Air Lease (AL, Financial), which is in the business of leasing aircraft to airline companies globally, has been a laggard in terms of stock returns even as the broad markets have surged higher. For fiscal 2016, Air Lease moved higher by just 3.3% and for the year to date, the company’s stock performance has been relatively better with returns of 9.2%.
This zone of long-term consolidation for Air Lease is a good buying opportunity for investors considering exposure to the stock for the next two to three years.
Big order book for growth
As of March 31 Air Lease had 353 aircraft for delivery in the coming years. The strong order book will ensure that the company’s revenue and cash flow growth remain steady.
The important point to note here is that the company has 100%, 99% and 91% of aircraft delivery in 2017, 2018 and 2019 placed under long-term charter. Therefore, as soon as the aircraft is delivered to Air Lease, it will be chartered and generate steady cash flows.
There are two other important conclusions here.
- First, the company’s growth is backed by leverage, and financing of aircraft delivery will not be a concern as the aircraft is already contracted on long-term lease and cash flow ready.
- Second, the robust leasing for aircraft that are scheduled for delivery in the next two to three years is indicative of the point that the industry is in good health.
To further elaborate on my bullish view, Air Lease had a weighted average lease period of 6.9 years with minimum future contracted rentals for our current and future fleet to $24.0 billion as of the first quarter. I don’t see any concerns related to steady cash flow.
I am focused on the company’s cash flow visibility and future contracts primarily because Air Lease has funded growth through leverage. For a bullish view on the stock, the first point that needed discussion was smooth debt servicing not just for fiscal 2017 but for the next few years.
Favorable industry trend
There are several industry trends that are positive for Air Lease and will ensure that leasing activity remains firm even beyond the next two to three years.
The first point to note is that for major regions globally, passenger volume is likely to grow at a CAGR of 4.9% between 2015 and 2020.
In particular, passenger volume in Asia-Pacific is likely to grow at a CAGR of 6.4% for the same period and projected growth is even higher for Africa at 7.9%. I expect steady demand for aircraft coming from these regions, and I am bullish on strong market activity in China and India.
The second point, when combined with the first, completes the story on the demand side. In 1990, leased aircraft were only 14.7% of the aircraft fleet, and it meant that airlines were more reliant on owning aircraft than paying lease rental.
In 2016, 39% of the aircraft fleet for airlines was through the leasing route. Therefore, airlines increasingly prefer to lease an aircraft for five or 10 years or more than an outright purchase.
This trend is likely to sustain as it does not burden the airlines industry balance sheet. Considering this factor, Air Lease has a favorable industry trend that is unlikely to change anytime soon.
Well-managed capital structure
For a company with total debt of $9.0 billion as of March, the capital structure needs to be discussed and Air Lease has a well-managed balance sheet.
The following points are worth noting in the company’s capital structure and credit profile.
- As of March the value of the company’s leased aircraft was $12.6 billion and for the same period, the total debt was $9.0 billion. This translates into loan-to-value of 71% and indicates further financial flexibility.
- As of March Air Lease had fixed-rate debt of 85%. This is important as interest rates are trending higher and debt servicing cost could have increased significantly in the scenario of higher percentage of floating rate debt.
- As of March the company’s contracted cash flow was 107% of the total debt, and this is an indication of the comfortable buffer provided by the long-term lease. Even with relatively high leverage, debt servicing concerns are minimal.
Considering these points, it is not surprising to see Air Lease command an investment grade capital structure with Standard & Poor's and Fitch rating of BBB.
Since I discussed the book value of the aircraft and the loan-to-value buffer, it is also important to mention here that as of fiscal 2017, the average age of the company’s fleet is just 3.7 years and the average age is likely to be 4.1 years by 2022. With a young fleet, the lease duration is likely to be long, and the resale value of the aircraft will also be high.
Air Lease has been reporting negative free cash flows, but I don't see that as a concern with robust credit rating for leveraging. Once the big investment cycle is over, the company's cash flow is likely to translate into higher dividends and shareholder rewards.
Conclusion
Air Lease has a well diversified presence with relationships with 200 airlines in 70 countries. The company has also made good inroads in high growth markets of Asia and Africa.
With strong fundamentals, clear revenue visibility and sustained growth from new aircraft delivery, Air Lease is certainly worth considering for the medium to long term.
The stock has underperformed in the last 12 to 18 months, and this is a good opportunity to accumulate for the next two to three years.
Disclosure: No positions in the stock.
