Aircastle: Further Stock Upside and Healthy Dividends

I have been writing on the aircraft leasing sector for the last few years, and the sector has not disappointed in terms of growth and returns. Among a few players in the industry, my favorite stock pick has been Air Lease (AL, Financial), but I have also covered stocks like Aircastle (AYR, Financial) and AerCap Holdings (AER, Financial) whenever I have seen good buying opportunities in these stocks.

This article will revisit Aircastle, and as the discussion proceeds, it will be clear that it’s an interesting time to consider exposure to the stock.

Aircastle has trended higher by just 10% for this year as compared to upside of 21% for AerCap Holdings and upside of 52% for Air Lease. 2018 can be potentially good for Aircastle, and the stock is likely to trend higher.

I must add here that purely from a dividend perspective, Aircastle is attractive with a dividend payout of $1.12 that translates into a dividend yield of 4.8%. Payout is sustainable and can possibly increase in the next 24 months. This article will elaborate on the reasons.

The growth push

The revenue model in the aircraft leasing industry ensures stability and clear visibility on cash flows. That’s one factor that is largely discounted in the shares.

But the key stock upside triggering factor is the growth visibility in the coming quarters. This is one of the key reasons to be bullish on Aircastle for 2018.

On Oct. 3, Aircastle announced an agreement to acquire 20 narrow-body aircraft from SMBC Aviation Capital. These aircraft are on lease with 13 airlines globally.

Aircastle has already acquired 28 aircraft this year, and the company expects to close 2017 with owned and managed fleet of over 220 aircraft.

The newly acquired aircraft will increase the revenue and cash visibility for 2018. This is likely to translate into stock upside considering the point that Aircastle has been increasing dividends on any potential growth. An increase in dividend in the next 12 to 24 months will further result in stock re-rating and upside.

Another important point to note is that Aircastle has improved its fleet age from 11 years in second-quarter 2012 to 8.7 years in third-quarter 2017. With further aircraft acquisition, it is likely that the average fleet age will decline, and that can potentially help the company improve on its weighted average lease terms.

As compared to Air Lease or AerCap Holdings, another differentiating factor for Aircastle is that the company has minimum long-term purchase commitments. Based on the financial resources and industry outlook, the company can increase or reduce its investment plans.

Considering the acquisitions in 2017, Aircastle seems to be in a relatively aggressive growth mode, and an increase in top line and EBITDA in 2018 will take the stock higher.

Strong financial position

For growth through acquisitions and for sustainability of dividends, the company’s financial outlook needs to be discussed. Aircastle has high financial flexibility, and the following points underscore my view:

1. As of Sept. 30, Aircastle reported cash and equivalents of $662 million, and that provides strong buffer for investments. Further, based on nine-month numbers, Aircastle is likely to report annualized operating cash flow of $520 million and that provides liquidity for acquisitions and dividends.
2. Aircastle is likely to report annual interest expense of $210 million to $220 million. Considering annualized EBITDA of $800 million, the company’s EBITDA interest coverage comes to 3.6, and this implies smooth debt servicing capability coupled with ample headroom for leveraging.
3. As of the third quarter, Aircastle reported net book value of flight equipment amounting $6.0 billion. With total debt of $4.1 billion for the same period, the loan-to-value is comfortable at 68%. Further, the net book value of unencumbered flight is $4.6 billion as of the third quarter, and this gives ample financial headroom.
4. As of the third quarter, the company’s weighted average lease term was 4.7 years and with more aircraft acquisition, I expect the lease term to improve. With a strong cash flow backlog, I don’t see any financial concerns.
5. For the third quarter, Aircastle reported portfolio yield of 12.3% and for the same period, the company’s net cash interest margin was 8.8%. With a comfortable gap between the yield and NIM, Aircastle can leverage for growth without any concern.
6. While Aircastle has aggressively purchased new aircraft, the company has also opportunistically sold aircraft, and it expects fiscal year aircraft sales proceeds of nearly $900 million. This adds to the financial flexibility and also allows Aircastle to design its aircraft portfolio based on demand.

Conclusion

The airline leasing industry has gained significant traction in the last decade, and this positive momentum is likely to continue with steady economic growth globally coupled with demand for leasing as compared to aircraft purchase by airline companies.

Aircastle reported 100% fleet utilization for the third quarter and even with an expanded fleet; I expect the utilization to sustain at these levels. With newly acquired aircraft to deliver growth in fiscal 2018, the stock looks promising at current levels with a medium to long-term investment horizon.

Disclosure: No positions in the stocks discussed.