AL - Macro Tailwinds Are Key To Air Lease Corporation's Sustained Growth

2023-08-09 06:21:31 ET

Summary

• Air Lease Corporation achieves Q2 revenues of $672.90mn, beating expectations.
• The company's lean operational strategy and net operating leases contribute to increased operational flexibility.
• Air Lease is undervalued and has superior growth prospects compared to its peers in the air leasing industry.

Air Lease Corporation ( AL ) is a Los Angeles-based aircraft leasing company which operates with a focus on leaner operations. Not only does the company focus on direct orders and tailored operational and financing solutions, but provides clients with net operating leases, which reduces overhead and increases operational flexibility for Air Lease.

These activities have enabled Air Lease to achieve Q2 revenues of $672.90mn, a $12.96mn beat, which enabled a normalized actual EPS of $1.58, a $0.19 beat.

Introduction

At the core of Air Lease's growth story is its multi-faceted fundamentals, with industry-leading executive experience, among the largest leasing platforms, a lean and liquid asset strategy, disciplined capital structure, strong diversification, and an inelastic customer base. Through this platform, Air Lease is able to effectively manage its expense base, ensure stable, long-run cash flows, and become a more nimble organization.

The combined accretive impact of Air Lease's lean business strategy, general macro tailwinds, and a level of undervaluation leads me to rate the company a 'strong buy'.

Valuation & Financials

General Overview

In the TTM period, Air Lease's stock- up 10.96%- has experienced middling growth between TradingView's Airlines Index- since airlines are most comparable as an industry to air leasing, itself up 15.37%- and the broader market, as represented by the S&P 500 ( SPY )- up 9.13%.

I believe that the airline industry as a whole experienced superior growth as a part of a broader COVID recovery theme, with Air Lease maintaining lower overall price volatility and thus seeing less growth.

Despite this, I believe Air Lease has more built-in and sustainable growth than its peers, proving to be a superior investment.

Comparable Companies

The air leasing industry remains highly capital intensive and therefore remains highly consolidated, with few major competitors. More so than that, there are even fewer public competitors, with many air leasers owned and operated by private equity firms, asset managers, and banks, among others. As such, I sought to compare Air Lease with other publicly listed air lease, aerospace, and airline companies. This includes the much larger, Dublin-based air leasing firm, AerCap ( AER ), a major US airline, the Fort Worth-based American Airlines ( AAL ), and the largest aerospace manufacturer, Boeing ( BA ).

As demonstrated above, among the peer group, Air Lease has experienced the second-poorest yearly price action, likely a product of the aforementioned reduced volatility, which saw a smaller recovery relative to airline industry peers.

Despite this, when assessing Air Lease on a multiples basis, overall growth, and shareholder return capacity, I believe the firm has superior growth prospects.

For instance, Air Lease maintains the second-lowest P/S ratio, P/B, and book value per share, representing value across the income statement and balance sheet.

Furthermore, with the lowest PEG ratio and second-highest ROE, Air Lease has demonstrated outsized growth capabilities. In conjunction with a best-in-class dividend, investors can expect stable and sustainable returns for years to come.

Valuation

According to my discounted cash flow analysis, at its base case, the net present value of Air Lease is $62.94, meaning, at its current price of $42.13, the stock is underpriced by 33%.

My model, calculated over 5 years without perpetual growth, assumes a discount rate of 9%, balancing Air Lease's low equity risk with its higher debt cap structure. Additionally, remaining conservative, I project a forward average revenue growth rate of 6%, lower than the trailing 5Y average for the firm, but adequately incorporating recessionary risk and slowed growth potential.

Alpha Spread's multiples-based relative valuation tool more than corroborates my thesis on undervaluation, estimating a base case undervaluation of 74%, meaning the stock's relative value is $160.20.

However, the model's inability to discount Air Lease's dividend or incorporate Air Lease's debt volume means that, in my opinion, Alpha Spread overvalues the stock.

Therefore, taking a weighted average of my NPV and Alpha Spread's relative valuation, the fair value of Air Lease's stock should be $72.66, with the company undervalued by 42%.

Air Lease Corporation Maintains Growth Through Demand Positioning, Macro Factors

Central to Air Lease's long-run strategy remains the existence and the ability of the firm to leverage long-term, secular growth trends across the industry. For instance, as a result of rising commercial and pent-up retail demand, international revenue passenger kilometres are up 230% from FY21 to FY22. This works alongside industrywide OEM production rate growth and a largely stagnant airline technology status quo- meaning Air Lease's current fleet remains effective over a longer period of time- signals asset quality.

Moreover, contrary to bear opinions of an extended drawdown of airline- thus air leasing- demand, history shows rapid recovery from major travel headwinds. And with positioning across retail and commercial purpose aircraft and primarily doling net operating leases means that akin to streaming companies for mining, Air Lease is less exposed to direct supply/demand dynamics than airlines.

These propositions are all the more enhanced by a virtuous global flywheel that moves onward regardless of temporary headwinds. The world is seeing a growing middle class, which generally prefers- especially when assessing younger consumers- experiences over goods. This directly leads to consumer spending skewed toward air travel, with demand management and the capital expenditure required leading airlines to gravitate toward air leasing services.

Wall Street Consensus

Analysts echo my highly positive view of the stock, estimating an average 1Y price target of $54.71, a 30.06% increase.

Even at the minimum projected price of $41.00, analysts expect a 2.54% decline, a small net loss, especially when incorporating dividend returns.

I believe this positive outlook reflects Wall Street's view on both the potential for long-run compressed airline demand and its impact on Air Lease individually.

Risks & Challenges

Sticky Interest Rates Raise Expense Base, Reduce Demand

Although Air Lease remains well-positioned to deal with uncertain demand relative to peers, the firm nonetheless depends on the renewal and continuation of leases to generate adequate cash flows, though rising interest rates dampen demand from consumers and companies alike. This, combined with rising costs due to Air Lease's higher debt levels and subsequent rising interest payments, means that the firm may be required to increase lease prices, though this may only serve to further depress demand.

Deeper-Pocketed Rivals May Augment Competitive Intensity

The aforementioned demand compression and need for rising leasing fees may be contradicted by the capability of Air Lease's competition, who are likely to be more successful in price competition, as they do maintain larger cash flows. This may result in hyper-compressed margins for Air Lease, scalability difficulties, and ultimately reduced shareholder returns.

Conclusion

Considering Air Lease's steep undervaluation, its positioning for macro tailwinds, and an overall lean operational strategy, in the long run, the firm is well-placed for scale expansion and growth.

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