Lease Your Airplanes With Air Lease


Business Description

Company: Air Lease Corporation (NYSE: AL) is the largest aircraft leasing company in the world. They purchase commercial jet aircrafts from the manufactures and lease them to airlines around the world. Currently, the company has leasing relationships with more than 200 airlines in over 70 countries. They also facilitates sales of aircraft to other leasing companies, financial services companies, and airlines. Finally, Air Lease Corp. provides fleet management services for aircraft owners. Air Lease Corp. diversifies its portfolio of leases and lessees by geography, lease term, age, and type of aircrafts. International sales account for 95% of the company’s revenue

Current Events

A: New Orders: Air Lease announces new orders from Azores Airlines for six new Airbus A321s. In this same report, it stated that Azores was expected to be ordering more planes in the future. This was the first placement of a long-term lease agreement signed between Air Lease and Azores Airlines.

B: Earnings/Revenue Beat: Air Lease beat third quarter earnings and revenue expectations. Earnings per share increased by 19.2% while the bottom line increased by $26 million and revenue beat by 7%. Guidance as well as price targets remained unchanged from Morgan Stanley and JP Morgan.

C: New Orders/New Partnership: Air Lease announces new orders with China Southern Airlines for five new Boeing 787-9’s. This is the third order from China Southern since July 1of 2016. China Southern is the eighth largest airline in the world and increasing lease placements every year.

D: Delayed Delivery/Downgrade: Airbus reports delays in aircraft delivery due to Pratt and Whitney delaying production of engines for the A330’s. In this same period, ALC was downgraded at Morgan Stanley from overweight to equal weight. Price target was revised down from $45 to $43.

E: Earnings/Revenue Beat: ALC reported that revenue rose 8.8% Y-o-Y. While earnings rose 9.5% Y-o-Y and EPS rose 8.6% Y-o-Y. EPS came in at $1.51 a share compared to $1.39 a year ago. RBC and Morgan Stanley raised ALC’s price target to $77 from $73 and $46 to $43 respectively.

Reasons the Roland George Investments Program should hold Air Lease Corp.:

• Growth in Global and Asian Markets: In 2016, Asia (Including China) accounted for 45% of Air Lease’s total revenue. Capital inflows into Asia reached $51 billion in 2016 and that number is expected to increase to $72 billion by 2020 according to the International Monetary Fund. Furthermore, the Asian market is expected to have GDP growth of 5.5% in 2017 and 5.4% in 2018. China alone accounts for 21% of total revenue for the company, and China is expected to grow GDP by 6.5-7% year over year through 2019.In addition to Asia, the International Monetary Fund projects a GDP increase of 3% for 2017 and 3.4% increase in 2018. Lastly, according to Boeing, 41% their orders with Air Lease are going to airlines in the Asian region.
Globally, Air Lease expects passenger air travel to increase by 50% through 2035, with Boeing mimicking their estimates and Airbus expecting growth of 50% 2036. According to IATA air travel is expected to increase in Asia by 4.1% annually and 4.2% globally. Airbus is projecting long term growth of 4.4% annually in global air travel, while Boeing expects 4.8% annually through 2035. It is projected by Wells Fargo that over the next 20 years, China will overtake the United States in air travel due to projected growth of 4.7%.

Trump and Trade:

President Trump’s trade policy has the stated goal of ensuring the U.S. has a “fair opportunity” in the local and global markets. The policy suggests actions such as renegotiating trade deals, using leverage to ease foreign tariffs, and protecting U.S. IP in foreign markets. The policy is light on specifics and heavy on repetition, but one country it mentions specifically is China, focusing on the growing trade deficit. Despite the hostile rhetoric on China during the campaign, Trump’s posture softened once he took office. He realized that China is a necessary ally when containing the North Korean threat. Similarly, the U.S. economy relies heavily on trade with China. This puts America between a rock and a hard place with regards of renegotiating trade deals with China. On top of that, Trump’s advisors would never allow him to act on his rhetoric with hopes of maintaining a good relationship with China. Gary Cohn, National Economic Council Director Gary Cohn views China as both an economic equal and adversary and has talked about a balanced, multinational approach to China rather than sudden and sporadic action. With this in mind, Air Lease’s Asian operations are secure with regards to geopolitical headwinds for the short to medium term outlook.

According to Politifact, trump has only kept 7.9% of campaign promises thus far. 25% of his campaign promises have failed and 4% have been broken. While he does have 64% of campaign promises either in the works or not started, policies that require congress have failed for the most part. Stopping trade with China, or any country would be a decision that would require congress to vote and approve a new bill. Given trump’s track record with congress so far, a decision like this would not pass. Furthermore, making the decision to eliminate China as a trade partner would cause both the U.S and China to go into a recession and could possibly cause a global recession. This is not something Trump would risk having happen as it would hurt the U.S economy, the thing he campaigned the most on fixing. If a global economic slowdown were to happen, air travel would be one of the first industries hit, causing airlines to need less planes and Air Lease to lose customers. However, based on the 1.2% price increase the day after the election, the market does not seem to be too concerned with Air Lease being affected by Trumps stance on China. In the data provided by politifact, the only mention of China is that Trumps plan to eliminate China from the World Trade Organization is in progress but appears to be stalling.

Based on the lack of progress on any of Trumps policies thus far, the probability of there being stoppage in trade with China is not probable.


• Interest rates on the Rise: Since the Election of President Trump, the economy has been improving. According the St. Louis Federal Reserve, the economy is on track to reach Trumps 4% GDP increase by the end of this year, and economic data is improving. According to Janet Yellen’s last statement, job growth is in line with estimates and growth is appearing stable. We have been in a rising interest rate environment since Q3 of 2015, and according to Jim Rickards, an economic lawyer and New York Times best-selling author, the Federal Reserve will raise interest rates 25 basis points every quarter until we get to 350 bps on the federal funds rate. There are three reasons the federal reserve would not raise interest rates including, job growth below 75000, deflation, or a stock market selloff of 10% or more. With none of these pause conditions in place, the probability of not increasing interest rates is low The risk of rising interest rates on debt is low as well. Air Lease has long term debt of 9.2 billion with almost off it being a fixed rate, or floating rate between 2.5 and 4%. Higher interest rates are good for Air Lease because that allows them to charge more for leases. They are currently increasing lease costs at an estimated 1.3% per year, and with higher interest rates, causing higher inflation, that will allow Air Lease to grow the rate at which lease costs rise and allowing the company to make more money. My projection is that lease placements will be increasing globally at 13% a year, an Air Lease will be increasing the price of a lease contract at 1.8% a year starting in 2019.

Growth Drivers

• Move toward Leasing: Per IATA, in 2015 32% of all European aircrafts were leased. That number is expected to rise to 40% by 2020 and 60% by 2025. American Airlines, the largest airline in the world by revenue has a fleet of 1063 aircrafts, 45% of that fleet is leased, up from 42% in 2015. China Southern, the eight largest airline in the world increased the percentage of leased aircrafts in 2016 to 32% from 28% in 2015.

• Aging Aircraft Fleet Globally: Air Lease focuses primarily on leasing to airlines who have planes older than one third of their useful life, which is eight years. Per Boeing, there are currently 23,000 planes in the world and 43% of them are above their useful life. In addition, Boeing expects there to be 400 replacements a year globally and it is projected 60% of those aircrafts will go to leasing companies around the world with 25% of those replacements going to Asia. Furthermore, by 2023 Air Lease expects 17,000 aircraft to be at or exceeding their useful life. In addition to Air Lease being able to replace planes close to or at their useful life, the International Aviation Association (IATA) expects aircraft leasing to reach 60% by 2023. American Airlines currently leases 42% of their aircrafts, and expects that proportion to increase to 50% by 2020.
• Aircraft Leases: The airline industry is one that is continuously evolving and has many complex parts and features to it. Airlines need constant flexibility and updating of their fleet to accommodate the needs of travelers. Air Lease allows the major airline companies to have access to the fleet of their choice without having to bear the entire financial burden of buying individual planes. Air Lease works directly with major airlines to assess their needs and create a long-lasting business relationship. Air Lease requires all payment in U.S. dollars to eliminate some of the foreign exchange risk. The company retains the rights to all the aircrafts, while all responsibility required for operation is on the airlines.
Air Lease corporation currently has all of their aircraft for 2017 and 2018 leased, 91% for 2019, and 84% of their aircraft are currently leased for 2020. Out of an additional 400 aircraft on order, 100 are currently reserved for lease. However, the first delivery was delayed by two months, inevitably pushing future deliveries further out.

• Customer Lease Placements: Air Lease has been increasing the number of aircraft in their fleet and thus increasing the number of planes leased to customers. As of December 31st 2016 Air Lease has 240 planes and all were leased to customers. As of June 30th (Q2 17?), rental payments from customers increased Y-o-Y from 23.8 billion to 23.9 billion. This is a breakdown of 9.8 billion of existing customer lease payments for 2017 and 14.8 billion in new lease placements through 2020. In the last 5 years, the average cost of a lease contract rose 8.8%, showing that Air Lease can increase the price of renting while also increasing their customer base. The current amount for rental contracts is $9.8 billion, compared to $9.3 as of December 30th of 2016 (Q416). Committed fleet rentals are also up from $14.1 in December 2016 to $14.4 in June of this year. The company expects current rental contracts and committed fleet rentals to increase to $10.1 billion and $15 billion, respectively, by December of this year. Lastly, Air Lease is seeing a larger demand for rentals from its larger customers. China southern has gone from making up 6% of revenue to 8% of revenue in 2017. While Air Lease has a policy of not letting any one customer make up more than 10% of revenue, this is a sign that Air Lease’s third largest customer by revenue is making a larger commitment to leasing and the company expects other customers to follow suit.

• Aircraft Sales & Management Strategy: Air Lease Corporations strategy is to maintain a young portfolio of aircrafts that are no more than one third of the aircraft’s 25-year useful life. The company only orders new planes to put them on long term leases, then sells them after 8 years of operation. The 8-year cutoff date ensures the maximum disposition value can be obtained. Additionally, there is no time in between the end of the lease and the sale of the aircraft. The company may not sell an aircraft out right to a company, but may simply convert the operating lease into a financing lease to simplify the transfer of ownership rights of the aircraft to the customer. This would continue to bring in consistent revenue for a long period. Air Lease Corporation also offers management services for owners of aircraft fleets. By leasing an aircraft to a company, they may also provide that airline with management services for how to better manage and finance their fleet. This will bring in additional revenues and build a stronger business relationship with their customers. Further, this would lead to help the trend of changing airlines towards leasing more aircrafts rather than purchasing.

• Financing Strategy: Air Lease Corporation has structured their company to be an investment grade company and has used unsecured debt financing and cash on hand to finance operations. Maintaining a BBB credit rating ensures a low cost of borrowed capital and further broadened their access to favorable avenues of financing. The unsecured financing allows the company to maintain flexibility when selling or transferring aircraft from one airline to another. This has allowed Air Lease Corporation to offer more competitive prices on their leases as well as decreasing cash outflows to credit holders. With this, they can grow and keep up with demand for new aircraft


Outlook

The airline industry is positively affected by economic growth. With an expected increase in GDP of 3- 4% globally and an expected inflation rate of 1.5% to 2.5%, this is a positive indicator for air traffic demand, increasing the amount of people that travel. There is an estimated increase in disposable income of 9.3% by 2020, which would also allow for increased consumer demand. The aircraft leasing industry is also affected by interest rates. With the U.S entering a rising interest rate environment, it will become more expensive for Air Lease to barrow money in the future. Fortunately for the company, they are paying down their floating rate debt and the financing for new planes is mostly fixed rate between 4-6%

Market Share

The aircraft leasing industry is composed of many different companies. These include banks, airlines, manufacturers, aircraft leasing companies, and other financing companies. Due to the assortment and different sizes of companies it is difficult to form an accurate comparison amongst all the competitors. However, one important distinguishing factor is the size of the aircraft fleet and amount that are leased. Air Lease Corporation currently has 240 aircraft that are all currently leased. This is the largest number of leased aircraft of any competitor. The next company that has the most amount of leased aircrafts is Air Castle United with 175 total aircrafts (163 leased). Third is Fly Corporation with 136 aircraft (124 leased). Another factor that is also prevalent in showing the competitive market is the number of aircraft on order. Air Lease Corporation has 372 aircraft on order through 2023, while Air Castle United and Fly Corporation currently have less than 150.


Financial Analysis
Revenue Growth

Since the 477% revenue growth in 2010 they have experienced an average revenue growth of 36% each year. The company’s growth is primarily due to their average revenue growth of 11% in Asia, 9% in Europe and 7% in Central and South America. The US only accounts for approximately 5% of revenues whereas Europe and Asia account for 45% and 33% of all revenues respectively. Revenue growth is completely dependent on the amount of leases the company can produce as they account for 95% of all revenues. The strong revenue growth for Air Lease Corporation is due to the aggressive acquisition of aircraft to build their fleet. They currently have all 244 of their current aircrafts leased and they have more than 363 aircrafts on order, and of which 100 of them already have signed lease contracts.
Rising Interest Rate Environment: As interest rates are on the rise in America, it becomes more expensive for firms to borrow money. Higher financing costs will encourage airlines to lease new aircraft rather than purchase outright. Additionally, when Air Lease converts the operating lease to a financing lease at the end of its 8-year life, they can command a higher interest rate from customers. This points to increased, long-term, and sustained revenue for Air Lease.

Margin Expansions

For Air Lease, there biggest cost is operating expenses. This accounts for 46% of revenue, giving the company a profit margin of 54%. Since 2010, the company has increased their profit margin from 40% to 54% due to airlines increasing the number of aircrafts they lease, Air Lease increasing lease prices, and Air Lease being able to buy aircrafts on more favorable terms. However, with interest rates rising, these favorable terms on which Air Lease buys aircrafts may begin to disappear. Interest expense has remained relatively constant at 20% of revenue, and if this begins to rise, it could in turn hurt bottom line growth of the company

Earnings

Air Lease Corporation has beaten earnings estimates six of the last seven quarters. Through continuously signing new lease agreements, acquiring new aircraft, and achieving great financing, they have been able to maintain strong earnings growth. Since 2010, earnings have grown an average of 20% each year compared to the industry average of 14%. Right now, the company is seeing no stopping in continuing to grow and generating high earnings.

Growth

Based on the assumptions of the current economy, and the demand for air traffic, I estimated revenue growth of approximately 14% for the next 12 months and earnings growth of 24% over the next 12 months. Interest expense is expected to increase as the interest rate increases. However, with Air Lease ordering 372 planes through 2023, this will have a significant impact on revenue growth as they sign new leases at higher prices. I estimated by the fourth quarter of 2017, Air Lease Corporation will have revenues of approximately $400 million, producing net income of 108 million, a 28% profit margin.
Pro Forma: For my Pro Forma, I looked at historic growth rates and saw that the rapid growth is

Financial Health

Since 2011, Air Lease Corporation has had an average return on equity of 8% compared to the industry average of 7.52%. This shows that Air Lease Corporation is better at generating profits from shareholder’s equity than its competitors. Since 2010, Air Lease Corporation has had an average Return on Capital of 4.7% compared to Air Castle, which had an average Return on Capital of 6.1%. These measures indicate that Air Lease Corporation is better able to generate cash flow relative to the capital invested in the business.

Debt

Debt to Equity: Currently, Air Lease Corporation has $9.3 Billion in long-term debt outstanding with a debt to equity ratio of 3.17. The industry average debt to equity ratio is 4.4. Air Lease Corporations Current Debt to EBITDA is 7.78 compared to the industry at 4.3. This shows that the company not only has a lower debt to equity ratio, but that they are also capable to pay off its debt compared to its peers
slowing. I estimated future revenue growth of around 3% quarter over quarter moving forward. Air Lease has 373 new planes arriving, combining current revenue with projected increases due to a larger fleet, I expect growth in net income. The breakdown of my operating expense is a percentage of revenue over the last 8 quarters, and I expect that percentage to have little charge moving forward given the fact that Air Lease likes to keep operating expense around 40% of total revenue.





Valuations

In this section, I estimated the fair values of Air Lease Corporations stock. It should be noted that all input data were derived from historical company data and pro forma estimates.
Residual Income Model: Referencing my Pro Forma Balance sheet, I was able to anticipate the company’s estimated book value and the present value of future residual income. The company’s current book value is. $34.73 per share and is estimated to grow over the next 12 months. Using the capital asset pricing model, I estimated a required rate of return of 11% I used a growth rate of 10%. This resulted in a fair value of $46.94, an undervaluation of 18%.
Holts Model: Using the Holts Model AL appears to be undervalued by around 16%. I expect AL growth to be 14% this being the growth rate of AL’s net income for forecasted 2017 and 2018 taken from my Pro Forma. I used Air Castle as the competitor due to Air Castle being Air Lease’s biggest competitor. The model produced an average fair value of$ 46.27.
Average Fair Value: The average fair value for Air Lease Corporation is $46, which is an undervaluation of 17.54%

Investment Risk

The airline industry is cyclical, economically sensitive and highly competitive. Airlines are affected by fuel prices and shortages, political or economic instability, terrorist activities, changes in national policy, pilot shortages and other factors affecting the world or regional trading markets. This causes a high risk of airlines to default on leases when they are under pressure, and decreases demand for new aircrafts. This will have a negative impact on the financial condition of the company. In a recession, it will not only have the risk of the airlines not paying or decreasing demand, but banks and other creditors will be less likely to issue financing on favorable terms or any at all. This could cause an increase to the payments of debt and inability to receive additional financing to grow and acquire new aircrafts.

International Risk

Air Lease Corporation operates mostly internationally and that can cause legal and regulatory conflicts. All aircrafts that are acquired by the company need to be registered in the country that it will be operated in. An inability to license and register an aircraft in certain countries will impact their ability to profit from those countries and could bring about additional costs. Economic conditions in all other countries will have an impact on the company as well. Although Air Lease Corporation does not have any country with more than 10% of revenues with the exception of China, any country that goes into recession or is in hard economic times could have a negative impact on the company. Emerging markets regulations and economic conditions have a heavy impact on the airline industry. The fastest growing area for the airline industry is the emerging markets, but they are also more vulnerable to economic conditions and improper regulations which could impact the quality of the airlines and additional airline risk.

Default Risk

If Air Lease has to repossess an aircraft, significant costs could be occurred by the company. Costs will include, legal, and governmental costs with both the U.S and whatever country the default were to happen in. During this time, if Air Lease is unable to lease a particular aircraft or multiple aircrafts, this could substantially hurt revenue. In addition, Air Leas could also incur substantial maintenance, refurbishment or repair costs if a defaulting lessee fails to pay such costs and where such maintenance, refurbishment or repairs are necessary to put the aircraft in suitable condition for remarketing or sale. Air Lease may also incur storage costs associated with any aircraft that Air Lease would repossess and are unable to place immediately with another lessee. Air Lease may be forced to pay off liens, taxes and other governmental charges on the aircraft to obtain clear possession and to remarket the aircraft effectively, including liens that the lessor might have incurred in connection with the operation of its other aircraft. Air Lease could also incur other costs in connection with the physical possession of the aircraft.

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