BCVVF - AerCap Holdings: Going Private In Slow Motion

2023-11-20 17:41:31 ET

Summary

• AerCap Holdings raised guidance and share repurchase estimates for 2023, appearing confident in its long-term prospects.
• AerCap's core business continues to perform well and its scale and relationships enable it to make unique and compelling investments.
• The company has been actively buying back shares at a discount, with the potential for significant capital returns in the coming years.

AerCap Holdings ( AER ) reported third-quarter earnings a couple weeks ago and again raised guidance and share repurchase estimates for the full year 2023. Shares continue to trade at a modest 7-8 times current year earnings, and although I do not see massive upside from current levels, I continue to be confident in the business's prospects and the ability for the company to reward shareholders over the long term.

Core business continues to perform well

AerCap is uniquely positioned to utilize its platform to make value-added investments throughout the aircraft and engine sector. Its breadth of transactions is significant and it routinely executes over 200 leases, purchases and sales per quarter, an unrivaled level of business activity that provides it with unique insight into the aircraft financing market. Its scale and relationships enable it to complete large scale, creative and compelling investments that are simply not feasible for other leasing companies. Examples in recent months include a 28-aircraft lease with Turkish Airlines, the acquisition of five spare GE90 engines from a subsidiary of Mubadala Investments, the cargo conversion of up to 30 A321-200, and the lease of 15 aircraft to Air Europa.

I have updated my financial model with my latest views on growth, financing and refinancing, and share buybacks and now forecast the following outlook over the next few years. It is generally similar to my prior estimates, with a slightly lower EPS number in 2024-25, slightly higher in 2026, and slightly higher BVPS than before:

I remain bullish on the company's long-term prospects and as a result am slightly upping my price target to $80 from $75. However, with shares trading near $70, this does not represent very much upside, although I don't see tremendous downside, either. I'll continue to maintain AerCap as a Buy, but as it approaches my price objective I'd be more apt to downgrade it to hold. My relatively cautious view on upside also means that I won't be looking to buy shares for my own account in the near term, absent a significant decline in price.

Trading = core earnings

I would stress that the above EPS / BVPS figures may be conservative on the basis that I assume a relative mean reversion of trading profits to a 10% margin on $2.5 billion in annual sales, or $250mm of gross trading gains per annum. That said, AerCap achieved nearly $300mm in disposition profits at margins over double this level. These earnings are often discounted by the market in favor of "core" earnings from the spread-based leasing business. However, I believe this is at least somewhat overblown as asset sales are undoubtedly a fundamental part of managing aircraft portfolios, and smart dispositions can add value to aircraft investments, just like any other financial investment. AerCap management have demonstrated their ability to consistently sell aircraft at a profit, and their recent margins have not only exceeded their own prior performance, but the performance of other lessors as well. AerCap has not only been the most active trader of aircraft in the industry by a sizable margin, but has also arguably executed its trading in the most successful manner and over the longest time period, as the table below illustrates:

Gains on sale through 2023

Source: Company filings, author's own calculations.

While some mean reversion is likely over time, the trading market continues to be robust and for so long as it does, margins above historical levels are likely to be maintained. This will allow the company to continue its strategy of buying shares at a discount using the proceeds of dispositions at a significant premium.

Share buybacks surge while GE exits at last

In my initial article on AerCap, I cited various reasons why I thought there was significant incentive alignment between the restructured, aviation-centric GE and the world's largest lessor of aircraft and engines. I posited that GE could well become a long-term shareholder of AerCap. Between the tremendous sales volume between the two parties, the potential to participate in the upside from selling GECAS to AerCap at a discount to NAV, and an ability to participate in the profitability of the leasing of this equipment over the long-term, I believed GE would decide to hang around for a while. Alas, I was very wrong, and recently, GE sold the last of its original 111 million share stake in AerCap. While you can argue whether or not this was the right decision by GE, this should no doubt come as a relief to AerCap shareholders, as the overhang of massive potential stock sales is no longer. In addition, AerCap took the opportunity to directly acquire nearly 32 million shares back directly from GE, at an average price of approximately $58.85 per share.

This move served multiple purposes. Firstly, it limited the supply that needed to be absorbed by the market, with this significant overhang no longer representing a potential impediment to share price appreciation. Second, it allowed AerCap to acquire even more of itself at a discount, and through mid-November the company has acquired more than 41 million shares back from GE and the markets, a truly stunning figure. That is about 17% of the company's outstanding shares at the beginning of the year, and at an average discount of approximately 20% of NAV/NBV. So in short, AerCap acquired them at a 20-30% discount to its value, which should significantly boost its own value, and is using cash flows from its business to acquire even more of its own business at a discount to its value. Based on my model, I estimate that AerCap will be able to repurchase something like $7-8 billion of its shares between now and the end of 2026. The company's current market cap is just over $14 billion, which should give an idea of how powerful its cash generation potential is. There's also the possibility, in lieu of or in addition to share repurchases, for the company to pay a dividend, particularly as shares equal or exceed book value. Whatever form the distributions take, there is clearly tremendous capacity for capital returns in the coming years.

Arrears / receivables update

AerCap's notes receivable balance increased by $158 million over the second quarter. This amount is almost completely attributable to the restructuring of Azul S.A. ( AZUL ) which is a significant customer of the firm. This will need to be monitored as Azul has the option to redeem these notes with equity in the airline. In addition, the fate of Gol Linhas Aereas ( GOL ) should be watched closely, as its two biggest domestic rivals have now completed restructurings while it has not. Inasmuch as AerCap may have material exposure to Gol, this could serve as another source of restructured or reduced revenue streams in the coming months.

Liability management and funding cost

The company recently initiated an exchange offer for up to $1.5 billion of existing bonds. While a few of the eligible exchangeable bonds have lower interest rates than the proposed New Notes, this will modestly reduce the amount of refinancing needed by the company over the next few quarters. The company also issued $1.75 billion of bonds in September at two tranches priced at 6.15% and 6.10% respectively. This was up slightly from the last issuance in June, but this coincides with a significant rise in interest rates across the board, so should not be viewed overly negatively. Based on my model assumptions, it's possible that cost of debt will rise from my current calculation of approximately 3.8% to closer to 4.5% by the end of 2024 and 5.0% by the end of 2025. This is higher than the company's cost over the past several years, but is still quite modest from historical standards and overall is quite manageable. My estimates on EPS and share buybacks also assume this rise in funding cost as well, which should hopefully be mitigated if the company has properly linked its new leases to interest rates.

Risks to investment thesis

1. Economic recession

2. Sustained higher interest rates

3. Arrears activity

4. Long-term manufacturer production rates

Conclusion

AerCap had a very solid quarter and I ultimately expect it to provide strong guidance for 2024 when it reports it full-year earnings next year. I maintain my Buy rating, with an $80 price target and will potentially look to acquire shares on a pullback.

For further details see: