AerCap Holdings (AER, Financial) is an aircraft leasing and aviation finance company. As of Sept. 30, the company had 1,168 owned and managed aircraft and 439 aircraft in their order book. The company caters to around 200 customers in approximately 80 countries. The global presence of AerCap helps it to achieve a broad market penetration while catering to the middle class of developing nations. I believe AerCap has the potential to grow and can be a good value stock.
Industry outlook
The world has witnessed economic turbulence over the past few years, yet the airline industry has not been significantly impacted. Air traffic has doubled every 15 years and in fiscal 2016, world traffic is expected to increase by 6.2%. A major revenue driver of the industry is the growing middle class, which is expected to increase over the next 20 years from 2.8 billion in 2015 to 4.8 billion. Moreover, with increasing per capita spending, the middle class is expected to contribute significantly to air traffic.
This, in turn, has resulted in increased demand for new aircraft. According to Boeing's Current Market Outlook 2016, the industry needs more than 39,600 new aircraft in the next 20 years, which means airlines and lessors are expected to receive five new aircraft every day. The major advantage of the companies operating here is the high entry barrier and fewer players in the industry. Since AerCap is the leader in the industry, the company has a competitive advantage based on its high cash generation and capital expenditure potential.
Fleet status
In the third quarter, AerCap operated at a 99.5% fleet utilization rate and generated more than $2.8 billion of adjusted net income post its International Lease Finance Corp. acquisition in 2014. In the last quarter, the company has been able to complete 143 aircraft transactions, including 96 lease agreements. Moreover, the company has been able to place its future scheduled expiries, further enhancing their already strong revenue visibility.
Considering the company’s excellent order book and its ability to schedule the delivery of 95% of aircraft by 2018, I believe AerCap has one of the strongest fleet statuses.
Compelling cash flows with appropriate capital deployment
In the first nine months of the year, the company generated operating cash flow of around $2.5 billion. The operating cash flow has increased by approximately $7.5 billion since the ILFC acquisition. AerCap is a capital-intensive company. The business demands significant capital investments, for which the company has incurred a high level of debt.
The company currently has a liquidity of $8.7 billion with cash and cash equivalents of $2.2 billion, and undrawn lines of credit of $6.5 billion. For fiscal 2017, the company has a total contractual obligation of $9.6 billion that can be easily met with current liquidity and operating cash flow.
Also, the company will have excess cash to return to its shareholders in the form of share repurchases. AerCap has been deploying its excess cash to repay its debt and the debt-to-equity ratio has declined from 3.8x in 2014 to 2.7x in 2016. Considering a strong liquidity position along with a disciplined approach in deploying capital, I believe investors need not worry about the company’s debt profile.
Valuation
The valuation of a company is key to long-term investments. The company is currently trading at an EV/EBITDA of 8.3 compared to Fly Leasing's (FLY, Financial) EV/EBITDA of 8.5, Atlas Air Worldwide Holding’s (AAWW, Financial) EV/EBITDA of 14.5 and the industry median of 10.
AerCap also has a forward 12-month price-earnings to growth ratio (PEG) of 0.70, which indicates gross undervaluation. Considering the large market cap and attractive valuation, I believe AerCap is most likely to outperform in the medium to long term.
Conclusion
With strong fundamentals and relative undervaluation, the company is a lucrative opportunity for investors interested in the airline industry. Since the company has an excellent fleet status with clear revenue visibility for next few years, I believe AerCap is well positioned to keep its investors happy.
Disclosure: No position in the stock discussed.
Start a free 7-day trial of Premium Membership to GuruFocus.
