In tough economic times, a high debt load can cripple a company. But when business is good, that debt can actually be a real benefit. That's because equity comprises just a small part of the company's total enterprise value (market value plus debt minus cash) and profits can become quite large relative to that small equity base. But investors remain wary of debt-laden companies, recalling that these were among the stocks that appeared to be headed toward bankruptcy when the economy started heading south two years ago.
As a result, shares of companies that buy and then lease airplanes to the major airlines, all of which carry lots of debt, are among the cheapest in the stock market. Yet if the global economy stays aloft and can finally grow, then these companies could see impressive profit and dividend growth.
Right now, the stars are aligning for this industry. Airline traffic is up +10% from a year ago, banks have become very supportive by providing very low interest rates for asset-backed loans for airplanes, and the key players are generating strong cash flow that is helping to reduce debt levels. Most importantly, a glut of unused airplanes that sat idle are returning to service, and with fewer airplanes available, lease rates are rising.
The industry is dominated by the finance arms of GE (NYSE:GE) and AIG (NYSE:AIG). But investors can play the sector through smaller players such as Aercap Holdings (NYSE:AER), Aircastle (NYSE:AYR), FLY Leasing (NYSE:FLY) and Willis Lease Finance (NASDAQ:WLFC). And as this table shows, all of these stocks appear quite cheap on a price-to-earnings basis:
|Company||Recent Price||Market Cap||Enterprise Value||Price/|
|Div.Yield||2010 P/E||2011 P/EEst.|
|FLY Leasing (NYSE: FLY)||$12.48||$353M||$1,468M||0.7||6.5%||7.8||10.1|
|Willis Lease (NYSE: WLFC)||$9.83||$92M||$742M||0.5||none||28.9||5.6|
As long as these stocks remain below book value, share buybacks make plenty of sense. And that's what FLY Leasing is doing. The company's fleet of planes (minus its debt) is worth more than $17 a share, well above the recent $12.50 share price. Of course, any weakening in the economy would change that equation. (In 2008, when the economy was sliding, airline lease rates fell sharply, dragging down the value of planes, so FLY Leasing's book value then was just $12 a share.)
Action to Take --> If the economy weakens anew, then these debt-laden stocks would be especially vulnerable. But all signs now point to a healthier airline industry. Lease rates should continue to rise as demand for new and used planes exceeds production from Airbus and Boeing (NYSE:BA). If you're in search of dividend yields, then Aircastle and FLY Holdings should hold great appeal, as these firms look set to hike their dividends further in 2011 as cash flow rises. Aercap is likely the most stable name in the group due to its relative size, which helps it to arrange special banks loans on especially favorable terms.
-- David Sterman
David Sterman started his career in equity research at Smith Barney, culminating in a position as Senior Analyst covering European banks. David has also served as Director of Research at Individual Investor and a Managing Editor at TheStreet.com. Read More...
This article originally appeared on StreetAuthority
Author: David Sterman