What a year it has been, and just as we are deluged with negative headlines, we also see these “distressed funds” popping up and raising money for dislocations in the bond and stock markets. 

 

I’m here to say that I have found one right in the sweet spot – a great company in a dislocated sector that has virtually only benefited from the downturn in business. That company is Aercap Holdings, a very simple business without many bells and whistles.

 

Below, I will discuss what Aercap is, its history, the numbers, and what the future of the business might be. Being a relatively young investor, I would hate to think I’m being naive in these discussions, but it is certainly possible. If you think I have made an error, please let me know in reply. 

 

We will be discussing mostly the equity, but the debt is also attractive in my purview, yielding nearly 8% per year in short term issues.

 

Aercap (AER) is an aircraft lessor and airline owner with minimal, decentralized management. It trades with good liquidity on the NYSE, though the headquarters are in Dublin Ireland. Office locations include LA, Amsterdam, Great Britain, Fort Lauderdale, Singapore, Shanghai, Abu Dhabi, France, and Seattle. 

 

AER was formed in 1975 and attempted an IPO in 1992. It failed, and AER had to restructure through aircraft sales and consolidation all the way up to its large-scale acquisition. In 2004, AER came back into the spotlight, when private equity behemoth Cerberus took an active position in what was then a private company. At the time, AER was taxed in the Netherlands as a global aviation finance company. One of the first moves was to move the tax domicile to Ireland, and grow market share until an IPO in 2006. This IPO was successful, but Cerberus didn’t cash out until many years later, in 2013. 

 

AER owns about 1400 aircraft worth about $48 Billion as of the end of Q1 2020, has over 200 commercial customers in over 80 countries, which all translates to about a 15% market share, over 3 times larger than its closest competitor. Because of this moat, AER still holds an investment grade rating today during this pandemic. 

 

Air traffic is booming, and has doubled every 15 years since AER was originally formed in 1975, according to the Society of Actuaries in Ireland. The projections from 2018 are to double in only 10 years, as flights become more accessible both from a socioeconomic and geographic standpoint. The industry is solid, and will not likely be upended until the jetpack becomes economically viable, which might never be the case. 

 

Because of the leader status and the strong industry forecasts, AER can maintain an aggressive capital structure of piles of debt. Every aircraft carries a loan against it about 75% loan to value, similar to a home mortgage. Through Cerberus, AER established and still maintains excellent banking relationships to structure those debts, which are mostly intermediate terms (<10 years). 

 

The CEO Gus Kelly began as an accountant with KPMG and has been with AER since he departed KPMG in the mid 90s. Gus was integral in the operations before Cerberus, and has been a driving force for Aercap’s ‘leader’ status in the aviation lessor/financier industry. Gus owns nearly 3% of AER as of end Q1. These are all ideal qualities that I look for in corporate governance – the guy eats, sleeps and breathes AER. There is 0 reason for any activist to enter and change things at AER – operational efficiency seems to be 110%.

 

There are now 4 investment firms with over 5% stakes, and they have all added to their positions over the last quarter. 

 

The business model was and is very efficient, only requiring 390 employees to generate an after tax margin of 23% in 2019 fiscal year ($1.2 Billion). The outlook for net income and revenue in the long term is likely to expand, though the high multiple of 23% will probably contract in years to come, though this might be offset with lower interest rates and higher margins on cheaper aircraft. Every dollar of investment in AER at current prices has a normalized yield of 28%. This compares to a yield of about 3% on equity for the S&P 500. Let that sink in.

 

The total value of the aircraft owned by AER is about $48 Billion, of which there are debts outstanding of about $38 BIllion, meaning that AER has equity in the aircraft of about $10 Billion. Keep in mind that the market cap today is about $4.3 Billion. The company easily has $1 worth of assets, but sells at only $0.50. The average for the S&P 500 is about 3.3. at this time. AER’s price to book is 0.5. Let that sink in, too. 

 

 

The largest expense in the business model is thus buying new aircraft from the likes of Boeing, Embraer, Airbus. Most scheduled purchases this year have been arranged for deferral. This means AER has reduced costs to relatively nothing and free cash flow grew to about $570 Million during Q1 alone. Of course, this is due to a black swan event, but it encourages me to think that the company becomes stronger during such a period. The likelihood of airlines owning aircraft instead of leasing them from here is even more remote, emboldening the business model further.

 

Bailouts are widely reported, though controversial, for the airline industry. When an airline is bailed out, AER rejoices. Why? Because very often, AER is the largest debt collector for airlines, meaning that they get the first money in the door. AER is being bailed out even more than the airlines themselves. Again, how encouraging it is to benefit from a downturn….

 

Furthermore, one of its customers, Norwegian Airlines, chose to pay in kind for its leases from AER. As of March 20 this year, AER owns about 16% of Norwegian. This allows AER vertical integration, better opportunities for negotiation with other airlines, and increases the competitive edge in the aviation industry. Hard to know the total scope of the ownership at this time.

 

The largest risks include negotiations on current leases, lower margins on future leases, and a large-scale drop in air traffic. These are all highly possible events, though it would seem to me that if these things happen, the entire world economy would continue to be depressed. If this is the case, AER still is in a strong liquidity position and may outperform.

 

In conclusion, the aviation industry has been decimated temporarily during this pandemic, which has left companies like AER dislocated. AER is an industry leader in a growing industry. The operations team is well seasoned and executing flawlessly pre and post COVID, and shareholders are applauding. The capital structure is well maintained and improving. If all that wasn’t enough, the book value and earnings yield aren’t even in the same ballpark as the top companies in the world.

 

With all the emphasis on WFH and tech, companies like AER are just overlooked, and I wonder why. But then I realize it can’t stay depressed forever, especially as an industry leader.