Michael Inglese - Chief Financial Officer
Aircastle LTD (AYR) 2012 Citi Global Industrials Conference Transcript September 19, 2012 2:00 PM ET
Thanks [Mark] and thanks to Citi for having us here today. We’ll look at our forward-looking statement legend. For those of you who don’t know us, Air Castle is a leading commercial aircraft lessor, depending upon how you count somewhere around number 10 in fleet size value in number of aircraft in the world.
We have a portfolio of modern aircraft with a large diverse customer base and excellent servicing track record and a strong lease revenue stream of area, integrated investment and capital structure approach to approaching the business, currently enjoy very strong liquidity position and have demonstrated access to the capital market and try to maintain discipline as an investor with a focus on creating shareholder value. And given the state of the world and aircraft values and demand for aircraft leasing overtime, we think we are very well positioned to continue to capitalize on our approach.
From an investment thesis standpoint, positive long-term industry fundamentals, air travel has historically grown at a multiple of GDP at around 1.5 to 2 times and the level of employments in the developing world as middle-class grow in places like China and Southeast Asia and Latin America, we expect substantial demand for additional aircraft in the world.
As I mentioned, we have a modern, diverse aircraft portfolio. We’d search on that in a minute. Very effective portfolio management and a very broad-based origination network for those lease placement, as well as acquisition and sales of aircraft, have had exhibited very stable cash flow and a very conservative capital structure in the context of some of the folks we compete with, and have an experienced management team very focused on creating shareholder value.
Quick slide on industry fundamentals. As I said, long-term growth in air transport traffic, the chart here depicts the forecast from the IATA, latest forecast via International Air Transport Association. Developing Markets, China accounted for nearly 30% of the delivery order book from the manufacturers so far in 2012 and a similar number last year.
The global fleet is expected to grow substantially. Both Boeing and Airbus are projecting a level that are around 17,000 commercial aircraft today to grow into the mid to 37,000 level depending upon manufacturer over the next -- over the next 20 years.
Our business as we are single asset class lessor, and so we think about diversification across the number of metrics as we run the business, aircraft type, number of lessees, geography in our case and market which means either cargo aircraft or passenger aircraft. And we try to maintain a lease portfolio that has good lease expiry dispersion. So you’re never repricing any particular -- particularly large size of your portfolio into any given market condition.
About 30% of our portfolio by net book value is in the cargo segment, which is the differentiator for us in the context that most of the people we compete with, only a few other lessors are GE and Guggenheim in particular play any meaningful role also in the leasing space to cargo airlines around the world.
In our portfolio, we have 67 customers on lease. Around -- 36 countries around the world, our portfolio average remaining lease term is just under five years and the weighted average age of our portfolio was around 11 years at the end of the second quarter.
Our customer base is well diversified around the world. The first 12 months of this year and at the end of second quarter, Europe accounted for about 38% of our portfolio, that's down from a number that was close to the 50% a few years ago and its representative, I think, of the industry as a whole. We’re overall seeing diminishing role of aircraft leasing. As the pie grows in Asia, there has been a shift between Europe and Asia for most of the lessors.
Our top 10 customers here listed, few do not have any names. We recognized South African Airways has four A330s on lease for us. Those were new deliveries as part of our Airbus program, the Hainan Group in China. The next set includes Emirates, the most profitable airline in the world. They have a couple of 747 freighters on lease from us.
U.S. Airways, Martinair, Airbridge Cargo and Iberia are three top customers in Europe. And across the 38% of our portfolio, that spread of aircraft around Europe comprises 69 aircraft on lease to 35 lessees. And those three top European customers, Martinair and Airbridge are both cargo customers. The Iberia, the pax customers on A320s and they represent about 60% out of that 38% in Europe.
As I said, keeping your lease placements well dispersed helps give you good visibility on cash flow and make sure that you're not repricing any large part of your portfolio into a tough market conditions over time. Obviously, that ebbs and flows and when things are in a better marketplace as they were in 2007 and 2008, we looked to do lease placements on as longer term as we could and we are averaging about five to six years of the duration for lease placements.
During 2009, when the world was going through the fiscal crisis, in the world, we were looking at much shorter term than a much tougher lease placement environment and our average lease placement term during that year was right around 3.5%, I'm sorry, 3.5 years. So as we look forward, we have a pretty good dispersion of our 156 aircraft across the coming year than in no particularly large percentage of our net book value subject to release over the next four years.
Our portfolio performance and fundamentally we are landlord and it’s our objective to maintain this high utilization as we can with this higher rental yield as we can on aircraft fleet. This chart here going back to the beginning of 2007 shows that quarterly performance maintaining at about 98% to 99% utilization with the portfolio yield, which is lease rental collections over our carrying value of those flight assets are between 13.5% and 14%.
We’ve been busy over the last couple of years growing the business again after the financial crisis in 2009. We fundamentally started investing again in the second half of 2010.
Our current focus over the past year or so, in particularly, in the first half of this year has been on high quality wide-bodies, mid-age narrow-bodies and the freighter aircraft as well. During the first half of 2012, we invested about $0.5 billion and have commitments to invest another $200 million during the second half of the year.
And that spread has been across those assets including A330s, 747 converted freighter on long-term lease to Asiana and a number of 767s that we did in sale-leaseback with the Condor subsidiary of the Thomas Cook Group out of the U.K. We’ve also been focused on selling aircraft in the last few years and currently are focusing on some of the older aircraft in the fleet and managing them to their end of lifecycle. And we’ve disposed over a couple of 737 classics, a 757 and a 767 that suffered an insurance loss earlier -- in the later part of 2011.
We continue to generate strong lease rental yield and EBITDA out of this business over time. You can see the graph on the left showing the average flight equipment held for lease and the lease rental performance and adjusted EBITDA performance of the business as I said during the second half of 2010. We started reinvesting and you could see the upper trajectory of both lease rentals and adjusted EBITDA from those investments.
At the end of the second quarter, we had annualized lease rental run rate at about $646 million, including $294 million from unencumbered aircraft. Our capital structure which is a little bit different than some of our peers and it’s an evolving topic for everybody in the aircraft leasing space given what happened since the financial crisis to the bank financing market.
Earlier this year, we did our third unsecured bond deal and transformed our capital structure by repaying some secured bank debt. We have about 60% total secured debt. The total debt in our capital structure today, we have unencumbered asset pool of about $2 billion worth of aircraft against our roughly $1 billion in a quarter of unsecured notes outstanding.
We have no significant debt maturities until 2017. And we have maintained a debt-to-equity ratio at around two times, which we think is an appropriate level, given that we’re standalone lessor and rely on ourselves to finance the business not a current life insurance or a banking company like some of our competitors enjoy.
Over the last few years, we have always been a dividend paying company. We paid dividends for 25 consecutive quarters since we went public in August of 2006. During 2011, as we continued to grow the business and grow the underlying operating earnings of the business, we increased our dividend to couple times by 50% over the beginning of the year run rate. It’s currently $0.15 a quarter and we will continue to look at the dividend size, and dividend as a return of capital to shareholders in the context of capital deployment there going forward.
We also repurchased almost 10% of the outstanding stock in the company during 2011, which is a $90 million purchase program, at about $11.92 a share. We’ve reauthorized about a $50 million program earlier this year, and we used about $29 million of that in August as part of a trade where Fortress Investment Group sold their remaining stake in the company, partially into the public, big slug, roughly 9% of our outstanding to the Ontario Teachers' Pension Plan and the company purchased 2.5 million shares back from Fortress. So we replaced an exiting private equity shareholder with a good long-term shareholder in the form of OTPP.
So we are very confident in the platform we’ve built to the performance of the business, who have maintained very good investment discipline around what we do with our capital, have a good diverse portfolio and we think we’re very well-positioned to continue to capture opportunities in the business, and grow the fundamental operating earnings and cash flow of the business.
And with that we are happy to open up the floor to questions.
Thanks for taking my question. Just wondering, what impact new narrow-body programs are having on your portfolio value and your lease rates as well as production rate increases, and kind of you see those new developments from Boeing and Airbus in terms of, again the new narrow bodies and production rates increasing, affecting your core business and the ability to get kind of rates that you are looking for?
We’ve certainly seen and see today some pressure on lease rates and on aircraft values. And I think it's a combination of both the production rate from narrow-bodies, from increases from both Boeing and Airbus and it’s also a function of the demand profile and sort of the economic circumstances around the world.
I think in just about every industry and airlines is that we see as our customers, people are much more cautious about what they're doing with their growth plans and capital. And I think, are less willing to commit too far in advance in terms of adding aircraft and replacing aircraft or even extending aircraft in some circumstances. And so it certainly had some effect on the Airbus side in particular.
In the A320 family, we see lease rates today that are down probably, and I'm using like a 10-year old plane as an example on a sort of year-over-year basis. We see those lease rates down somewhere in the 15%, and in some case it’s 20% range from where they were a year ago.
On the Boeing narrow-body product, those lease rates have been consistent and relatively firm year-over-year and a different sort of dynamic in the marketplace for the Boeing products still than we’ve seen for the Airbus product. But new technology coming, new planes coming, that’s a fact that goes on in this business and that’s no surprise to anyone.
Three or four years ago, when we were and others who were investing in narrow-body aircraft, everyone was assuming that Boeing and Airbus were going to introduce brand-new versions of their narrow-body aircraft at the end of this decade. As it turns out, they both decided to do new engine versions of the existing technology and so it’s a much smaller, sort of technological step forward than most people were thinking about.
And thinking about residual value and how lease rates evolve over time and it’s one of the things we and other lessors do as part of our business model. And so what they've done with reengineering was not a surprise and it's not an uncommon no fact of life in aircraft and how those production runs and play out over time.
You are talking about the -- excuse me, the freighter business. Is there a kind of strategic level and you charted 22.7% of net book value? Is that where you wanted to be to outgrow it?
In total, freights about 30%. The pie chart has some A330 freighters that are in that flesh of the pie. I think it’s been as high as about 33% in the mid-20s over the last five years for us. Where we are today is a level that we are generally comfortable with and we try to look at it in the context of, it’s an incremental deployment.
In the past few years, we've sold freighters and we bought freighters and we think of them like any other type of asset as we look at where we are in the asset life cycle, what we think will happen to that particular type of plane or how we are thinking about lessor.
I think we are looking at, if I can get this yield and redeploy in something else is an asset that we will look to sell, until we’ve sold both narrow-bodies 737-400 freighters as well as 747 production freighters in the last few years. And we actually, as I mentioned bought a 747 converted freighter that’s on a long-term lease with Asiana in the middle part of this year. So we're comfortable with it. We think it’s over time a good end market diversification play, and I think we are pretty happy with performance overall.
Since there’s a lot of talk about the funding gap in terms of the bank stepping away from the business and if you, what are your thoughts looking out over the next couple of two or three years where the funding is going to come from?
And that’s a topic that’s been high on everybody’s list since the financial crisis. Clearly the aviation banks, many of them who were European based and who financed the industry in a very large way over time have either dramatically scale back or in many cases disappeared from the landscape.
People, the ECA and export credit regimes in Europe and in the U.S. have stepped up in a big way. Since 2009, they’ve been funding something in the order of about a third of the delivery book and into the marketplace, which is about twice their historic level. People like us have developed incremental access to the U.S. capital markets, other lessors have followed both in the unsecured market as well as in the secured bond market.
Exim and ECA have developed a bond product if you will where their guarantees will go to bond investors, not just to banks who underwrite loan. And I think you'll see more and you’ve seen renewed interest and activity in the EETC market here in the U.S., where U.S. airlines have always enjoyed pretty cost-effective financing for their effort.
So some of the Asian banks in China, Japan, other parts of Asia, Singapore, Australia have stepped in more than they were historically, taking up some of the flack from Europe. But I think there still is a lot of question mark and swirling around as to, as the value of deliveries is increasing because now you are delivering more mid-bodies 787, A330s and they’ve been historically.
So the value of delivery is going from somewhere around $70 billion to call it a, $100 billion. Notionally, there is a lot more capital that’s going to be needed in the states and I would expect the U.S. capital markets to play a big role over time. And I think some form of bank financing and secured loans sort of structure from the existing bank players, and other people who will probably pop up from Asia and that part of the world will help fill the funding gap.
But it’s not -- the gap has never quite materialized even though we've all been talking about it now for, going on three plus years. But that's not to say that it's not something that won't play to us in our strength, in other lessor strengths in the export credit regime, in both in Europe and in the U.S. the -- they were looking to basically drive people back into the commercial market and so what they’ve done with their regime is basically charge a much higher upfront fee for accessing all type of financing. And that new regime under those export credit rules will kick into effect in 2013.
And so as an example, when we borrowed in that market and got an ECA guarantee for our Airbus deliveries as a BB credit, we were paying something like four and five eights upfront to get that guarantee, to get a bank to underwrite that loan. That equivalent amount today under the new regime would be around 11%.
And so amortized over 12-year loan, it’s not the end of the world. It’s another maybe 50, 60 basis points but also what they have been doing is try to manage their own exposure and they’ve been forcing airlines around the world basically telling them you can’t show up with your whole order book.
We’ll finance the portion of it, but we are going to expect you to go to the commercial markets and look to finance the rest of it out there. The export credit regime isn’t build and I don’t think anyone anticipates that as sustainable playing at 35% of the order book over a long period of time.
I am just curious in your thoughts on EADS announcement and what you think it might mean for future industry consolidation. What EADS maybe thinking in terms of to a sign way from several just any broader -- is it indicative of things to come, maybe the dealer don’t go through that….?
To be honest with you, other than Airbus, who is obviously part of EADS and what that might mean for them commercially which I am not -- I certainly haven’t figured out yet. I am not sure that it will have a lot of direct impact on commercial aviation at Airbus and compared to Boeing and what it might mean for people in our space. And how that deal plays out whether it goes through, how it translates into U.S. defense, M&A its kind of -- outside my purview, I did that 20 years ago, but its been a long time for me.
What do you think the sustainable dividend growth rate is for you guys, when you take it up substantially but what sort of a steady stake growth you can think about over the next two to three years given we are today and then maybe balance that with the opportunity for share buyback as well?
I don’t think I am prepared to broadcast this sustainable dividend growth rate today. I think the way we think about and then the way we are thinking about the business is to the extent I believe I can find accretive investments to deploy capital and I can grow my underlying earnings base and operating cash flow in the business.
I would expect it will be able to grow the dividend consistently and sort of commensurately with how we can expect to deploy that capital. But I don't have a big order book. I don't have -- I don't know how much I’m going to buy next year. I’m only going to buy more planes next year, if I think it makes sense and if I can raise capital and maintaining an adequate spread on doing that.
So, that’s how we build our business. That's how we continue to think about operating it going forward. Share buybacks, we did a big chunk last year. We've done some more this year, we may do some more in the future as we look at the trade-offs of buying more planes, thinking about dividend increase and share buyback.
We think there is an appropriate mix that’s going to vary over time, but fundamentally share buybacks I don’t think we view as the ultimate path to creating value over the long-term and getting the market to -- we recognize that -- I think the fundamental underlying value of these businesses.
Quick two part, I guess you just brought up cash deployment priorities not only if how you think about really ordering planes has changed today versus six months ago versus a year ago and did you think year ago that you would order more planes in 2013 then you do now? And then just a quick second part of that is how do you view airline financial health in terms of them being viable partners as to what you do?
Maybe the second part first, I mean you said about airline how -- asking about how do we think about in the context of investing in assets or more broadly…
Being able to place your assets with airlines how interested are they, meaning how do you list the top customers, how healthy do you think your top customers are?
Okay. I mean we make two bets. Every time we buy a plane with a lease, we are betting on an asset and we’re making a credit debt. And so we have a group of people who spend their day, keeping in contact with our existing lessees, looking at new opportunities where we are looking to expand our customer base and understand those people split plans, how they expect to finance themselves and what they are going to do with their capital. It’s a mix bag around the world of, sort of, how people compare today to where they were 12 months ago.
But keeping on top of airline, operating performance has driven us on more than several occasions in our life to actually go to an airline, where we saw trouble brewing in and say, we think you have too much capacity. We think we have -- and we think we have a better place to put that plane.
So we basically go in and negotiate an early termination and have those people give us the modest payment, put our plane back into the shape. It’s supposed to be in on the delivery conditions in our lease and we take it out and we bring it some place else. And we've done that on several occasions where we were a fair bit ahead of the curve of trouble that follows.
Because in our business, when you smell trouble, you way better off taking a few lumps early and getting your asset out and getting it back and deploy it in the market than being the last guy to know and have the last guy show -- be the last guy to show up and have your planes coming out when your competitors have been out in the marketplace looking to replace capacity. So its very important facet of our business and something we stay really focused on.
We don't always get it right, people do fail. We've had in our seven plus year history, I think we had three customers filed for chapter 11 and we’ve taken our lumps. We’ve gotten our planes back and got them back at on leases quickly and is at a higher lease rate as it can.
So, it’s a really important part of what we do. In terms of buying planes and we have historically bought more planes in the secondary market then around new order basis. So, I would say today we still feel like there is a fair bit of the investment target opportunity. But it's -- we’re constantly sort of filling and executing on a pipeline and raising money and kind of going through that cycle and China match up that capital raise and the deployment as quickly as we can, because as I said we don't have an insurance company that we can call up and say hey, I need a 100 million next week to buy a few plane.
And in which segment might you see those opportunities that you are mentioning?
We’re still seeing sort of three fundamental buckets. I think we actually like the 777 from Boeing as well as the passenger and the freight aircraft from an asset perspective. I think its our view and that’s probably shared by many others that it’s one of the few, if not the only plane doing build today that’s likely to be rolling off to production line in 10 year. And so we think it has enjoyed a pretty broad operator base and we’ll continue to do so and broaden that. We think it has pretty strong residual value sort of profile overtime.
The downside, if you will, of wide-bodies, when your lessors, if you are looking to release the wide-body to a different operator in a weak market, you're likely to pick up a bigger share of the reconfiguration cost of that transition then if you are doing so in a strong sort of lease market.
And so naturally the cost of reconfiguring a 777 is much higher than reconfiguring a 737. So, there is no opportunity that has only upside to it. So you’ve got to be conscious to what that means and how that factors into you thinking about return.
We also think there's still opportunities in mid-age narrow-body segment and it’s really the 737-800 is enjoying a much stronger run still than the A320 family, although we have in fact bought A320s in the last 12 months. But it's really a question of what the price you're getting in at and what’s your realistic expectations through how you run that asset to its end of life overtime if that’s the path you choose.
And then we still -- as I said some opportunities in the freight sector and purchased a 747 late in the second quarter of this year. So, we haven't really changed our view on the types of things that we are likely to invest money in those, sort of, three broad buckets.
You talked about what lease rates are doing for A320s and 737, can you talk a little bit about what makes for the disparity in lease rate performance for the last year or few quarters?
I think there is a couple of factors and I'm not entire frankly, I am not entirely clear I’ve quite figured it out or I’ve heard the best explanation from anybody in this business. But I think a couple of things, I think Airbus had ramped up production on this product ahead of Boeing.
I think and I should say this may be, but Airbus having come from behind to get to roughly 50% market share narrow-bodies, I think, has a customer set that maybe was not as strong as Boeing customer set. And there were a number of particular carrier failures late last year and early this year where the fleet population coming back into the market from those I spoke was predominately sort of A320 product.
So, I think those factors and I'm not exactly sure, how to weight them probably explain most of that difference. So, historically there is always been a value and lease rate differential. But that the widening of that in this time period is sort of bigger than people have seen on a historic basis.
Thanks for taking my questions. What opportunity do you see in cargo I know it’s – what kind of differentiation for you guys, what opportunities do you see there just given the environment around cargo being down we think…?
Yeah. Cargo is a tough market today. We’re not making a long-term investment decision based on just what’s happening today. I think we see the 777 freighter as I said as a really strong asset. It has great range and cargo capability. It will -- it’s not quite as big as a 747-400 in terms of capacity, but it’s not far off. It has equivalent range and it has two engines instead of four engines.
And so I think over time, we see the 747-400 will probably come out of the market overtime as the Dash 8 version of the 747 deliveries which is significantly bigger than the Dash 4 version. And we think that a 777 freighter variant will pickup a lot of the slack and emission capability that the Dash 400 version plays today in the marketplace.
Thank you very much. Appreciate your time.