FTAI - FTAI Aviation: Risks But Great CFM56-7B Market Growth And Inexpensive

2023-04-18 03:14:21 ET

Summary

• FTAI Aviation Ltd. is a global aviation and power equipment leasing company that acquires, manages, and sells high-quality aviation assets.
• The CFM56 market is expected to grow at close to 16% between 2022 and 2030.
• Employees inside the organization worked in Fortress Transportation and Infrastructure Investors LLC, which accumulated a lot of expertise in the aviation industry for many years.
• I would be expecting effective use of leverage, which could bring significant return on investment.

FTAI Aviation Ltd. ( FTAI ) is targeting the CFM56-7B/5B aftermarket market, which grows at a double digit. Besides, FTAI counts with an external manager, who is an affiliate of Fortress , and brings a lot of expertise and accumulated knowledge. Considering the expectations of FCF for 2023 as well as market expectations, I believe that future FCF could justify higher stock valuations. There are some risks from the total amount of debt, asset obsolescence, or supply chain disruptions as well as macroeconomic risks; however, FTAI stock looks undervalued.

FTAI Aviation Ltd.

FTAI Aviation Ltd. is a global aviation and power equipment leasing company that acquires, manages, and sells high-quality aviation assets essential to the movement of goods and people around the world.

The company owns an aerospace products segment, which develops and manufactures aircraft engines and aftermarket components primarily for the CFM56-7B and CFM56-5B commercial aircraft engines.

FTAI operates through its subsidiary, FTAI Aviation Holdco Ltd., and is externally managed by FIG LLC, a subsidiary of Fortress Investment Group with a team of experienced professionals focused on the acquisition of infrastructure and transportation assets since 2002. FTAI Aviation aims to generate strong cash flows and earnings growth from its portfolio of assets, which include aviation leasing and aerospace products. The following is a list of assets reported by FTAI.

I believe that FTAI is worth having a look because of some of the markets that the company targets. The CFM56-7B/5B aftermarket market is large and growing. The CFM56 market is expected to grow at close to 16% between 2022 and 2030. In my view, further growth will likely have a beneficial impact on the cash flow statement of FTAI.

The number of shop visits and quick-turns is also rising. Management believes that the number of quick-turns is expected to grow at close to 17% y/y from 2022 to 2030.

Finally, I believe that investors will do good by having a look at the FCF expectations for 2023. The company expects to deliver an adjusted EBITDA of $575 million and total available cash close to $297 million. In my view, the numbers after the spin-off will likely be appreciated by market participants.

Expectations From Other Market Analysts Include Significant FCF Generation From 2024

I believe that it is worth noting the expectations of other financial analysts because they are quite beneficial. They expect 2024 net sales close to $1.174 billion, 2024 EBITDA of $610 million, operating profit close to $408 million, operating margin of 34.8%, and 2024 net income of $266 million. It is also worth noting that 2024 free cash flow could stand at close to $228 million after many years reporting negative FCF.

Besides, I believe that having a look at the ratio expected by market participants may also help understand the financial situation of FTAI. With a capitalization / revenue ratio of close to 2.63x, EV/ revenue of 4.51x, and EV/EBITDA close to 8.69x, I believe that the company is trading at a discount.

Assets

In 2022, the company reported a significant decrease in assets and liabilities due to discontinuation of certain activities. The new balance sheet does not really look very different as compared to that in 2021. The asset/liability ratio is still close to 1x, and the total amount of leasing equipment, inventories, and intangible assets increased.

As of December 31, 2022, cash and cash equivalents were equal to $33 million with restricted cash of $19 million, accounts receivable close to $99 million, and leasing equipment of $1.913 billion. Besides, FTAI also reported property, plant, and equipment of $10 million, investments around $22 million, intangible assets close to $41 million, and inventory of $163 million. Total assets were equal to $2.429 billion.

Liabilities: Debt Decreased Significantly

In my view, it is quite beneficial that FTAI reported a significant decrease in its total debt. FTAI reported accounts payable and accrued liabilities close to $86 million, debt of $2.175 billion, maintenance deposits of $78 million, security deposits around $32 million, and other liabilities close to $36 million. Total liabilities were equal to $2.410 billion.

Assumptions Under My Model

I assumed that FTAI would successfully acquire high-quality aviation assets and equipment, which will offer predictable cash flows in markets that provide long term worth. Employees inside the organization worked in Fortress Transportation and Infrastructure Investors LLC, which accumulated a lot of expertise in the aviation industry for many years. I believe that this accumulated expertise will help FTAI deliver future FCF.

Our manager has significant prior experience in all of our target sectors, as well as a network of industry relationships, that we believe positions us well to make successful acquisitions and to actively manage and improve operations and cash flows of our existing and newly-acquired assets. These relationships include senior executives at lessors and operators, end users of aviation and offshore energy assets, as well as banks, lenders and other asset owners. Source: Annual Report

I would also be expecting that FTAI will successfully find assets that are distressed or undervalued, which will offer an appealing return on investment. FTAI made a comment about these strategies in the last annual report.

We look for unique investments, including assets that are distressed or undervalued, or where we believe that we can add value through active management. We consider investments across the size spectrum, including smaller opportunities often overlooked by other investors, particularly where we believe we may be able to grow the investment over time. Source: Annual Report

Finally, I would be expecting effective use of leverage, which could bring significant return on investment. In this regard, it is worth noting that the manager knows well how to allocate leverage in acquisitions to multiply future cash flow under certain safety conditions.

We and our Manager also spend a significant amount of time on structuring our acquisitions to minimize risks while also optimizing expected returns. We employ what we believe to be reasonable amounts of leverage in connection with our acquisitions. In determining the amount of leverage for each acquisition, we consider a number of characteristics, including, but not limited to, the existing cash flow, the length of the lease or contract term, and the specific counterparty. Source: Annual Report

My DCF Model Implied A Valuation Of $50 Per Share

Under my financial model, I assumed 2032 net income of $610 million, equity in losses of unconsolidated entities of $278 million, 2032 security deposits of -$195 million, loss on extinguishment of debt of $81 million, and changes in deferred income taxes close to $42 million. I also included change in fair value of non-hedge derivatives of -$8 million, amortization of lease intangibles close to $80 million, and amortization of deferred financing costs of around $63 million.

By assuming changes in inventory close to $54 million, changes in accounts payable and accrued liabilities of -$155 million, 2032 CFO of $1.251 billion, and 2032 capex of -$279 million, 2032 FCF would be close to $972 million.

With a multiple of EV / FCF of 9.55x, the terminal free cash flow would be $9.2425 billion, and with a WACC of 10.15%, the implied valuation would be $7.19355 billion. Besides, with cash and cash equivalents of $33.5 million, restricted cash of $19.5 million, and debt of $2175.5 million, equity valuation would be close to $5071.5 million. Finally, the implied price would be close to $50 per share.

Risks

FTAI Aviation Ltd. faces various risks related to macroeconomic conditions, geopolitical instability, industry regulation, and asset concentration. Any uncertainty in these areas can impact demand for assets, result in breaches of contracts, limit access to capital, and lead to unexpected negative effects.

Besides, the aviation industry is subject to periods of oversupply, affecting lease rates and asset values. Compliance with industry regulations is essential, as non-compliance can affect operations. Asset concentration and focused investments in specific sectors may be adversely affected by market demand or specific issues within that sector. In addition, the company is exposed to risks related to joint ventures, asset obsolescence, supply chain disruptions, fluctuations in fuel and energy prices, and routine maintenance costs.

There is also the fact that the company appears to be managed by an external manager, an affiliate of Fortress, who will receive a fee for his services. We cannot really know whether the fee is enough or too much for the services the company receives. I wonder if the company would not make money having its own management team inhouse.

On July 31, 2022, in connection with our spin-off, we entered into a new management agreement with the Manager, an affiliate of Fortress, pursuant to which the Manager is paid annual fees in exchange for advising us on various aspects of our business, formulating our investment strategies, arranging for the acquisition and disposition of assets, arranging for financing, monitoring performance, and managing our day-to-day operations, inclusive of all costs incidental thereto. Source: Annual Report

FTAI reports a significant amount of debt, which may make certain financial advisors uncomfortable. If FTAI cannot repay its debt obligations, management may have to sell assets, or renegotiate with new debt holders. As a result, I believe that the fair value of each share would most likely decline. The company provided a certain commentary in this regard.

Our ability to make payments on our indebtedness as required depends on our ability to generate cash flow in the future. This ability, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. If we do not generate sufficient free cash flow to satisfy our debt obligations, including interest payments and the payment of principal at maturity, we may have to undertake alternative financing plans, such as refinancing or restructuring our debt, selling assets, reducing or delaying capital investments or seeking to raise additional capital. Source: Annual Report

It is also worth noting that FTAI is a company incorporated in the Cayman Islands, where shareholder rights are completely different from that of the United States. It means that shareholders may receive less protection than in other cases, and directors may have less obligations than in the United States.

Our corporate affairs are governed by our Articles, the Companies Act of the Cayman Islands and the common law of the Cayman Islands. The rights of shareholders to take action against the directors, actions by minority shareholders and the fiduciary responsibilities of our directors to us under Cayman Islands law are to a large extent governed by the common law of the Cayman Islands. The common law of the Cayman Islands is derived in part from comparatively limited judicial precedent in the Cayman Islands as well as from English common law, the decisions of whose courts are of persuasive authority, but are not binding on a court in the Cayman Islands. Source: Annual Report

Competitors

The company faces competition from traditional aviation companies, commercial and investment banks, hedge funds, private equity funds, and other private investors. FTAI Aviation competes with other market participants based on industry knowledge, availability of capital, experience, and flexibility in structuring deals. I believe that its manager's experience in the aviation and offshore industries, access to capital, and diversified approach to assets and clients provide a competitive advantage over competitors who maintain a single-sector focus.

Conclusion

FTAI has a sound and well-defined investment strategy to generate predictable cash flows and earnings growth from its portfolio of assets. The company faces several risks, but its experience in the aviation and offshore industry, a large number of assets and customers, and ability to add value through active management give it a competitive advantage over its competitors. Overall, I believe that the company appears to be well positioned to achieve its long-term goals and generate returns for its investors. Considering the future market growth of CFM56-7B and CFM56-5B commercial aircraft engines and the beneficial FCF expectations, I believe that the stock is undervalued.

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