Portfolio Spotlight: AerCap
Share Cannibal devoured 20% of shares outstanding in 2023, while trading < 8 P/E. The CEO "gets it".
Disclaimer: This content is for educational and entertainment purposes only and is not intended as financial advice. Perform your own research and consult a qualified financial advisor. The author may hold positions in the discussed stocks. This is not a recommendation to buy or sell securities.
Imagine a stock trading below 8x fwd P/E. The CEO strategically sells company assets above book value and and uses the proceeds to buy back shares below book value. They're on track to repurchase about 20% of their shares in 2023!
“As long as that trade continues, we'll keep hitting it.”
“It should be clear from our actions that we see significant value in our stock today and that these repurchases create long-term value for our shareholders”
This CEO owns 2.6% of shares outstanding, worth over $400m. He says things like:
“I don’t care about growing my balance sheet, I care about making profit”
“The only thing that we think about is how to create value for our shareholders. …my shareholders pay my wages. … You're here for your shareholders and no one else.”
When I come across an investment pitch like this, to be honest, I'm not even sure I need more information. Does it even matter what the business is? As long as it’s not an overly cyclical stock with delusional management, this setup seems like a winner to me.
But ok, maybe you do prefer a bit more detail. No worries, I got you!
Intro
AerCap is the biggest aircraft lessor in the world. The business consists out of buying assets (airplanes), financed through a mix of about 30% of equity and 70% of debt. The core of their earnings comes from the spread between the cost of funding and the leasing yield (= what they get for renting out the plane).
Bigger players in the industry have an inherent advantage for a variety of reasons. But the main one has to be having the lower cost of capital, which boosts profitability.
Valuation
AerCap just upgraded its FY2023 outlook to $9.5 EPS. At a current share price of $74.32, this is a P/E of 7.8x.
The assumptions in this outlook are conservative, so AerCap should be able to beat this. On top of that, CEO Aengus Kelly expects the current tailwinds for the industry to continue over the next few years.
My simplified way of thinking about valuation is that the stock should be worth at least 1x book value. Maybe it never gets there… but that’s more than fine with a CEO smart enough to take advantage of it by aggressively buying back stock, with value accruing to remaining shareholders.
It's important to note that the current reported book value ($78.28 at the end of Q3 23) likely understates the actual value. More about that later in this post.
Tailwind
AerCap is currently enjoying a tailwind created by supply constraints hitting the post-COVID air traffic rebound. Kelly said during the Q3 23 earnings call:
“Everybody knows that the OEMs are not going to make the number of airplanes they're saying. That's just not going to happen. And every airline in the world knows that. “
After 2020, Boeing and Airbus have been dealing with screwed up supply chains and they are simply not going to achieve their stated delivery targets.
On top of that, there are issues with Pratt & Whitney engines on the Airbus A320neo. The problem forces airlines to ground their Airbus A320 fleets because the engines need to get inspected. This take airplanes out of service, increasing the pressure on available supply.
In a short interview on CNBC from a couple of weeks ago, Aengus explained why he sees supply shortages for the rest of the decade:
We are 3000 planes "short" from trend since 2019. They only produce 1200 per year!
Engine issues: the network isn't there to repair them when they break this fast. Not enough maintenance parts. When in the past you needed 10 planes to cover a route, maybe now you need 11 (because one or more planes are offline for maintenance)
Book Value
This excellent article goes deep into why current reported book value ($78.28 - Q3 23) understates real value, and makes the case for it being $123 per share.
The biggest driver is caused by acquisition of GECAS (GE Capital Aviation Services) at the end of 2021. Long story short: AerCap basically acquired $36B of assets for $30B. But post-transaction, they are on AerCap’s books for $30B. So the book value understates the real value. The author of the SA article thinks this is worth about $20 per share. He makes some other points, but I’ll just stick to this one showing that real asset value is at least $100 and likely more.
Buybacks & GE Ownership
As a result of the GECAS transaction, GE ended up owning over 45% of AerCap shares at the end of Q4 2022.
GE has sold its stake in 3 big secondary offerings in 2023 and no longer owns any shares as of November 16th. AerCap took big bites out of every one of these. This was a real gift to them: normally companies end up having to pay a premium to buy back 20% of the float in a year.
"And clearly, today, we firmly believe the cheapest aircraft in the world are the AerCap shares. We are selling assets to professional aircraft traders at significant gains & then buying back the shares in our own business from what the public equity market values our aircraft at a significant discount. As long as that trade continues, we'll keep hitting it."
(CEO Aengus Kelly during Q2 23)
While GE selling AerCap shares put downward pressure on the price, it did allow AerCap to increase intrinsic value per share. With those shares now absorbed by the market, continued buybacks will put more upward pressure on the share price. Good if you want number go up, bad if you want value creation from buybacks below book.
Why does the Opportunity Exist - Risks?
AerCap is very levered and the share price gets hit hard in times of stress and uncertainty. The company however has managed to successfully pass these tests.
Airlines are a notoriously bad business. But it’s important to realise that AerCap has a different business model than airlines, and the CEO is doing his best to get out that message. AerCap gets paid before the shareholders of airlines do.
Rising rates may sounds scary. But in a recent in depth interview, Aengus Kelly made it clear that it’s not a big deal, at least directly:
From a lessor perspective: increase in rates has been passed on to the customer. The increase in leasing rate is not really a big deal for airline's P&L. Increase in leasing rate has no real impact in airline's decision to take the airplane or not. That decision is driver by consumer demand (and global demand is robust).
Higher for longer? Doesn't matter: it's the cost of doing business and we pass it on to customers. Our most profitable years (as ROE) were with 5% interest rates pre-GFC.
(Indirectly the impact of interest rates on the global consumer matters: how much money does consumer have to spend?)
The world can be a scary place. It may seem like we have more geopolitical issues lately than we used to. When asked about it, Aengus didn’t seem worried and replied:
(Geopolitical issues?)
They world always has them. But the structural trend of more and more people flying every year, is there.
And finally: from a “flows” perspective (as opposed to a value investing perspective based on company fundamentals): AerCap is not US-domiciled and doesn’t have high index ownership. In an environment where a lot of money flows into big indices, or is benchmarked against these indices, orphan stocks like AerCap simply don’t get the appreciation they should. This however is an opportunity for aggressive, value creating share buybacks!
Resources
There are a couple of interesting follows on Twitter/X that regularly talk about the stock:
AerCap has been written up multiple times on Value Investors Club
Value Vault on Seeking Alpha has written multiple in depth articles about the company
CNBC interview with CEO from 7th Dec 2023
In depth CEO Interview - KPMG Aviation Industry Leaders Report 2024
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What's your opinion on the recent 737 max incident? Is it bearish for Aercap or it wont change a thing?