|Why Air Lease Should Soon Be Flying High|
Air Lease has been buffeted by fears of rising rates. But its virtues should propel the stock up over 30%.
Updated May 13, 2017 12:23 a.m. ET
Globally, middle classes are growing and filling airplanes and airports with new travelers. That’s bullish for aviation leasing companies. Rawpixel Ltd/Alamy
To travel the world is one of life’s persistent romances, and lately it seems everyone wants to do it. The throngs of international tourists have grown from 25 million in the 1950s to 1.2 billion last year, says the World Economic Forum, and their ranks—and airports and airplanes—will only get more crowded as the global middle class expands by three billion people by 2031. In China alone, a small projected uptick in the percentage of passport holders, from 4% of the population to 12% by 2025, will disgorge millions into tourist meccas from Tuscany to Tokyo.
A long-term travel boom is good news for Air Lease (ticker: AL), which buys planes from Boeing Co. (BA), Airbus (AIR.France), and Embraer (ERJ), and leases them to 86 airlines in 54 countries. Because smaller airlines in emerging markets—where growth often is fastest—lack easy access to cheap financing, and because they don’t order enough planes to have bargaining power with manufacturers, they often turn to leasing companies like Air Lease. It also lets airlines focus on operations and keep hefty assets off their balance sheets. Today, 42% of the world’s commercial jets are leased, from zero in the 1960s.
With airlines operating at record capacity, and with ugly publicity about the fallout from overbooking, you’d think shares of Air Lease would be soaring. Yet the Los Angeles company’s shares have been more turbulent than its results. Revenue is climbing steadily, from $660 million in 2012 to $1.05 billion in 2014 to $1.42 billion last year. But shares have fluctuated between $23 and $42 since 2014. They were recently at $34.91, just 10 times projected 2017 profit, and trading at book value, near the low end of their range since a 2011 initial public offering.
The 13 analysts who cover Air Lease think shares are worth $46.42 on average, or 33% higher. But the company is often misunderstood—and unjustly shunned. It’s a growth stock with a value price tag, and that unnerves investors from both camps. Because Air Lease borrows to fund purchases, investors fret about its debt as interest rates rise, even though tepid economic growth should keep rates lower longer.
A WORLDWIDE RECESSION or a fresh outbreak of terrorism would hurt travel, but how many companies in today’s pricey stock market are immune to such events? Air Lease’s management has navigated crises from the 9/11 attacks to the SARS outbreak, and has the experience to buy more planes when prices fall and sell as the cycle peaks. By the time Alitalia filed for bankruptcy protection, for instance, Air Lease had trimmed its exposure to just four planes, which it stands ready to repossess and lease to new customers.
Chris Retzler, portfolio manager at Needham Asset Management, calls Air Lease “an asset manager—but of airplanes,” adding it helps that “the management team is at the forefront of where aviation is headed.” Air Lease may have started life only in 2010, but it was founded by Steven Udvar-Házy, who pioneered aircraft leasing in 1973 and had run another company that was eventually acquired by American International Group AIG ition and then merged into AerCap Holdings (AER), another leasing company. Today, Udvar-Házy—who is to aircraft leasing what Bill Gates is to software—is executive chairman of Air Lease’s board and owns 5.2% of the stock, which should give management extra incentive to lift shares to cruising altitude.
What elevates Air Lease above its peers? It has one of the industry’s youngest fleets—its 243 planes are an average age of 3.7 years old—which lets it borrow at cheaper rates even as it charges customers more. It has more than 300 planes on order, and has already snagged long-term leases for 91% of planes scheduled to be delivered through 2019 and 72% of deliveries through 2020, which gives it a predictable stream of future revenue. Its ratio of fixed- to floating-rate debt stands at a prudent 85% to 15%, and a BBB credit rating keeps average borrowing costs at 3.48%. RBC analyst Jason Arnold rates Air Lease his top pick, given its “sizable and growing fleet of new and in-favor aircraft,” and “the highest return-on-equity and lowest leverage in the sector.”
While Air Lease earned some 6% of its revenue in 2016 from buying and selling jets, the 94% it earned from rental income is geographically diversified—with 28% from Europe, 21% from China, 22% from the rest of Asia, 8% from Central and South America, 7.5% from the Middle East and Africa, and the rest from North America and Australia.
In early May, it reported first-quarter profits that missed forecasts, but manufacturer delays had caused 40% of its first-quarter deliveries to arrive only in the quarter’s final two weeks. Analysts have trimmed estimates but still expect Air Lease to earn $3.48 a share in fiscal 2017 and $4.16 in 2018, up from $3.44 in 2016.
Air Lease’s interest-rate risk also isn’t as big as feared, argues David Swartz of investment firm Pacific West Land, who has shared his views of air-leasing stocks on SumZero.com, a social network for fund managers and professional investors. Contract clauses let Air Lease boost lease rates if interest rates rise after the contract was signed. As CEO John Plueger once pointed out, airlines need leasing companies in good times to deliver more planes, while in bad times airlines need leasing companies for their balance sheets.
Air Lease recently sold 19 older jets into an entity it created called Thunderbolt, which was then securitized. This lets Air Lease collect servicing fees and maintain a young fleet. While the industry worries about a possible glut in wide-body jets, 80% of Air Lease’s fleet are narrow-body, single-aisle planes considered the industry’s workhorses.
A 2016 Deloitte study showed that only 6% of the planet’s seven billion people flew on an airplane in 2015, which shows how vast and untapped the market remains. Aircraft makers’ backlog ballooned from 6,913 planes in 2009 to a record 13,467 by 2015. With 233 airlines and leasing companies vying for that backlog, and possible economic turbulence ahead, investors should climb on board only with a seasoned expert like Air Lease.