Spotting an entry point into AER is Four Tree Island Advisory founder and SumZero contributor Eric Gregg, whose research into the company suggests a deep value opportunity given its robustness under strain. “Stress testing an investment in AerCap in the context of Covid-19,” Gregg writes, points to the company’s desirability at an attractive price.

According to Gregg's long call on AER:US: “AerCap is currently trading 35% below its all-time high achieved a month ago, less than 60% of book value and at ~53% of likely 2020 YE book value. Given that AerCap could, in theory, liquidate its aircraft portfolio at least at book (if not a premium to book value) even in this environment, a huge discount to its book value makes its current valuation, seemingly ridiculous.” Keeping long-term risks as well as the market’s behavior, Gregg raises some critical questions in assessing AER’s value over the coming months. “Is AerCap likely to suffer a liquidity issue that could force it to impair the value of its assets? Or is the market just trading algorithmically/technically and not appreciating the fundamental differences between AerCap and its customers (the commercial airlines)?”

Liquidity, he finds, is not a problem. Citing the company’s Q4 ER, Gregg writes that “AerCap has, as of YE 2019, 1.5x the liquidity it needs to cover all debt and capex obligations over the next 12 months.” “This suggests that AerCap has $3.9 billion more liquidity than it needs over the next year. Notably, even AerCap's cash flow were to be cut by 50% vs. AerCap forecasts (highly unlikely), AerCap would still have $2.3 billion of excess liquidity over the next 12 months.” “If AerCap’s operating cash flow were cut to $0 (just not happening), the Company would still have $800mm of excess liquidity beyond its obligations for 2020. This excess liquidity is a tremendous asset in this environment. It should allow AerCap to buy aircraft, order new aircraft, step in and do sales leaseback activity at a time when many struggling airlines need liquidity or buy highly undervalued AerCap stock.”

But what about the obvious weak link in AER’s business model: the airlines themselves? Concentrated contracts or a lack of diversification in the company’s portfolio, particularly in these turbulent times, could pose a major threat to AER in the form of airlines going bankrupt. Gregg addresses this in analyzing the company’s airline contracts, looking for any potential weak links that could potentially leave them without a customer. In this case, AER’s strength is actually derived from a small, but significant, concentration of contracts with Chinese airlines. This kind of relationship, as you may recall, is one of the strengths of Chinese eCommerce firm JD.com. “18.7% ofAerCap’s 2019 lease revenues were from China and ‘approximately two-thirds of {AerCap’s} revenue comes from the big three state-owned carriers’ per AerCap’s CEO on the most recent earnings call. As it would seem highly unlikely that China would let any of its big three state owned carriers go bankrupt, allowing those carriers to defer rents a month or two seems like smart business and is likely to be highly beneficial to AerCap's market position in China over the long-term. So on 12-13% of AerCap’s lease book it should be assumed that rents will be deferred for a month or two, but that bankruptcies are unlikely on those that AerCap is likely to allow some lease payment deferral.”

Nevertheless, Gregg remains cognizant of the challenges airlines currently face, stating forthrightly that “we may be shifting to an industry that’s overly long aircraft relative to what’s needed to satisfy near-term, shrinking air traffic demand. This is likely to have three impacts on AerCap: 1) the disruption this virus is causing global air travel is likely to accelerate the bankruptcies of any already poorly operating carriers and possibly some previously soundly run carriers (flybe the domestic UK carrier declared bankruptcy on 3/5 – AerCap doesn’t lease to flybe) 2) placing the aircraft that come out of bankruptcies is likely to take longer than it would have in a normal operating environment and 3) the prices AerCap achieves for the sale of mid-life aircraft are likely to decline from their previously attractive levels (typically 5-10% premiums above AerCap’s conservative marked book values for their aircraft).” With those challenges in mind, Gregg’s thesis, like Deuchler’s, is that the COVID19 outbreak is an idiosyncratic and transient variable particularly affecting the airline and travel industry.