The Commercial Plane Shortage: Why Air Lease is a Beneficiary
TLDR; Boeing has had ongoing production problems for years and Airbus is being held back by supply chain issues. The resulting shortage of commercial planes means that already built and functioning planes are more valuable. Through the stock of Air Lease, we believe investors can own planes and the associated leasing income for a big discount and represents an attractive opportunity. While the stock currently trades under $43 per share, we believe it is worth $65-$100.
Who is Air Lease?
Some History: Steven F. Udvar-Hazy long ago recognized the need for airlines to partner with leasing companies to finance their aircraft. He helped pioneer the industry back in 1973 when he co-founded International Lease Finance Corporation and sold it to the insurance company AIG in 1990 where he built it into the most valuable aircraft lessor in the world. After AIG came under fire from the financial crisis in 08/09, he left the company and AIG sold off the business to AerCap. Steven’s right-hand man since 2002, John Plueger, went with him to form Air Lease in 2010.
The Business: The business is relatively simple. Air Lease makes purchase orders for planes from Airbus and Boeing and then, upon delivery, leases the aircraft to airlines. They do this on long term (about 10 years) contracts that are triple net. This means the airlines are responsible for things like fuel and maintenance. Air Lease gets paid a fixed rate regardless of how full the plane is or how often they fly. Currently, Air Lease owns 474 aircraft with an average age of 4.7 years and leased out to 120 airlines in 62 countries. They also have about $19B in aircraft on order, 64% of which is already spoken for by customers.
Why don’t the airlines just buy planes directly? They do, but the leasing model is becoming the preferred route for a few reasons:
Cost of financing: Because of the diversified and relatively stable revenue model, Air Lease gets cheaper financing compared to airlines. They are simply viewed as a safer bet to lend to and receive an investment grade credit rating by S&P whereas few airlines could say the same.
Business Planning: Aircraft must be ordered several years prior to taking delivery, even without delays from manufacturers. Air Lease expects some of EXISTING orders to be delivered in 2029 or later. As an airline, it is difficult to accurately predict with that much lead time what types and how many aircraft their business will require. By leasing, they can delay that decision until about 18 months before taking delivery. Air Lease buys sufficient quantities of various aircraft to play matchmaker with the airlines.
What’s Air Lease Worth?
A simple business model allows for a simple heuristic on valuation. This company's value is derived from its assets, mainly its airplanes. There are no “intangible assets” to report like goodwill that are difficult to measure. Air Lease has roughly $31B in assets on their balance sheet against about $23.7B in debt and other liabilities. This means that assuming you could sell the assets for list price, the company could taken apart and sold in pieces with $7.3B (or $65.61 per share) in cash left over. The value of the company’s stock is at about $4.8B or (just under $43 per share). Buying $65 for $43 sounds pretty good, but I think it’s better than that.
The $31B asset number has some adjustments related to accounting. Yay! Accounting! I’ll keep it brief. The value of planes on their books assumes a constant decline (depreciation) in value over a 25-year period with an ending value of 15% of purchase price (scrap value). Because of the shortage of aircraft (see supply and demand sections) Air Lease has been able to sell its older aircraft for about 11% more than the value on its books. Of the $31B in assets, about $28B is planes. If we assume that the average plane is 11% more valuable, then you can tack on another $3B+ in value. We are up to $10.3B or around $91 per share.
And just for kicks, they have an upcoming lawsuit with their insurance company for the reimbursement of $771M for planes that were seized by Russia. You could also make an argument that because much of their order book was placed at prices that would not be achievable today (due to going from Covid worries to now an airplane shortages), there is additional value in those contracts. The $100 range is not out of the question, in our view.
Supply Problems
Both Airbus and Boeing have had difficulty ramping up production of aircraft. Deliveries at the two firms have been stuck at about the same level since 2019 (see chart below). It might seem counterintuitive, but this is a GOOD thing for Air Lease and other air leasing companies. Air Lease negotiated their orders prior to the shortage becoming apparent.
Now the airlines are faced with two options:
1.) Win a bidding war
2.) Lose market share to competitors
Boeing seemingly lost its way from an engineering and safety culture long ago and because aircraft involve long design and testing lead times, it is difficult to see their issues corrected overnight. Recent issues started coming to light in 2019 with the 737 Max software problems. More recently, they have taken to forgetting to properly fasten panels. These are not isolated incidents. Five years into this Boeing is still not exactly impressing. They recently agreed to a charge of conspiracy to defrauding the United States over the 737 Max crashes.
Air Bus recently cut their 2024 delivery guidance from around 800 to around 770 commercial aircraft citing supply chain issues including but not limited to engines, aerostructures and cabin equipment.
Demand
It is no surprise that travel demand fell off a cliff during the pandemic. Remember though, Air Lease still got paid on their leases during that period due to the contract structure. During that period, airlines weren’t exactly plotting expansion, which left fewer bidders. We don’t know the exact details of the orders Air Lease placed during that period, except their comment suggesting it would not be possible to get the same price today. Fast forward to 2024 and air traffic is growing quickly but deliveries of aircraft are stuck in the proverbial mud.
What will Air Lease do with all that profit?
Air Lease has expressed a desire to reduce the debt on their balance sheet relative to the amount of their assets. This will likely be achieved sometime in the next 12 months or so. They currently pay a cash dividend as well (the stock currently yields about 2%). They do have a lot of orders coming in over the next few years that will require significant capital, but as they reach their leverage targets we expect Air Lease to turn its attention towards buying back their own stock. This could end up being a very significant driver of value. Air Lease trades at about 10X analyst estimates for 2024 profits. If they directed 100% of profits towards buybacks they would be purchasing 10% of the outstanding shares. However, the favorable leasing terms agreed upon as this shortage developed have not yet come into force so we expect their profits to grow from here. If our analysis is correct, Air Lease will become a major buyer of its own stock and drive the price higher.
Risks – What do we see as the biggest risks?
Geopolitical – Major or regional wars could cause oil prices to skyrocket and/or depress demand for air travel for many years making new leases uneconomical and cause financial distress amongst their airline customers.
Major Recession – A major economic recession could lead to reduced air travel globally for years leading to a weak leasing environment.
Supply Returns – We believe it will take several years for Airbus and Boeing to meet demand. However, it is possible they surprise us by ramping up production more quickly than we anticipate. We believe this is many years into the future but eventually they will supply the market in whole and/or another supplier will eventually emerge and oversupply the market.
Final Thoughts
At Aurora, we are constantly looking for attractive investment opportunities for our clients. We look for businesses with economic moats, quality balance sheets and attractive upside potential. This blog represents our thinking at the time of publication. If you are a DIY investor, use this only as a starting point for your research and be sure to do your own due diligence. For questions regarding our asset allocation and individual stock strategies, please reach out to us!
Invest Curiously,
Austin Crites, CFA
Austin Crites is the Chief Investment Officer of Aurora Asset Management, an Indianapolis-based subsidiary of Aurora Financial Strategies which is located in Kokomo, IN. He can be reached via email at austin@auroramgt.com. Investment Advisory Services are offered through BCGM Wealth Management, LLC, a SEC registered investment adviser. This blog does not constitute advice. This is not an offer to buy or sell securities. Advisor is not licensed in all states. Any mention of a particular security and related performance data is not a recommendation to buy or sell that security. BCGM Wealth Management, LLC manages its clients’ accounts using a variety of investment techniques and strategies, which are not necessarily discussed in the commentary. Investments in securities involve the risk of loss. Past performance is no guarantee of future results. Clients may own positions in the securities discussed. SEC registration does not constitute an endorsement of the firm by the SEC nor does it indicate that the adviser has attained a particular level of skill or ability.
