AerCap Holdings (NYSE:AER) reported second-quarter earnings this week and management revised its 2023 earnings guidance upward to $8.50 – $9.00 per share, excluding gains on sales expected to be realized in the second half of this year. They also guided towards $2.5 billion in asset sales for the full year, and assuming a similar profit margin to what AerCap stock has achieved historically, this would add another $0.60 – $0.85 in after-tax EPS in 2023. Assuming that AER sells $625 million in assets per quarter at a 10% margin, I forecast just shy of $9 per share in adjusted EPS including all asset sale gains, which is a bit more conservative than the company, but still means that shares continue to trade at a modest 7-8 times current year earnings.
Supply/demand imbalance persists
The aircraft leasing business continues to be characterized by supply constraints amidst issues in the production line for the manufacturers.
Supply of aircraft as measured by new aircraft deliveries still significantly lags pre-COVID levels, with both major manufacturers grappling with supply chain issues and production delays. This lack of supply is incentivizing the company’s lessees to retain aircraft via lease extensions and/or purchases of aircraft from AerCap. Meanwhile, storage rates of the new-technology aircraft that comprise the majority of AerCap’s fleet are at their lowest levels since 2019. These dynamics are positive for lease rates and asset values of both new-technology and current-technology aircraft.
This backdrop, combined with AerCap’s relatively low cost of capital, provides formidable earnings power over the next few years. I have updated my model and now forecast the following outlook over the next few years:
|$7.00 – $7.50
|$7.50 – $8.00
|$8.00 – $8.50
|$9.00 – $9.50
|$9.50 – $10.00
|$10.00 – $10.50
|Book Value per Share
|$82 – $83
|$92 – $93
|$102 – $103
While a lot can happen over the next few years, I remain bullish on the company’s long-term prospects, although they may take time to be reflected in the share price. I think it is preliminary, not withstanding my outlook, to move my $75/share price target at the current time.
Trading activity update
I previously predicted that there might be an improvement in gains from sales of aircraft assets, and AerCap has not disappointed on this front. AerCap just sold approximately $650 million in book value of assets at a 25% margin, its best quarterly result in the company’s history. AerCap CEO Aengus Kelly continues to emphasize airlines’ appetite to buy aircraft as one characteristic of the current market that is boosting sales. He also remarked that the second-quarter sales were all of current-technology aircraft, which allows AerCap to continue to increase the percentage of its fleet allocated to the most fuel-efficient, in-demand new technology assets like the A320neo, 737 MAX, and 787. They have increased assets held for sale even further to $808 million in this most recent quarter, reflecting the robust pipeline of sales that the company has in the near term. I continue to assume a 10% margin on $2.5 billion of annual asset sales, but recent performance suggests that there could be further near-term upside to the contribution of trading to the P&L. It’s fair to wonder whether this is as good as it gets from an asset sales perspective, and the company’s performance on this front should be closely monitored for any deterioration, or at least some mean reversion back to, or close to, historical margins. If things are as strong as they appear on the trading front, it stands to reason that AerCap should look to exceed its annual sales targets, with the excess cash being used to buy back shares or potentially some of its higher cost debt.
Share buybacks occurring at an accelerated pace
Through July 28th, the company had purchased $857 million of its own shares this year at prices slightly below current trading levels. It currently has $143 million of remaining authorization on its program that it initiated in April and it just instituted an additional $500 million share repurchase program expiring at year-end. Shares are trading at approximately 90% of my estimate of current diluted book value per share and AerCap is still willing to purchase stock at those levels. There’s an argument to be made that given the substantial discount to NAV at which GECAS was purchased that AerCap’s true book value is higher and therefore its discount to book is greater than the GAAP level. If and when shares trade at a premium to book, the buyback conversation may change. However, until then, I am hiking my buyback target and now expect closer to $1.5-2 billion in share repurchases annually over the next few years, which plays a significant role in the upward revisions to my earnings and book value estimates.
AerCap continues to slowly recover small amounts related to its aircraft seized by Russia. However, the majority of its near-term recoveries were likely already realized in the form of drawn letters of credit and reduction of maintenance and security deposit liabilities that offset the write-off of its Russian fleet. The trial date for the insurance claims is still set for next year, and there’s not been any update in terms of how that is proceeding or whether there is any possibility of settlement, and if so, on what sort of terms. Aside from this, there continue to be periodic rumors of plans by Russian airlines to buy the aircraft that they have seized. Whether this ever happens, and whether it is permitted by the relevant Western countries, is another matter altogether. It does not make sense in my opinion to attribute value to either an insurance and/or direct settlement, but there’s some chance it does pan out, which would help shares.
Watching arrears / receivables
While loans and notes receivable have come down significantly from their COVID highs, they are still some ways below their pre-COVID levels as a percentage of the fleet. Loans receivable are up nearly $100 million in the past quarter, although credit provisions for these loans are still below $5 million. And although trade receivables dropped by half, AerCap’s notes receivable balance was up over $50 million. Given the strength of the overall backdrop and continued improvement in traffic levels relative to pre-COVID benchmarks, I would hope to see receivables balances decrease across the board, even if gradually. This may warrant closer scrutiny as even with the growth in fleet size from GECAS, they have remained stubbornly elevated, even if at least a modest rise in charge-offs would be manageable from a P&L perspective.
Risks to investment thesis
1. Economic recession
2. Longer-term rise in interest rates
3. Arrears activity (see above)
4. Long-term manufacturer production rates
Another strong quarter is in the books for AerCap and the company continues to navigate the recovery in air traffic well, all while keeping its cost of capital as low as possible. At the current price there is some upside but not a tremendous amount. I maintain my Buy rating and prior price target and continue to preach patience as the company builds momentum.