Airline stocks have been hammered by the COVID-19 pandemic, which has brought global travel to a halt and left carriers scrambling to bring down costs by canceling flights and grounding planes.
That's also causing a trickle-down effect on businesses that serve airlines, including aerospace suppliers, plane manufacturers, and the leasing firms that buy planes and rent them to airlines. Leasing firms have become increasingly popular in recent years as airlines try to move toward more of an asset-light model and keep huge plane expenditures off their balance sheets.
Shares of one such lessor, AerCap Holdings (NYSE:AER), are down more than 50% year to date on investor concerns that a wave of airline bankruptcies might leave the company with planes it is unable to place in revenue-generating service. Those fears are misplaced, and AerCap might be the best stock to buy for investors interested in betting on an eventual airline recovery.
Earnings messy, but manageable
Before markets opened on May 5, AerCap reported first-quarter earnings of $2.14 per share on revenue of $1.24 billion, surpassing estimates for $1.75 per share in earnings on $1.18 billion in sales. Leasing rents and net interest margin were both down slightly year over year, but overall, the business held up well.
Of course, the full effect of the pandemic was not fully seen in North America and Europe until April, so the second quarter results are likely to show more of an effect. AerCap is bracing for the storm, reducing full-year capital expenditures by $2.3 billion, in part by revising new plane delivery schedules. AerCap said it has all of its new deliveries between now and December 2021 leased.
The company is also granting lease deferrals of two to three months to try to help its customers through the crisis, which will affect a sizable portion of total 2020 revenue.
"The COVID-19 pandemic is creating significant challenges for the global aviation industry and for economies around the world," CEO Aengus Kelly said in a statement. "AerCap entered this crisis in a position of strength, with a strong balance sheet and liquidity position, an attractive aircraft portfolio and a high-quality customer base including many of the world's leading airlines."
Investors were correct in assuming AerCap would take a hit from the pandemic. But in slicing off half of the company's market capitalization in a matter of months, the markets are wrongly worried AerCap can't take the hit. As of quarter's end, the company had about $11 billion in available liquidity, more than $28 billion in unencumbered assets it can borrow on if needed, and a relatively-low-for-the-business 2.5 to 1 leverage ratio.
Hedge funds have taken notice
AerCap is one of the largest holdings of Greenlight Capital, the hedge fund run by investor David Einhorn. In his first-quarter letter to investors, Einhorn said he believes AerCap "could double by year-end and still be incredibly cheap."
At the time of writing AerCap shares traded at $28.12 apiece, which Einhorn said was 39% of book value and 3.3 times trailing earnings. Earnings are headed down, and AerCap will likely have to deal with troubled customers, missed payments, and perhaps some bankruptcies. Planes will be returned, and AerCap could face challenges getting them to new customers quickly.
Still, Einhorn said he believes most global airlines -- with government assistance -- will survive. And AerCap is in a better financial position than its customers, with liquidity in place and nearly 70% of its planes available to use as collateral if it needs to borrow further.
"[AerCap] stock has fallen much further than an index of global airline equities, which, given [AerCap]'s comparatively lower risk profile, seems unjustified," Einhorn wrote.
It's interesting to note that Einhorn has been thinking for a long time about this perceived government backstop for airlines. The investor's senior honors thesis at Cornell was focused on the airlines. He argued at the time that airlines face a constant tension between making profits and serving as a public utility, a tension that works in favor of airlines surviving but which can work against airline shareholders.
A lower-risk way to bet on an eventual recovery
The good news is that AerCap can weather what lies ahead. The bad news is that what lies ahead could indeed be difficult, and AerCap could be getting back a lot of planes that will be tough to place for now. It costs money to store planes, and the issues with airlines are sure to weigh on the lessors as well.
But even if it does take AerCap time to recover, the stock does seem undervalued today. AerCap can be viewed as a lower-risk way to bet on an eventual airline recovery.
Buying into individual airlines comes with significant risk right now, because if the pandemic-induced recession is lengthy, it is possible we will see a large number of bankruptcies. But if you believe demand for air travel will eventually recover, then AerCap will eventually find opportunities to place whatever planes are returned with whatever airlines are still flying.
It is hard to predict what AerCap shares will do in the quarters to come, but over the long term this stock still looks like a winner.