Moody's is understating the fundamental credit risk of AerCap Holdings N.V. (NYSE:AER) with its cross-over Ba1 credit rating. Our fundamental analysis highlights a riskier credit profile for AER since even the combination of their cash flows and cash on hand will not be able to cover their material debt maturities beginning in 2017. Valens therefore rates AER four notches lower at an HY2 credit rating (B2 using Moody's ratings scale). (To register for free access to our corporate credit ratings, please click here.)
In addition, credit markets understating AER's credit risk with a CDS of 198bps and a cash bond YTW of 3.115%, relative to our Intrinsic CDS of 281bps and our Intrinsic YTW of 3.955%.
Cash Flow Profile
We produced a Credit Cash Flow Prime™ chart for AerCap Holdings N.V., as we do for every company we evaluate. The chart provides a far more comprehensive view of credit fundamentals than traditional ratio-based analyses. It shows the cash flow generation and cash obligations related to the credit of the firm, adjusted for non-cash financial statement reporting distortions from GAAP.
The blue line indicates the gross cash earnings (Valens' scrubbed cash flow number) expected to be generated based on consensus analyst estimates and Valens Research's own in-house research team. The blue dots above that line include the cash available at that time while the blue triangles indicate that same amount plus any existing, available lines of credit.
The colored, stacked bars show the cash obligations of the firm in each year forecast. The most difficult obligations to avoid are at the bottom of each stack, such as interest expense. The obligations with more flexibility to defer year to year, such as pension contributions and maintenance capital expenditures, are at the top of the stacked bars. All of the calculations are adjusted for non-cash distortions that are inherent in GAAP accounting, including the highly problematic and often misused statement of cash flows.
If the company generates and has cash levels that are above their obligations, the risk of default is extremely low. Even if the cash generated yearly is close to the levels of the stacked bars, a company generally has the flexibility to defer payments of various kinds. For example, they can allow assets to age a little longer, or they can cut certain maintenance costs such as maintenance capex. While decisions such as those can create other business concerns, the issue in credit risk is simply this: Does the company have enough cash to service their credit obligations?
AER's cash flows would be sufficient to meet yearly operating obligations. However, the firm's cash flows and cash on hand would fall short of all obligations in the face of their consistent material debt maturities beginning in 2017. Additionally, the firm has a poor recovery rate of 34% on unsecured debt, indicating that they may struggle to access credit markets to refinance their debt going forward.
We provide analyses of companies' statements on earnings calls, termed Earnings Call Forensics™. This analysis is meant to help assess a management team's confidence in their conference calls when discussing certain areas of the business such as operations, stability, strategies, their ability to manage business risks, and especially, their liquidity and solvency.
In the case of AER, the analysis of their Q1 2016 earnings call highlights negative markers from management. They may be exaggerating the positive impact of lower oil prices on their business, and may be concerned about expenses related to the integration of AeroTurbine. They also appear concerned about their ability to manage leverage going forward. Finally, they may lack confidence in their ability to further improve their liquidity position.
Ultimately, a company's credit risk (or lack thereof) is driven by cash available against cash obligations. AER's credit risk is understated by both Moody's and credit markets, given the firm's consistent material debt maturities and poor recovery rate, as well as management's concerns about their ability to manage leverage and further improve their liquidity position. A widening of credit market spreads and a downgrade in ratings are therefore expected.
Our Chief Investment Strategist, Joel Litman, chairs the Valens Equities and Credit Research Committees, which are responsible for this article along with the lead analyst, Rafael Formoso. Professor Litman is regarded around the world for his expertise in forensic accounting and "forensic fundamental" analysis, particularly in corporate performance and valuation.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.