ASLE - AerSale Corporation: A Major Disruptor In The Commercial Aircraft Space

2023-04-11 04:48:35 ET

Summary

• AerSale intends to augment its 757 P2F conversion program with an additional 12 conversions expected by 2024.
• ASLE reported that it had begun its FAA certification flight testing in February 2023 for AerAware. This move, if successful, will see AerAware enter commercialization by 2025.
• ASLE’s FY 2022 revenue of $408.5 million fell short of its intended guidance range of $420 million to $450 million.

AerSale Corporation ( ASLE ) has gained 10.98% since my last article outpacing the S&P 500 which is up 3.24% in the same period. The company's Q4 2022 revenue of $95.13 million missed estimates by $27.66 million and was down 18.54% (Y/Y). ASLE's EPS of $0.23 beat estimates by $0.03 pulling an upside surprise in a year, the company described as "excellent" in its report. Total annual sales hit a record $408.5 million up 20% (YoY) boosted by market success and the 757 passenger freighter [P2F] conversion program.

Thesis

After strategically executing its 757 [P2F] conversion in 2022, AerSale hopes to grow the program into 2023 in support of the recovery of the aerospace industry. By H2 2024, AerSale is scheduled to receive more feedstock as well as commercialize AerAware to increase revenue sources. Additionally, despite the 2.77% (QoQ) drop in cash to $147.2 million, AerSale still has stable liquidity with an undrawn revolving credit line to help in capital deployment on profitable ventures into 2024.

Business Overview

AerSale owns used aircraft, and spare engines and is a global leader and innovator of aviation products. The company's progression has been commensurate with the rising demand for aftermarket support not just in the passenger/ cargo business but also in government aviation-related orders. We also have to consider the global commercial aircraft disassembly and recycling market which was valued at $5.95 billion in 2021 and is expected to reach $14.35 billion by 2032 (growing at a CAGR of 7.85% in the stated period).

As of 2021, the top four commercial aircraft turbofan manufacturers were Pratt & Whitney, Rolls-Royce, GE Aviation, and Safran. General Electric and Pratt & Whitney formed a 50/50 alliance close to 17 years ago that has enabled them to sell engines to renowned clients such as the Airbus 380. GE's aerospace revenue in 2022 hit $26 billion with service revenue accounting for 70% while the profit margin rose 18.3% (YoY). The aerospace segment (in this company) is more profitable than the renewable energy sector whose profit dropped 17.3% (Y/Y) while the power sector realized a 7.5% (YoY) profit rise.

Growing the 757-P2F conversion program

We cannot compare ASLE and GE in terms of the global installed base since the latter has at least 49,000 commercial and 26,100 defense aircraft engines on top of its gas/ wind turbines. While there is a huge gap between these two, ASLE is riding on a wave of its own. In Q4 2022, ASLE sold 6 engines and 3 aircraft with one consisting of a 757 [P2F] converted aircraft. The prior year (Q4 2021) saw ASLE sell 3 aircraft and 4 engines with 2 P2F converted aircraft as part of the trade.

The 18.54% (YoY) decline in the revenue to $95.13 million can be rightly attributed to the reduced sale of 757-P2F aircraft conversions. This assertion holds since ASLE sold 3 more engines in Q4 2022 (than in Q4 2021), 4 engines but only 1 P2F-757 conversion against 2 sold in the prior year. Studies conducted early in 2022 indicated that the narrow-body P2F aircraft conversion had an average cost of $4.2 million for a Boeing 737-800 and about $6.1 million for an Airbus A321-200. In contrast, a wide body P2F conversion could cost $14.7 million for a Boeing 767-300ER while an Airbus A330-300 went for $18.4 million. Considering the inflationary pressure into 2023, these costs have increased thereby explaining ASLE's reduced sales into the year.

That being said, ASLE is looking towards augmenting its 757 P2F conversion program with an additional 12 conversions expected by 2024. The company explained that it will subcontract these conversions from multiple providers with nine slated for completion by 2023 and the remaining 3 by 2024. As seen earlier, subcontracting may be the best option for ASLE as compared to manufacturing the components. A look at the technical ops sales for ASLE shows that its sales increased 20.8% (YoY) due to higher on-airport maintenance, repair, and overhaul [MRO] the company was able to save from subcontracting the 757-P2F conversions to third parties. This aspect also increased demand from both cargo and passenger airlines in the long run.

The coming years will be phenomenal in the aerospace industry given that AAR ( AIR ) is expected to procure at least 9 Boeing 757-200 jets powered by 18 Rolls-Royce RB211 engines. It may just be a coincidence that AAR intends to procure the exact number of 757-200 jets that ASLE is bringing on board. Another aspect to consider is that ASLE is known to power its 757-200 aircraft conversions using Rolls-Royce RB211-535 engines. Such a contract will be crucial in helping AerSale to revamp its 757-P2F program, which as we have seen is integral to the company's revenue growth.

AerAware certification

ASLE reported significant progress on its FAA certification of AerAware- its enhanced flight vision system. The global market value of enhanced flight vision systems was estimated at $199.7 million in 2022 and is forecast to reach $245.5 million by 2028. It is expected to grow at a CAGR of 3.5% within the stated period. It is also likely that AerAware's unique software may be sold at an upside of $100,000 since uncertified flight vision systems have historically been sold for at least $6,000. However, the pricing strategy of AerAware is still a developing concept and we may see stronger upsides after the STC and into 2024.

As we had highlighted in our previous article on ASLE, the company reported that it had begun its FAA certification flight testing in February 2023 for AerAware. ASLE had completed two stages out of the 5 stages required for flight testing with the 5th test expected for completion by the end of April 2023. ASLE is on course to receive its supplemental-type certification [STC] with FAA. We can here deduce by inference that ASLE may begin commercialization of AerAware by 2025 or thereabout if it does not face further delays in its certification.

Cash availability and Valuation

AerSale ended FY 2022 with $147.2 million in cash supported by an undrawn $150 million revolving credit line. The company invested in vendor payments for $13.3 million concerning the 757 P2F conversion program. Additionally, it put in $37.6 million to increase inventory for sale. AerSale is positioning itself to leverage growing feedstock availability and increase returns not just for the company but for shareholders as well.

ASLE's price return has gained 9.20% (YoY). The company went public in December 2020 through a Special Purpose Acquisition Corp [SPAC] and its revenue has gained 20% (YoY). Since December 2020, ASLE's revenue has almost doubled to $408.5 million.

In terms of valuation, ASLE's forward P/E GAAP ratio is 22.44 about 23.04% higher than the industry average of 18.24. The current P/E also stands at 20.46 illustrating that ASLE's earnings are likely to decrease in 2023. Further the EV/Sales [TTM] ratio of ASLE stands at 1.83 about 12.47% above the industry average of 1.63. These metrics support the idea that the stock is slightly overvalued.

Risks to Consider

ASLE's FY 2022 revenue of $408.5 million fell short of its intended guidance range of $420 million to $450 million. However, its adjusted EBITDA of $87.4 million (representing 21.4% of sales) was within the $80 million to $90 million provided in November 2022. It may also be expected that ASLE may not attain the revenue range of $460 million to $490 million set for FY 2023. This situation is likely if ASLE continues to experience contractual delays with its conversion providers which was noted in its Q4 2022 report.

Further, ASLE's leasing portfolio is also doing dismally due to the availability of fewer aircraft on lease. The company may opt to resell the aircraft to supplement the reduced income. Additionally, limiting leasing to short-term engine leasing will work to improve margins as compared to long-term leasing.

Bottom Line

AerSale is set to realize higher returns from the successful implementation of its 757-P2F aircraft conversions. The company is also on course to achieving certification of its AerAware- enhanced flight vision software. ASLE also intends to increase capital deployment to enhance capacity and increase aircraft acquisitions for the benefit of shareholders. However, contractual delays are likely to affect earnings and affect the ROI. Still, this stock is a major disruptor in the aircraft management space and is worth watching in 2023. For these reasons, I will propose a hold rating for the stock.

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