AerCap Holdings (AER, Financial) is an independent aircraft leasing company with a robust business model. Amid positive developments in the company from a fundamental perspective, the stock has trended higher by just 5.2% this year. The stock is likely to break out on the upside in the foreseeable future.
Here is the concern most investors might have when looking at the company’s financials. As of the third quarter, AerCap Holdings had total debt of $29.3 billion with an average cost of debt at 3.6%. However, high debt is not a concern considering the following points:
The aircraft leasing industry’s growth is backed by debt since aircraft purchase requires significant funding. Not just AerCap Holdings, other players in the industry such as Air Lease (AL, Financial) also have significant debt.
As of Sept. 30, AerCap Holdings had 5.9 years of remaining average lease term. In other words, there is strong revenue and cash flow visibility for the next few years; this ensures that debt servicing is smooth.
As of September, AerCap Holdings had cash and equivalents of $1.3 billion and the company’s operating cash flow for 3Q15 was $796 million. This translates into an annualized operating cash flow of nearly $3.2 billion and makes the company liquidity position robust.
As of Sept. 30, AerCap Holdings had total available liquidity (in the form of undrawn credit facility) of $6.4 billion; this underscores the point that the financial institutions don’t view current levels of debt as a concern, and further leveraging is likely for growth.
It is a part of the company’s strategy to sell aircraft that are relatively older. For the first nine months of 2015, AerCap Holdings sold 55 aircraft and this provides additional liquidity boost from time to time. Further, it also reduces the overall age of the company’s aircraft fleet.
Considering these factors, the company’s debt is not a concern, and investors should instead focus on the company’s growth and cash flow potential in the coming years. From a growth perspective, AerCap Holdings has 458 aircraft on order for delivery through 2022. This will ensure that the company’s growth trajectory is stable in the coming years.
An important point to note here is that in the last 12 months, the lease agreement that has been signed for new aircraft have an average lease term of 11.6 years. This is significantly higher as compared to the company’s current lease term of 5.9 years. The point I am trying to make is that as new aircraft are delivered, the company’s average lease term will increase, and this will further strengthen the revenue visibility.
Smooth leasing of new aircraft with strong demand from the airline industry in emerging Asia is to be expected. With new aircraft likely to be leased well in advance of being delivered, financing for new aircraft shouldn't be a concern.
AerCap Holdings has a strong credit profile even as the company is significantly leveraged. Further, the company’s debt is likely to increase over the next three to five years, but that will be associated with an increase in EBITDA and cash flow. With a big pipeline of aircraft delivery, the stock should trend higher in the foreseeable future. From a valuation perspective, AerCap Holdings is trading at FY16 PE of 6.8 and price-to-book value of 0.98. This provides some insights on the company’s attractive valuation. Exposure at current levels and on any decline is advised.
Disclosure: No positions in the stock
