Sifting Through Beaten Down Travel Stocks With Air Lease

With the global travel industry shutting down over the last several weeks, travel stocks have declined severely in price, significantly under-performing the broader market. While some companies are not going to make it through to the other side without significant balance sheet impairment, others like Air Lease
AL
seem positioned for success when the recovery begins. And the stock offers tremendous value for investors at the current price.

An Attractive Business

Los Angeles, CA-based Air Lease Corporation is the third-largest player in the global aircraft leasing industry, behind GE and AerCap Holdings. None of the other competitors come close in terms of scale to the top three players in a category where scale confers considerable competitive advantages. The Company was founded in 2010 in the wake of Credit Crisis by Steven Udvar-Hazy, the founder of International Lease Finance Corporation and the visionary father of the modern commercial airplane leasing industry. Udvar-Hazy was the CEO of ILFC, formerly a division of AIG, from ILFC’s 1973 founding until 2010 when he departed from AIG. He brought over his entire ILFC team to help him manage Air Lease, after successfully navigating ILFC through 9/11 and the Credit Crisis.

 The aircraft leasing business model involves Air Lease purchasing planes from Airbus, Boeing, and Embraer directly and then leasing them to the global commercial airline industry while using limited leverage (debt/equity of 2.6x). Air Lease receives monthly lease payments from its airline customers, with the primary cost items being depreciation, overhead, and financing costs. Leases are typically done on a triple net basis in that the lessee is responsible for taxes, insurance, and maintenance, regardless of whether or not the plane is flying. Air Lease has 100% of its expected lease revenues for the next two years already contracted. Earnings visibility and business predictability are high, evidenced by the fact that the total backlog of signed leases currently stands at 14x 2019 revenues. Since Air Lease’s inception, the Company has achieved an average rental yield of 11-12% with a surprisingly tight spread, and utilization rates have averaged 99%+. The average age of the fleet has stayed near 3.6 years since inception, and the remaining lease term has averaged 7.2 years, which is a very important aspect of the business in today’s coronavirus crisis environment.  

Not only does Air Lease have the largest order book of any lessor, but Air Lease also is at the front of the queue of the most energy-efficient airplane models. Air Lease holds exclusive seats on aircraft design and planning committees, giving management visibility into future industry trends and providing them with top-level access to new planes, which were very oversold before the coronavirus era began. Airplanes are depreciated over 8 years for tax purposes (and 25 years from an income statement perspective); because of this sizable depreciation shield, Air Lease reports zero taxable income. When Air Lease sells its planes (typically at 7-8 years old), as long as the proceeds are used to purchase new aircraft, the process is treated as a 1031 tax-deferred exchange (much like commercial real estate). Essentially, Air Lease can roll its cost basis into the new assets and defer taxes from gains on sales of fully depreciated assets.

The primary risks include competition, capital markets access, economic, geopolitical, and interest rate risks. However, two new risks have arisen in the last year. First, roughly 5% of the current fleet are Boeing 737-8 MAX aircraft, which are parked in the desert somewhere until Boeing addresses the flaws of this aircraft model. Beyond that, Air Lease has over 100 MAXs on order. The MAX issue is more of a Boeing problem, which will be solved in time with increased training, a comprehensive software fix, gobs of penalties paid by Boeing to their customers, and possibly an airplane rebrand. Plus, the MAXs in Air Lease’s current fleet are not an issue because the lessee continues to pay rent to Air Lease, whether they are used or not. 

Second, the coronavirus scare has caused investors to sell all of their airline and aircraft-related stocks, including Air Lease. While lower levels of airplane utilization will unquestionably impact airlines and air freight companies due to lower demand for air transportation services, this should not have a significant impact on Air Lease. Regardless of near-term demand for commercial aircraft, Air Lease’s customers must continue to pay Air Lease for aircraft usage. Thus, unless the coronavirus illness becomes a widespread pandemic that causes a massive global depression thereby reducing long-term consumer demand for air travel, Air Lease will continue to get paid by its customers in full and on time. 

A Business With Staying Power

The company’s shares are priced as if the company is about to go bankrupt, and that would be a very surprising outcome given the nature of the business and the quality of the balance sheet. Air Lease is currently trading at less than half of tangible book value.

To be sure, some customers will request payment deferral from Air Lease, and some weak carriers will go bankrupt, as they do every year. In addition, placing the aircraft that come out of bankruptcies may take longer than it would in a normal environment. Lastly, the prices achieved from the sale of mid-life aircraft are likely to decline compared to historical rates. For these reason, earnings will likely be depressed this year. However, flights are already starting to come back in Asia, and flights will start to come back again in North America and in Europe, too, later in 2020. Meanwhile, most of the company’s customers are state-owned, which means that they are likey to receive a state-sponsored bailout. In the United States, air carriers are not state-sponsored, but they too will be receiving a state-sponsored bailout.

Air Lease also has an strong balance sheet, with $338 million in cash, $175 million in an untapped short-term revolver (expiring 10/18/20), and $5.78 billion in an untapped long-term revolver (expiring 5/5/23). That compares very favorably to a total debt load of $13.6 billion, of which $1 billion is due this year, $1.95 billion in 2021, and $2.65 billion in 2022.  Beyond that, 2019 capex was supposed to be $4.2 billion, but I would be surprised if Air Lease spent more than $1 billion on new planes this year. While the equity and debt are definitely pressured, liquidity simply is not the problem. 

It seems that investors are throwing the baby out with the bathwater. Currently, Air Lease is trading at 4.2x trailing earnings and 0.4x tangible book value, which is shockingly low given its low teens ROEs and predictable business model. Compare that to another financial stock, Bank of America, which has an ROE of 10.4% and trades at 7.6x earnings and 1.1x tangible book value. Valuing Air Lease at 1.25x tangible book value in a normal operating environment implies nearly 200%+ upside from current levels. Even if you are more conservative and just value Air Lease at book value, the upside is more than 100% from current levels. 

Disclosure: Adam Strauss owns Air Lease (AL) in some of the investment portfolios which he manages. This article is for informational purposes only and is not a recommendation to buy or sell a security. The views are those of Adam Strauss as of the date of publication and are subject to change and to the disclaimer of Pekin Hardy Strauss Wealth Management.



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