Last week, I wrote about Atlas Air Worldwide (NASDAQ: AAWW), an aircraft lessor that operates in the air freight industry. A reader emailed me asking my thoughts on AerCap Holdings N.V. (NYSE: AER), another aircraft (and engine) lessor, but this time operating largely in the passenger segment of the aerospace industry. The reader noted that AER’s P/B ratio makes it look significantly more attractive than AAWW. Let’s first look at the two companies, and then consider the use of P/B.
Though AER also looks somewhat undervalued, the margin of safety appears to be much smaller than in the case of AAWW.
First, AER has more volatile revenues. Recall that in the case of AAWW, major customers were tied up with the company through joint ventures and long term contracts, some of which were guaranteed by much larger entities, effectively ensuring the continuation of those revenue streams. AER, on the other hand, generally operates on shorter term leases, particularly with its engines which are usually leased for 180 days. In fact, leases representing 28.9% of AER’s lease revenues are scheduled to expire before Dec 31, 2013. This leaves AER more reliant on new leases or extending old leases, which creates a less certain revenue picture.
Beyond lease revenues, AER has significant revenues from the sale of flight equipment. This revenue is by far the least certain, as it is not contractual, carries no backlog and is highly cyclical. We see this in the company’s revenues from 2008 to 2009, when sales revenue fell by nearly 50% while lease revenue stayed approximately the same. I feel much more comfortable with a company like AAWW which derives its income from long term contractual revenue.
Additionally, AER has exposure to the passenger segment (rather than AAWW which operates all but one of its flights in the freight industry). The passenger segment experiences much greater volatility than freight traffic according to the IATA, due both to the greater elasticity of income (as noted by Saj Karsan here) as well as the disruptive forces of terrorism and pandemics. AER also operates largely in developing nations (59% of revenues are derived from developing nations), which adds even greater volatility to the revenue side.
On the plus side, AER has 271 aircraft and 95 engines on lease with more than 131 operators. It also has an aircraft management and servicing division that serves twelve companies covering 300 aircraft. This lack of concentration provides some cushion in that the loss of a single customer will not cripple the company, which in many ways is superior to AAWW, which is more reliant on relatively fewer customers.
Second, AER is more highly levered than AAWW. AAWW’s debt to equity is less than 50%, whereas AER operates closer to 300% (though it is worth noting that AAWW will be increasing its debt as it takes on new planes in the next year, however these planes have already been contracted). Also, the majority of AER’s debt is floating rate (~5 billion), though this is somewhat mitigated by the company’s use of interest rate caps (options that limit the level to which interest rates can rise, “capping” the potential interest expense).
Now, switching back to the P/B metric. AER is trading for book value, whereas AAWW is trading at a 60% premium to book, so one could argue that the investor would be well compensated for the added risk. Unfortunately, this metric doesn’t take into account the wide variation in capital structures between the two companies, so a better comparison than P/B would be EV/EBITDA. AER trades at an EV/EBITDA of 14x and AAWW trades at 6.03x, indicating that the relative discount may be the opposite of what the writer who posed the question original thought.
Combining more volatile revenues with higher debt levels is a recipe for disaster, which leads me to pass on this company. I would need a significantly lower entry price or for debt to come down in order to take a closer look.
Author Disclosure: No position