AerCap Holdings: Exiting Turbulence, Stock Looks Cheap (NYSE:AER)

I’ve been looking at companies in the airline industry looking for potential bargains among the depressed stocks. This is especially true now as developments in the coronavirus situation slowly point towards a return to normalcy. Out of all the stocks in the industry, I am most bullish on AerCap Holdings (AER). Below, I walk you through my investment thesis.

Just a brief business overview on AerCap. It one of the largest airplane leasing companies in the world. Its business model effectively works similarly to a financing company. AerCap uses its scale to acquire aircraft at discounted prices, funds this using lower-cost debt then turns around and leases the aircraft to airlines all over the world.

AerCap owns 931 aircraft which it offers for lease. The company’s fleet is relatively young with an average age of 6.4 years. Given the number of flights canceled this year, its aircraft probably didn’t suffer a lot of wear and tear and their useful life may have been extended somewhat. As of the end of the reporting period, 890 out 931 of the company’s aircraft were on lease, and out of the remaining ones not on lease 22 were for sale or sold, 12 were being shopped around for new leases, while 7 were already about to be leased. Despite the coronavirus pandemic absolutely decimating the airline industry, AerCap’s utilization rate for Q2 2020 was 97% and 98% for the first half of the year. These are impressive numbers given those were the months where the coronavirus lockdowns had the maximum impact. In fact, AerCap’s utilization rate has been better than those of some retail and office REITs I have seen.

This pretty much underscores my entire bullish case for the company. As an aircraft leasing company, AerCap needs its airline customers to survive but not necessarily thrive. In other words, air travel doesn’t need to immediately return to 2019 levels for AerCap to be fine. As long as its customers remain above water, even if it means operating at breakeven, the leases will get paid. We can see this thesis playing out in the company’s short-term results. In Q2 2020, it reported revenues of $1.2 billion, down only 6.5% from the same time last year. Net income was $246 million ($1.92 per share) vs. $331 million from the same time last year, a huge decrease but not catastrophic. The company had EPS of $4.06 for the first half of 2020.

Given the level of commitment governments have shown to support the airline industry, this is a likely outcome. In the US, the Trump administration is already mulling an additional $25 billion support package for the industry. China has already announced its support for its airline industry. Air France, the company’s 4th largest customer, received an aid package this April. While LATAM Airlines (LTMAQ) and Norwegian Airlines (NWARF), the company’s 4th and 5th largest customer respectively, have filed for bankruptcy, they have already resumed operations. AerCap now also owns 15.9% of Norwegian Airlines, as its previous lease obligations were converted to equity. Given the depressed share price at the time, these were obtained for a bargain. The company operates in a wide geographical area, with the majority of its revenue coming from Asia, which has managed the coronavirus crisis better than its Western counterparts.

Source: Company Annual Disclosures

Source: Company Annual Disclosures

Rapid testing is a game changer for the airline industry

A few days ago, Abbott (ABT) announced that the FDA approved its rapid test for the detection of the coronavirus. This test will be cheap at $5 and provide results within 15 minutes. With a rapid test, every single flyer could be tested before boarding an airplane, preventing the spread of the coronavirus. This means that airlines could be back to normal operations sooner rather than later even without a vaccine available.

Airlines will be among the first to get the rapid test given the coronavirus risks present when flying. TSA screenings have also increased in August, where it had screened more than 800,000 people in US airport checkpoints, the most since March this year and rebounding from April lows. The development of a rapid test, coupled with the increase in TSA screenings, indicates to me that people want to travel again. So, while demand may take a while to reach 2019 levels, as mentioned above, as long as airlines survive, AerCap’s leases will get paid.

Source: Air travel data from company website

Source: Air travel data from company website

Financial Analysis and Valuation

Due to the company’s scale, AerCap has the “power of supplier” (from Porter’s Five Forces) over airlines. According to the Corporate Finance Institute, supplier power is defined as “the degree of control a provider of goods or services can exert on its buyers”. The company is the largest aircraft lessor in the industry, with a 12% market share. The industry itself is highly concentrated, with the top 3 firms holding more than 30% market share.

Source: Investor Relations

We can see this play out when comparing the company’s margins against airline companies. AerCap’s EBIT margin of 58% and Net Income margin of 25% is much higher than that of the airlines. Most airlines in my comparison set of Spirit Airlines (SAVE), JetBlue (JBLU), Southwest (LUV), Delta (DAL) and Alaska Airline (ALK) can barely get above 15% EBIT margin. I consider this set to be among the best-run airlines in the industry. AerCap has healthy margins, which I consider a prerequisite for long-term investments.

Source: Author’s calculations

Source: Author’s calculations

AerCap right now is trading at an extremely cheap price by virtually any metric. Book value per share is a good metric to use given the asset-heavy nature of the business. At the current price of $31.4, it is trading at 0.48x tangible book value per share of $65.8. Remember, aircraft are long-lived assets, and AerCap’s fleet is still relatively young (average age of 6.4 years as discussed above). Using P/E ratio as a metric, to be extremely conservative we can assume Q2 2020 earnings of $1.92 (annualized to $7.68) is the “new normal”. It is a conservative measure, as this was during the “peak” of the lockdowns. This gives us a P/E ratio of 4.1x, which is severely undervalued and provides an investment “buffer”. AerCap is a solid buy and is, in my opinion, the best way to invest in the recovery.

Disclosure: I am/we are long AER. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Caveat emptor! (Buyer beware.) Please do your own proper due diligence on any stock directly or indirectly mentioned in this article. You probably should seek advice from a broker or financial adviser before making any investment decisions. I don’t know you or your specific circumstances, therefore, your tolerance and suitability to take risk may differ. This article should be considered general information, and not relied on as a formal investment recommendation.

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