Will you let this stock fly away?

A recent addition to my portfolio at a price of around $35 is Air Lease (AL), and to be honest it almost looks too good to be true.  The company has grown sales and EPS at double digit rates with an ROE in the teens while trading at a P/E of under 10x and at a discount to book value!  And not only is growth expected to continue but the company is also run by possibly the best management in the industry!

So what does the company do?  It’s an aircraft leaser.  Basically, it purchases airplanes from manufacturers like Boeing and Airbus and leases them out to airlines.  They have the youngest fleet among lessors with an average age of under 4 years and they keep it young as they sell planes as they age (8+ years old).  Currently they own 275 airplanes and will take delivery of another 371 over 2019-2023.  100% and 91% respectively of 2019 and 2020 deliveries are on lease.  The company also manages 61 airplanes (under the Thunderbolt program). 

Over the last 5 years, sales and EPS have risen 14% and 28% respectively.  This growth is the result of positive industry factors which include:

1. Rising air travel:  Passenger traffic grew globally 6.5% in 2018 and is forecasted to grow 3.5% annually in 2018-2023,
2. Growing demand for airplanes from developing counties (“160m people per year will be added to the middle class through 2030”),
3. Demand for leasing.  Leased airplanes have risen from 15% of total fleet in 1990 to 39% in 2017.  Leasing is attractive to airlines as they don’t have to tie up capital, provides fleet flexibility, earlier delivery vs direct order, etc. 

(Source:  Air Lease)      

The company’s chairman is Steven Udvar-Hazy.  He essentially pioneered the business of aircraft leasing and while he is no longer CEO (since 2016), John Plueger (current CEO) has worked with him for 31 years.  To provide a little background, Udvar-Hazy became involved in aircraft leasing in the 70s and listed International Lease Finance Corp (ILFC) in 1983.  In 1990, AIG bought the company but it operated independently with Udvar-Hazy at the helm.  He left ILFC in 2010 and founded AL.  Over 20 employees followed him to AL.  The team is regarded to be the best in the industry and draws a lot of respect.  They are considered master negotiators (with both airlines and manufacturers) and their long experience adds value in what could be considered a commodity business.  It may partially explain why the stock trades at a premium to competitors.  The company has also borrowed at better rates.  The chairman and CEO positions in the company are 5% and 1% respectively.  Udvar-Hazy bought 5,000 shares at around $34 in December.  In monetary terms that’s not much, however, this could be seen as a signal as the CEO rarely makes purchases.  The last 2 times he bought shares was in 2015 at $30 and in 2011 at $28.

Airlines bankruptcy is not really a worry because AL repossess the aircraft and re-lease it.  Regarding this risk, in the 4Q18 conference call, management had this to say:  “… we are proud to say that despite over 200 airline failures of all sizes since ALC was born in 2010 our company has taken zero, I repeat zero credit loss during the last nine years.”  And while there is competition, Plueger believes that the pie is huge and getting bigger:  “This pie cannot be consumed by the top global lessors as their balance sheets fit here today. At the same time, we believe rising interest rates will begin to filter and test the more recent entrance into leasing space or those who are looking for immediate quick returns rather than having a long-term dedication in view towards the airline industry.”

41.8% of the company’s order book consists of the 737 MAX which as you know have been grounded.  Depending on the time taken to fix the plane, the delays could slow company growth but beyond that I don’t believe there are other implications.  Currently, only 5.1% of its fleet is the 737 MAX and all leases are triple net so outside of bankruptcy an airline has to pay its leases.  Some type of reimbursement to AL (perhaps in the form of future discounts) is possible.  This is essentially a one-off event and it is not the first time such as event has occurred. 

Investors may also be worried about rising interest rates but the company’s lease rates have adjustment clauses.  This adjustment is based on an undisclosed financial index.  Eventually rising rates do work their way through the leasing sector with a lag.  In addition, see the chart below which shows that ILFC had positive pre-tax income from 1991-2009 despite wars and crisis.  Note that 90% of their debt is unsecured with 80% fixed rate debt.  As of Q4, their borrow rate was 3.5% while they made an 11.1% rate on their leases.  The ROE is 11% but keep in mind that the company doesn’t pay cash taxes due to accelerated depreciation (pre-tax ROE is 14%).  An also interesting stat is that the company only has 97 employees but generates $1.6bn in sales!

(Source:  JP Morgan)

There is a lot to like about this company and I recommend you check it out.  The conference calls are very helpful with management providing insights into the company.  Over the last 5 years, the average P/E and PB have been 12x and 1.2x respectively which would put the stock at around $60.  I believe a $50-60 value is justified thus presenting 40%+ upside. Keep in mind that is AL continues to grow at this pace, the upside in the long-term will be even higher!