The Debt Dogs of Aerospace

Charlie Munger, Warren Buffett's business partner, has condemned drugs, liquor, and leverage as humanity's three biggest downfalls. The first two are your own responsibility, but if you're invested -- or are thinking about investing -- in the aerospace industry, you should know which companies in the space are the deepest in debt.

Leverage is not inherently bad for a company. A fast-growing company can intelligently employ debt to exploit its market opportunity. At low interest rates, debt can fund shrewd strategic acquisitions. Since it's generally cheaper than equity, debt can also lower a company's cost of capital.

But too often, companies end up abusing debt -- and as Munger reminds us, excessive leverage can lead to ruin. Let's examine a few of the most heavily indebted aerospace companies.

Company

Total Debt/Capital

Interest Coverage

GenCorp (NYSE: GY  )

204.0%

1.1

TransDigm Group (NYSE: TDG  )

84.2%

3.4

Boeing (NYSE: BA  )

81.3%

9.1

AerCap (NYSE: AER  )

74.8%

2.1

Kratos Defense & Security Solutions (Nasdaq: KTOS  )

61.3%

1.1

First of all, look at GenCorp. The company has twice as much debt as actual capital, meaning its book value is negative. And with that whopping debt load, it's not surprising that the company is struggling to make its interest payments. At an interest coverage ratio of just 1.1, a mere 10% of operating income flows to equity holders.

Of the others, the one stock that jumps out at me as being different is Boeing. Boeing has a nice slug of debt -- more than $12 billion -- on its balance sheet, but it also has more than $10 billion in cash. The business also produces plenty of operating income; the 9.1 times interest coverage ratio tells us that Boeing isn't having any problems meeting its interest payments.

On top of their heavy debtloads, these companies are all trading at relatively rich multiples. AerCap is trading at 10 times EBITDA, and both TransDigm and Kratos are trading north of 16 times. Investors should make sure they do their homework before investing in these stocks.

For an easy way to stay current on any of these stocks, add them to My Watchlist:

Neither Alex nor The Motley Fool owns shares of any company mentioned. TransDigm Group is a Motley Fool Hidden Gems recommendation. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (6) | Recommend This Article (4)

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  • Report this Comment On February 25, 2011, at 3:26 PM, krowekamp wrote:

    I calculate AER to trade at less than 3X EBITDA...not 10 times as Mr. Pape has quoted. Please review year-end financial information and calculate for your self.

    http://finance.yahoo.com/news/AerCap-Holdings-NV-Reports-prn...

  • Report this Comment On February 25, 2011, at 4:27 PM, TMFPapester wrote:

    Hey krowekamp,

    The calc was based on numbers pulled from Capital IQ earlier. Based on current numbers, pulled from the same source, here is my calc:

    Enterprise value = 2,077.3 (mkt cap) + 6,566.2 (debt) - 404.5 (cash) = 8,239.0m

    LTM EBITDA = 869.4m

    EV/EBITDA = 8239/869.4 = 9.5x, which in the article rounds to 10x.

    These CapIQ numbers reflect the latest quarter - they are up to date as of 12/31/2010.

    Cheers,

    Alex

  • Report this Comment On February 25, 2011, at 8:35 PM, software3758 wrote:

    Alex,

    It does appear you understand this company, the aircraft leasing market or the underlying aircraft assets. I believe you have made a very misleading analysis regarding AER.

    Yes, AER has debt but it’s fully collateralized by 350 or so modern, commercial jet aircraft, any of which can be sold individually in a heartbeat at a significant premium to book value, if for some reason they are not leased. The book and market value of these aircraft is significantly in excess of the debt. This is a relatively unique situation as most companies with debt don’t have these types of liquid assets.

    Adding back the debt on the individual aircraft and making an EBITDA calculation on enterprise value is not valid or meaningful (unless you also then subtract the book value of the aircraft which would arrive at a ridiculously low multiple on EBITDA) for an aircraft leasing company.

    Actually, the appropriate and meaningful calculation for a leasing company would be a multiple of cash flow, not EBITDA. Since interest is a core cost of doing business for a leasing company it should not be subtracted.

    Based on 2010 results just released, AER’s cash flow multiple is 3.3

    AER Operating Cash flow for 2010: $615 million

    AER current market cap (not EV): $2.05 billion

    I’m very positive on this company given the following reasons:

    • Price reflects very low multiple to cash flow

    • Solid balance sheet (I view the aircraft as appreciating assets in an inflationary environment)

    • Excellent growth – both organic and through acquisitions

    • Excellent management

    Hope this helps you and your readers to understand this better.

    Ken

  • Report this Comment On February 25, 2011, at 8:36 PM, software3758 wrote:

    Sorry, meant to say in my first line that it "does NOT appear you understand this company"

  • Report this Comment On February 26, 2011, at 2:37 PM, TMFPapester wrote:

    software3758,

    Thanks for your comment. In this article, I was simply commenting on the five most indebted companies in the industry. I included the EV/EBITDA multiple because many investors screen based on such criteria. I'm not bashing AER or any other company in the article - as I wrote in the last line, I just suggest that investors need to do their homework before investing. It seems clear that you have done so, and I would suspect that others who followed in your footsteps would invest more intelligently as well.

    Cheers,

    Alex

  • Report this Comment On February 28, 2011, at 9:40 PM, Vanmusicblues wrote:

    Comparing Boeing and AER is like comparing GM and Avis. The only thing common is ownership of an end product the other makes.

    If you put 25% down and have a good balance sheet, banks will finance planes you lease, for more than you pay. This is a flying REIT, not aerospace. The aircraft are a hedge against inflation with rent!.

    A waste of time article

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