Aircastle is projected to earn over $4.00 in free cash flow per share (earnings + depreciation) in 2008, easily covering the $1.00 dividend. It looks like the company is conserving its cash, but I hope it starts increasing the dividend soon.

I believe Aircastle has been hammered, along with almost every stock I can think of that is in a financial business. At this time the market is not discriminating between companies in good shape and those that have problems. It is having a sell-off of all of them. I cannot predict when the carnage will end, but I recently added to my position in AYR.

Note: I have a long position in AYR.

Comments

[Alan Brochstein]

I have been leery of this one and its peers for a while, though I have no position. While I think that there could be a baby in the bath water syndrome here, more likely investors are looking out at a future with higher supply of planes, especially the older ones that I believe AYR tends to own. Higher supply --> lower profitability. There have been several IPOs besides just AYR in the sector over the past few years. I know these analogies may sound whacky, but the travel nurse industry and the Medicaid insurance provider industries saw very poor performance (fundamentally, not just the stocks) after a flood of IPOs in the sector.

[Enes K.]

I would disagree with few of those arguments. Before Aircastle and its likes made their IPOs, they were already in the market. They were leasing airplanes. They did not, all of a sudden, increase the number of airplanes available. All of these entities were already operating as part of a group or conglomerate.

The only people who would be able to increase the supply are those at Boeing and Airbus, and they are not able to do so.

Aircastle's age is also an issue that is relatively minor. I believe their average age is about 7 or 8 years. That number for United is about 12 with all of the cuts that have taken place. The average age of the world supply is between 15-20 years depending on the region and type of airplane. Age talk also needs to include engines and wing adjustments, which Aircastle, unlike United Airlines and others, have not invested in.

Anybody can write an insurance policy, but not everyone can build an airplane (licensed and able to operate in the modern world). Airplane supply is growing along with the population rate, but it is not keeping up with the world GDP growth rate. So, the more people are able to afford airplane tickets, the faster the demand grows. I believe the long term growth is about 6-7%.

[User 214159]

Tim.. have a look at AER. the key is that this is a very misunderstood industry due to the fact that most of the publicly traded stocks went public about 2 years ago. The reason I would prefer the AER over others is that they are not paying a dividend and will therefore have more excess cash flow to buy more NEW fuel efficient planes. Stock is at 4.5x this years eps. And as you stated, airlines can only get out of their leases if they go belly up, otherwise they must honor the contract. (ps) AER is at the Wachovia Nantucket conference this week.

[Tim Plaehn]

Thanks, I will take a look at AER.

[bsharvy]

I own AER. The fundamentals are similar. One big difference is that AER is a Dutch company. It might have more revenue in Euros than AYR, so there might be some currency speculation in picking one as an investment. Agreed that both are getting sold in sympathy with airlines, when their business model is quite different, and this is probably a buying opportunity.

[Tokyo Picker]

In fact 86% of AYR's planes are new generation. If you bother to check the facts (easily available in the presentation to Credit Suisse mentioned in the article) your comments may become more illuminating.

I think you're misunderstanding the way this business works. As the fuel price goes up, the sufferers are not these guys, but the airlines who own older, less fuel efficient airplanes. Those older airplanes tend more to be owned by airlines. The newer airplanes are owned more by these lessors. When the pressure gets too much, the airlines go under. The shareholders/lenders of the airline are stuck with the old airplanes (as well as the legacy pension costs, etc). The lessors can easily get back their planes, even in the US (thanks to section 1110 of the bankruptcy code), and lease them to the younger, stronger airlines, thus creating a virtuous cycle.

Obviously there is a frictional cost to this repossession and releasing, which can be quite substantial - the planes may be idle for a few months, although that is not happening yet. That's why, if you look at the history of operating leasing in the last 20 years, operating lessors with short-term lease-specific debt and hair trigger covenants (e.g. GPA) go under, whereas operating lessors with higher credit and more stable sources of funding (e.eg. GECAS and ILFC) survive. Obviously the backing that GECAS and ILFC have is not as valuable anymore. But the trick in picking winners here remains looking closely at the terms of their debt . If they are stable on that, they will make a lot of money. Provided that they do not try to buy cheap by buying older generation aircraft - that is a quick and easy form of suicide these days.

[Tokyo Picker]

Should have said - last post was response to Alan - sorry

[Tokyo Picker]

All airplane operating leases are always denominated in dollars (with the exception of some esoteric tax products not relevant here). It doesn't really matter where the company is domiciled - Aircastle is in fact a Bermuda corporation.

One issue to be aware of is that most of these companes are PFICs, certainly AYR and AER. I believe GLS and FLY also.