Aercap (NYSE:AER) – Drunk as Hell but No Throwing Up

  • Aercap, one of the largest airplane lessor company in the world, has seen its stock price decimated by almsot 60% as the Covid-19 epidemic takes a toll on the air travel and tourism industry.
  • Aercap’s is facing the biggest challenge ever faced and priced as if all of their customers, the airline companies, are going bust.
  • Aercap is a creditor and they are facing requests from airline companies to defer their lease payments.
  • I feel that the company’s balance sheet is strong enough to survive this pandemic and come out stronger on the other end.

Aercap’s (NYSE:AER) is a relatively simple business, but it does not mean that it is easy to run. To put it simply;

  1. They borrow money from capital markets like financial institutions,
  2. Uses that money to purchase aircrafts from manufacturers like Boeing and Airbus.
  3. Sometimes they purchase directly from airlines through sale and leaseback operations.
  4. They will then lease the aircrafts to the airlines for periods ranging from 10 to 12 years, after which they either re-lease or sell the older aircrafts in the secondary market.

You can have a look at their company factsheet here: https://www.aercap.com/media/2739/aercap_fact_sheet_1q_7-4-2020_v2_a4.pdf

Covid-19 Outlook

As you all know, the aviation sector is one of the worst hit sectors last quarter. We are seeing travel restrictions everywhere and global cancellations of flights. The global fleet has more or less been grounded as countries try to stop the spread of Covid-19. This has greatly impacted airlines all over the world, which are Aercap’s customers.

So to say, the major concern for Aercap would be that the airlines are going to default on their lease payments during this period and that would be detrimental to Aercap as they themselves also have to fulfill their financial obligations like debt repayment to financial institutions. Failing to do so may lead to Aercap having to sell off their assets to raise funds to avoid bankruptcy.

Airlines default

https://edition.cnn.com/2020/03/16/business/airlines-bailouts/index.html

Currently, the largest airline to fold this year would be Flybe. CNN reported that most airlines could be bankrupt by May if there was no financial assistance. Luckily, we have seen that most of the airlines like Qantas, Singapore Airlines, Norwegian Air and Air Frane-KLM are going to receive some sort of rescue package.

Also, I would like to point out that airlines going bankrupt is quite common, in 2019 alone, we have 23 airline bankrupcies and I probably only heard about Thomas Cook and Jet Airways in the news.

A mass default, while possible, seems unlikely as air travel is crucial in the globalization of commerce and trade and we have also seen countries starting to bail out their national carriers due to it being an industry closely linked to national interests.

Deferment of lease

Similar to the retail and F&B landscape, airlines are requesting for some sort of relief from the payment obligations under their leases. As the collapse of airline companies will have a negative impact on Aercap, I would expect them to have some sort of rent deferral arrangement with most of their customers.

This is because the other alternative would be to repossess the planes and that would be a lose-lose situation as airlines will lose their planes and Aercap will then have in possession a depreciating asset and must move quickly to secure another lease (Especially bad when there is almost no demand for aircrafts now).

Thus the next concern is whether they have enough liquidity to tank through this period.

How much can the Balance Sheet withstand?

In the JP Morgan Industrials Conference held in March 2020, Aercap announced that they have $8.2B of liquidity and expecting $3.1B of operating cash flow this year. This amount is able to cover their capex and debt maturities of $7B for the year.

Even assuming that they are not going to get the $3.1B this year, they do not really run into any danger of bankruptcy anytime soon.

It is worth noting that in this period of global lockdown, manufacturers like Boeing and Airbus will not be able to meet their expected deliveries, which means that Aercap will have lesser investments commitments to meet.

Diversified Customer Base

Aercap has already identified over-concentration on one customer as a potential risk and therefore, diversified their customer base to over 200 customers in 80 countries. Their top 5 customers make up 26% of their revenue.

Of the 5, China Southern has resumed their operations and should be paying back the deferred rent soon, US Trump Administration has reached an agreement in principle to a $25B bailout to US airlines, LATAM is facing less than 10% sales compared to normal times but expects flights to fully recover by end 2021. Air France and Norwegian Air are receiving some sort of state support.

Long Aercap

With all that mentioned, I feel relatively confident about Aercap’s ability to survive this pandemic.

I would love to talk about the other aspects that I like about Aercap but I’m afraid that not many would be interested about it as our major concern is whether they will throw up before the end of this bumpy ride. But it is also important to know why it is worth investing in Aercap even without this Covid-19 pandemic.

Without elaborating much, here goes:

  1. Expected global air traffic growth at rates of 3.5% per year.
  2. Airline companies’ preference to lease aircrafts to be more asset light (read about how Virgin Airlines started)
  3. An unparallel global platform where their huge global presence gives them an information advantage in the aviation industry.
  4. Economies of scale where manufacturers are happy to give Aercap discounts on huge orders.
  5. Their size also allows them to access Capital Markets to seek financing instead of just banks.
  6. Management has proven to be great capital allocators with their track record of selling second-hand aircrafts at a premium to book value and aggressive share buybacks when prices are trading at a discount to book value. This increased book value per share at an annualized rate of 22% for the past 9 years.
Imagine selling planes at a premium to book value and then buying back shares at a discount to book value….

Drunk As Hell But No Throwing Up

Aercap is hit hard during this Covid-19 pandemic but i opined that they will be able to ride out this storm. With Aercap trading at P/B of 0.33 and P/E of 2.75 at time of writing, the pros far outweighs the cons and this is a case whereby you may lose 100% if you’re wrong but will stand to gain 300-500% returns if you are right.

Cheers

The Moss Piglet is long AER at $15.

6 thoughts on “Aercap (NYSE:AER) – Drunk as Hell but No Throwing Up

  1. Holly shit this is a lot of information. Thank you. Any guesses on how long it will take them to recover? It looks like there are AER calls out to December, any chance of a mild recovery by then?

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    1. Well, one of their peers Avalon reported recently that they have deferred lease arrangements with their clients on an average of 3 months. So hopefully we should be able to see recovery starting from June/July

      Liked by 1 person

  2. Hi, thanks for the nice write up. Do you have additional information on the lease agreement between Aercap and their major airline customers? Do the agreement different across customers?
    As of now, there is still no sign of countries opening up air travel signficantly, do you think the outlook for Aercap will change?

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    1. I have found a few lease agreements online and the terms are pretty much the same. Aercap reserves the right to claim from the lessee any loss besides from the missed payments like releasing the repossessed aircrafts at lower rate. Here’s one with LATAM https://www.sec.gov/Archives/edgar/data/1378789/000104746914002538/a2219001zex-4_3.htm
      As for overall travel outlook, I expect more airlines to declare bankruptcy or restructuring in the coming months. This will be detrimental to aercap’s outlook but overall I’m not that worried as most customers only contribute to a small percentage of their overall revenue.

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