Aercap (NYSE:AER) – Surprise Winner in Airline Industry Collapse

Aercap (NYSE:AER) reported 2Q2020 earnings this week and results have shown that they are the surprise winner in the airline industry selloff.

https://www.prnewswire.com/news-releases/aercap-holdings-nv-reports-financial-results-for-the-second-quarter-2020-301101884.html

Note: Please click below to read my previous articles on Aercap

Q2 2020 Highlights

In Q2 2020, Aercap reported net income of $246 million and earnings per share of $1.92. Net income for 1H20 was $523 million and our EPS was $4.06. This was 21% lower yoy.

Revenue for 2Q20 was $1.197bil, a decrease from $1.281 billion last year. Lease rents were down 12% due to a combination of;

  1. lease restructurings and extensions at lower rates. This means the remaining rental payments will be spread over the remaining term of the original lease plus the extension period.
  2. rental payments deemed no longer probable. Airline customers accounts for about 15% of their aggregate lease revenue.
  3. sale and purchase of aircrafts resulting in a net increase of $15million in basic lease rents.
AerCap Capex Reduction Q22020

On the liquidity front, Aercap managed to reduce their cash capex for 2020 and 2021 by a total of $5.3B. They continue to maintain high levels of liquidity that is worth about $12B. Aercap now has the lowest leverage ratio since 2014, with sources-to-use coverage at 2.2x. This is a slight improvement compared to last quarter’s 2.0x.

Book Value per Share has increased 13% since June 2019 from $67.08 to $75.51. This is due to the improvement of shareholders’ equity and the cancellation of shares to create value for shareholders.

Management Commentary

Airline Industry Outlook

Aercap’s management has stated that from their own data, they are starting to see recovery in the industry but only in certain parts of the world.

China’s domestic flights are back to almost 90% of pre-Covid levels. In Europe, there is an increase in flights from 2099 flights in April to 16,300 flights in July. However, they have not seen a meaningful recovery in Latin America.

As for North America, their story is beginning to draw parallels to Eminem’s discography. From “Curtain Call” (The crash) to the current stage of “Relapse” (Surge in cases after months of decline). Hopefully we can see a “Recovery” soon and then “Revival”.

Eminem Album

The management also highlight a key point that airlines have received over $130bil of government support. This support comes in the form of loans, subsidies and guarantees.

They have also seen a significant acceleration of retirements from airlines around the world, who are rightsizing their fleets for the future. 950 aircrafts were retired so far, equivalent to 4.5% of the world’s fleet.

Aercap Outlook

The main focus of the management is to maintain a strong liquidity position in the current environment. This is done by raising new funding and revolver facilities.

They have also negotiated with their suppliers for the rescheduling of aircraft purchases. The rescheduling of these deliveries has reduced cash capex by a total of $5.3 billion. They have also recently cancelled orders for 15 Boeing 737 MAX aircrafts.

Analysts have raised questions on the deferral of revenue that Aercap faces. At the end of June, their deferral balance was $430mil and they are expecting it to increase to about $800 mil over the next few quarters. This is due to the customers who have filed for bankruptcy in the last number of months. Management has also emphasized that they have about $1bil of security deposits backed against the deferral balance.

The Surprise Winner

Still Picking Up the Cash Flow

In an industry that is almost decimated by global travel restrictions, Aercap continues to collect cash from the majority of their customers everyday.

In the early stages of the pandemic, the major concern for Aercap is the potential default of most airlines and that would be detrimental to Aercap. Failing to fulfil Aercap’s debt obligations may lead to forced selling off their assets to raise funds to avoid bankruptcy.

Although there are still airlines filing for bankruptcies, Aercap has only experienced a 26% decline in their operating cash flow so far. This is way better than the base case mentioned in my earlier posts. Also, this shows that AerCap is receiving the government support given to the airlines when they pay the lease. A clear winner in this industry while the airlines are suffering from almost zero income.

New Technology Aircraft

AerCap has an advantage in leasing out planes when demand picks up. 59% of AerCap’s fleet consists of in-demand new technology aircraft. Customers will be more willing to move into new technology instead of end of line/current tech or even old tech assets.

AerCap Aircraft Portfolio. New technology aircraft 57%

The aircraft that were retired by the airlines were of the older models. This represents less than 1% of AerCap’s aircraft fleet. The management is shrewd enough to invest in newer aircrafts for the long term. They have even rejected sale and leasebacks of older airplanes and stuck to the newer technology assets which have better value.

Now, no other entity owns a greater percentage of new technology aircraft than AerCap.

Strong Liquidity Position

AerCap Q2 2020, Strong Liquidity Position

From their 2Q20 presentation slides, AerCap has double their cash needs for the next 12 months. This allows them to be well-positioned to weather an extended period of turbulence and support the recovery of the airline industry in the future.

Initially, there were many who doubted their ability to survive without cashflows from the airlines. More than 4 months have passed since the pandemic struck and AerCap is still standing strong with record amount of liquidity and strong access to funding.

The Negatives

Not everything is awesome at the moment. The pandemic is still raging and it is still too early to see a meaningful recovery in the aviation industry. There are still risks that might decrease their revenue in future periods.

More Restructuring Programmes

Similar to the case of Norwegian Air, airlines which are recipients of government support could be forced to fulfill certain obligations which might negatively impact AerCap.

This includes

  1. Removal of less environmentally friendly aircraft
  2. Waiver or reduction of future lease payments
  3. Deferral of lease payments.

More Bankruptcies

AerCap recognises rental revenues using a cash accounting method for payments that are deemed improbable. Their management expected the deferred balance to grow to about $700 to $800mil over the next quarters. This is backed by S1bil of security deposits. Anything more than this will be bad.

If there are more bankruptcies as the financial condition worsens, more rent payments could be recognized using the cash method. This will further decrease the basic lease rents.

Besides lower rents, bankruptcies may result in grounding of AerCap’s aircraft. This could depress its market value and affect AerCap’s ability to recover the aircraft and re-lease to another customer.

Lower Cash Flow From Operations

AerCap could receive lower than expected cash flow from operations should they experience higher than expected deferral arrangements or payment defaults.

However, this is not really a major concern as they have more than sufficient liquidity for the next 12 months.

Conclusion

AerCap’s Q2 2020 earnings report have shown that they are the surprise winner in the airline industry selloff. Their management has done a tremendous job to reduce capex and increase liquidity in order to survive the pandemic. In addition, they managed to continue collect about 80% of their lease payments.

Compared to the airlines and airports who are struggling with near zero income, AerCap has emerge as one of the stronger companies in the selloff of the aviation industry.

After the earnings beat, I feel that the narrative is no longer focused on its survivability. The market is now looking at how AerCap can recover from the pandemic and continue to grow its business. Any potential loss of income will have an impact on its share price.

With a book value of $75 per share, AerCap currently trades at 0.35x P/B. The valuation is still very attractive and I will continue to hold on to my shares.

Cheers.

Note: The Moss Piglet is vested in AER at $15.

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