2023-10-31 11:37:32 ET
Summary
- AerCap Holdings N.V.'s adjusted net income exceeds revenue growth, beating analyst estimates by $0.42 per share.
- The company's liquidity position remains strong, with an increase in cash and lower debt maturities.
- Growth drivers for AerCap include upward pressure on lease rates, gains on sale of aircraft, and potential settlements related to Russia.
AerCap Holdings N.V. ( AER ) likely has been one of my favorite and most rewarding investments. At the start of the pandemic, AerCap stock plummeted as fears were rising that significant write-downs would be required on the flight equipment which barely seemed to recognize that lessors were in a superior position to support the recover and despite economic shocks at times flight equipment has strong value retention. The world is looking a lot different these days, and whereas there were uncertainties about value retention years ago, lessors have shown to be able to adapt to the situation and today they are in the position that previous generation airplanes can be sold at significant gains while the current inability of OEMs to meet production schedules puts airplane lessors in a golden spot.
The stock performance also reflects this having gained more than 100% compared to a 40% gain for the market. Aircraft lessors for a long time have not quite been appreciated by Wall Street, but we are now seeing that there is more eye for the extremely strong position these companies have supporting the travel industry.
In this report, I will be discussing the most recent quarterly results and provide a valuation method based on a price-to-book method and based on an EV/EBITDA method.
AerCap's Adjusted Income Exceeds Revenue Growth
In recent quarters, AerCap has shifted focus to emphasis shareholder returns by means of share repurchases driven by value recycling from asset sales as well as settlements related to the situation with Russian airlines. The company puts less focus on year-over-year changes in adjusted revenues, but using the information available I have compiled a table myself to look at how the business is performing on adjusted basis.
Adjusted Revenues AerCap | |||
Q3 2023 | Q3 2022 | Change | |
Basic Lease Rent | $ 1,616 | $ 1,524 | 6% |
Maintenance Rent | $ 149 | $ 150 | 0% |
Total Lease Revenue | $ 1,765 | $ 1,674 | 5% |
Net gain on sale | $ 130 | $ 69 | 88% |
Other | $ 61 | $ 62 | -2% |
Total | $ 1,956 | $ 1,805 | 8% |
When adding back the purchase accounting practices which do deform the reported numbers on top and bottom line but not the actual operational performance, we see that year-over-year the basic lease rent increased by 6% while maintenance rent remained flat for a 5% higher total lease rent and including gains on sale and other revenues the total top line increase was 8%. The surge in gain on sale can be explained by the strong market for selling flight equipment which boosts the volumes as well as the value of the assets. What is important to note is that the company is generating 6% higher basic lease rent on a smaller asset base, which is partially driven by catch-up payments coming in but also provide the earliest signs that the current leases being signed are bringing in more revenues, which is likely driven by a higher share of next generation airplanes.
GAAP reporting requires AerCap to amortize certain items related to the acquisition of GECAS at an accelerated pace, which significantly affects the company's income. These are non-cash items that are required but don't really affect the underlying performance of the company. Therefore, looking at the adjusted net income makes a lot of sense. GAAP income was $1.1 billion during the quarter compared to $440 million in the same period last year. This increase was driven by the previously discussed settlement with the Aeroflot Group. Excluding this, the net income would be $35 million or 8% higher in line with the revenue growth during the quarter.
Adjusted net income, also adjusted for purchase accounting and income taxes, was $639 million or $2.81 per share, beating analyst estimates by $0.42, which is a strong beat and provides a 19% expansion of profits year-over-year.
AerCap's Liquidity Position Remains Strong
Sequentially, the excess overage increased by $3 billion driven by an increase in cash of $1 billion, and $1 billion lower cash CapEx and $1 billion lower maturities in the coming 12 months and lower debt maturities. The sources-to-uses ratio improved from 1.3x from 1.7x while cost of debt increased to 3.5% from 3.4% last quarter and 3.2% last year. What is a sign of strength in my view is that despite its significant share repurchases, the leverage ratio has remained stable at 2.51x sequentially and leverage decreased from 2.69x last year. So, the aggressive share repurchase program are actually done in a very prudent way.
Growth Driver #1 For AerCap: Upward Pressure On Lease Rate
The current high rate environment provides quite a positive backdrop for AerCap. Lessors tend to have a better credit rating than airlines meaning they have lower cost of debt, making leasing quite attractive to airlines. So, AerCap has little to no issue at all passing through the higher cost of debt to lessees. Furthermore, demand is strong and supply of new airplanes is limited which means that new leases that are currently signed have higher lease rates attached. While that is not directly translating into higher lease rates now as airplanes are already on lease and lease agreements are finalized well in advance it does provide a longer-term upward pressure for revenues.
The bigger near-term boost is the fact that releasing the airplanes can happen at more attractive terms as the value of airplanes that have been delivered to AerCap years ago to be leased to customers has improved due to the significant shortage of airplanes. We’re also seeing that due to the issues with the Pratt & Whitney engines, lease extensions are high in demand. As an example , Volaris will be extending leases on 18 airplanes. So, we are seeing that the grounding of hundreds of airplanes in the coming years will put additional upward pressure on lease rates.
Growth Driver #2 For AerCap: Gains On Sale
Next to supply constraints driving lease rates higher, AerCap has another growth driver, and that is that instead of providing an airplane on lease at a higher rate, the company can also decide to sell the aircraft at attractive margins. The margins are very strong at this point, allowing lessors to sell older airplanes at a 20 to 25 percent margin to book value while the historic trend hovers around 8 to 10 percent. So, there is a big opportunity here to book significant gains. AerCap provides guidance without assuming any gain on sale. I previously already estimated that around $1.60 per share to $2.15 per share could be added to the EPS by the inclusion of gains on sale and with the lower share count that would be in the $2.23-$2.68 at a 20% profit margin.
Growth Driver #3 For AerCap: Selling Claims And Settlements Related To Russia
While I don't want to make any forward projections based on the recent settlement with the Aeroflot Group, the settlement does provide some indication that the remaining unsettled balance of roughly $2 billion could eventually be settled. Furthermore, while I believe chances of repossessions which would likely reduce the claim amount as well there are possibilities for AerCap to eventually start selling claims for buying parties to pursue and the successful settlement that AerCap announced provide some base to assume that other settlements will follow in the future, but also give some conviction that the claims can be pursued successfully, which could make the claims appealing to buy by legal companies.
AerCap Guides For A More Bullish 2023
During the third quarter, AerCap beat expectations by $0.42 per share which looks like a strong beat, but it should also be kept in mind that around $0.58 of earnings per share came from gains on sale which AerCap does not guide for. While analysts likely include some gains on sale, the lack of guidance on this item line makes beating the estimates somewhat easier. However, we also see that the guidance excluding gains has been stretched by $0.50 per share on higher lease revenues and asset utilization as well as the engine leasing business performing well and higher share repurchase activity. So, there is strength in the underlying leasing business as well as strength in the disposal of flight equipment held for sale further amplified by share repurchasing activity.
A Higher Book Value For AerCap
Compared to its book value per share, AerCap is trading at an .78 price-to-book value. However, the $3.3 billion discount that AerCap received when acquiring GECAS is not reflected in this. To adjust for this, we add the $3.3 billion back and apply depreciation to this. By doing so, we get an adjusted book value of $92.64. Normally, I apply a discount to the book value of around 14%, which was in line with the discount to book value that we saw prior to the acquisition of GECAS. With that in mind, I believe AerCap shares should be trading at $79.67 at this moment providing 30% upside. If AerCap were to trade at elevated book values again reflecting the full book value, the upside would be 51% to $92.64.
Furthermore, AerCap's share repurchase program also adds upside to the stock, which could boost the book value per share to $93.75 and the stock price target to $80.63. I would consider the lower of both values to be the value that AerCap should be trading at right now and the high value to be the longer-term target.
Wall Street analysts have a $80.33 price target, which more or less coincides with my price target for the stock using the adjusted book value per share and share repurchases.
The Risks Of Adding The GECAS Acquisition Discount Back
While adding the discount to NAV that AerCap secured when acquiring GECAS does make sense, a few things should be kept in mind. Adding the full $3.3 billion discount back is the easy way to do things, but I believe that in the same flight, equipment is depreciated, the value of the discount to NAV should be "depreciated" as well, which introduces some uncertainty as assumptions need to be made. At the same time, we don't know when GECAS flight equipment is being sold and at what price point. When that happens, we should remove that part from the discount as well, and with the information that the lessor provides, we cannot do this with certainty. So, we should keep in mind that while adding the discount to NAV back, there are some risks and uncertainty involved.
EV/EBITDA Valuation For AerCap Stock Shows Significant Upside As Well
I also ran the stock price analysis for AerCap using the evoX Financial Analytics tool. Our base adjustments are as follows:
- A tapering share repurchase program in 2024 and 2025.
- Part of maturing debt in the coming years to be refinanced.
In this scenario, I have not included any future recoveries of Russian airplanes or settlements regarding the outstanding claims. In this scenario, AerCap stock would provide 37% upside for 2023 with a $83.70 price target and incremental stock price target increases in the years beyond primarily driven by stock repurchase programs. While my monitor provides a Buy rating, I would even mark the stock a strong buy as the company has been successful booking gains on sales and any settlements or insurance payments related to the Russian fleet are not reflected in the estimates while I do expect that AerCap has a strong case to recover the losses either via selling claims, settlements or court orders for insurance companies.
Conclusion: AerCap Stock Remains A Strong Buy
I believe AerCap stock remains extremely attractive and its current price to book value is below the usual 0.86x while the company faces a positive environment for leasing airplanes at higher prices in the years to come as well as the ability to sell airplanes at higher gains on sale. Furthermore, I would expect the company to be able to sell litigation claims or reach settlements which could further increase the company’s valuation.
For further details see:
AerCap: Why I Am So Unbelievably Bullish