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AerCap: Size Up As General Electric Sells Down

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The Setup

AerCap Holdings N.V. (NYSE:AER) is the largest aviation leasing company globally. Led by CEO Aengus “Gus” Kelly, AerCap recently acquired GECAS (GE Capital Aviation Services), solidifying its position in the industry. The company faced challenges in recent years due to disruptions caused by factors such as the Covid pandemic and the Russia-Ukraine War. However, these challenges are mostly behind them now. The overhang on the stock comes from General Electric (GE), which currently owns 14.5% of AerCap shares and plans to sell down its stake by the first or second quarter of 2024. Once this selling pressure subsides, AerCap is poised for growth. The stock is currently undervalued relative to its book value and earnings potential, making it an attractive investment opportunity.

Business Description

AerCap specializes in leasing airplanes, engines, and helicopters to a wide range of clients. The company owns and manages a diverse portfolio of 2,323 aircraft, engines, and helicopters. They offer various types of assets for lease, including narrow-body and widebody aircraft, regional jets, freighters, engines, and helicopters. Their leasing model allows them to acquire desirable flight equipment at competitive prices and efficiently finance them. AerCap is also the largest engine leasing company globally, with over 900 engines in its portfolio.

Thesis

Despite the positive aspects of AerCap’s business, the selling pressure resulting from GE’s stake sell-off has weighed on the stock price. While the near-term upside may be limited, I believe it presents an opportunity for long-term investors. As GE continues to sell and reduce its ownership to 3% or less, AerCap’s stock price should benefit. Additionally, AerCap’s track record of share repurchases will further enhance shareholder value. It is important to consider the potential volatility associated with such sell-offs, as they can be influenced by external factors and market sentiment.

Unit Economics

AerCap operates on a spread business model similar to that of banks. They borrow funds at lower rates and use those funds to purchase aircraft assets at discounted prices. They then lease these assets to customers at higher rates, factoring in credit risk. The net spread on assets provides an indication of their profitability. AerCap’s net spread has been consistently positive, supporting a healthy margin. The company’s revenue primarily comes from lease rents, supplemented by maintenance revenue, gain on sale, and other income. The pandemic disrupted lease rates temporarily, but with the recovery in air travel demand, leasing trends are expected to improve in the coming years.

Valuation

I have conducted two valuation analyses for AerCap: price-to-book (P/B) ratio and price-to-earnings (P/E) ratio. Considering potential asset writedowns and the company’s historical asset volatility, a P/B ratio of 1x and a P/E ratio of 10x seem appropriate. These valuations suggest that the stock is currently undervalued. My one-year price target for AerCap is approximately $78, with a downside risk of $56. Additionally, there is potential upside if gain sale margins and leasing rates continue to improve. Given the favorable risk-reward profile, AerCap presents an attractive investment opportunity.

Balance Sheet

AerCap maintains a leveraged balance sheet, with important items including net fixed assets (carrying value of aircraft assets), long-term debt, and book equity. The company has recently seen an increase in equity in planes, which enhances financial stability and downside protection. However, this has led to slightly lower return on equity (ROE). The balance sheet reflects prudent management of leverage, which better positions the company to weather unforeseen events. It is important to monitor AerCap’s debt financing costs, as increasing rates could impact their net spread and profitability.

Management

The CEO of AerCap, Aengus “Gus” Kelly, has over 12 years of experience in the aviation leasing industry and is highly regarded for his expertise. He has demonstrated transparency, honesty, and sound decision-making during his tenure. It is important to note that executive ownership of AerCap shares is relatively low, which may be a concern for some investors. However, the company’s equity compensation plan aligns management’s interests with long-term value creation.

Risks

One of the main risks for AerCap is the demand for air travel, which directly affects the demand for leased aircraft. A decline in air travel demand could lead to lower demand for AerCap’s assets and potential impairment of their value. Another risk is the company’s ability to adjust lease rates to compensate for increasing financing costs. If the net spread contracts, it may impact profitability. Lastly, the ongoing sell-down of shares by General Electric could create short-term selling pressure and volatility in the stock.

Q2 Results

AerCap reported strong Q2 results, including a $500 million share repurchase authorization, a 14% increase in book value year-on-year, and an upward revision of full-year adjusted EPS guidance. The company also received a cash insurance settlement of $645 million, which further strengthens its financial position. These positive developments indicate the company’s strong performance and growth potential.

Summary & Forward-Looking Items to Monitor

AerCap offers an attractive investment opportunity due to its undervalued stock and strong growth prospects. It is recommended to start with a small position and gradually increase it as General Electric sells down its stake. Monitor key metrics such as net lease spreads, lease revenue per plane, gain on sale margins, GE’s ownership stake, and AerCap’s buyback rate. These factors will provide insights into the company’s performance and potential future returns.

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