It's been a tough year for the airlines, and for the multitude of industries that rely on aviation for revenue. The COVID-19 pandemic has caused global travel demand to plummet, and it will likely take years before the industry fully recovers.
The stocks look cheap, with most airlines and major suppliers including Boeing (NYSE:BA) off 50% or more year to date. But the risks are real. The airlines are bleeding through millions per day and expect to continue doing so into 2021.
I believe aviation will eventually recover, and I'm personally comfortable accepting the risk and buying into a few of the top names in the industry and hoping for the best. But for those who are interested in betting the industry will recover without taking on the risk associated with owning an individual airline, AerCap Holdings (NYSE:AER) is a name to add to the watchlist.
AerCap's stock has been hit harder than its business
AerCap is in the business of buying planes from manufacturers and leasing them back to customers, a model that has gained popularity among airlines in recent years as the carriers try to shrink their liabilities and gain fleet flexibility. AerCap owns 1,357 planes leased to airline customers around the globe.
Aircraft lessors by their nature carry a lot of debt, and can end up in a precarious position when the aviation market heads south. The markets have assumed the worst, with AerCap shares falling 75% from Jan. 1 this year and, even after a slight recovery, still down more than 50% in 2020.
COVID-19 has taken its toll. AerCap has provided many customers with rent deferrals to help them through the crisis, and those deferral requests are likely to continue in the months to come. But what the market has missed is that AerCap is well-positioned to manage through the crisis. As of June 30, AerCap's deferral balance was $430 million, or about 9% of total revenue. AerCap has about $1 billion in security against that amount in case it is never recovered.
On a late July call with analysts, CEO Aengus Kelly said management is seeing a slowing of deferral requests in both Asia and Europe, which together account for more than half of total company revenue. The United States market continues to struggle, but AerCap's global diversification should serve it well.
A survivor's balance sheet
AerCap had $12 billion in total liquidity as of June 30, which is equal to about 2.2 times the company's expected cash needs over the next 12 months. The company also has about $27 billion in unencumbered assets available to use as collateral.
That's a cushion of $6.4 billion worth of excess cash, plus a large stockpile of available assets to borrow against as insurance if conditions deteriorate further. Yet the stock today trades at less than 0.4 times AerCap's book value, less than half the multiple it traded at prior to the crisis.
AerCap is still adding to its fleet during the downturn, but all new deliveries the company will take through the end of 2021 are currently committed to customers. AerCap has canceled a portion of the Boeing 737 Max planes it has on order, and maintains the right to cut an additional 80 737 Max planes on its order book if their corresponding leases are canceled.
The markets were worried about aircraft lessors going into the crisis because of the dangers of having billions in commitments at a time when customers are struggling to pay their bills. But looking closely at AerCap's available cash and future commitments, it is hard to imagine a scenario where the company ends up in financial trouble.
Well-positioned for a recovery
Looking ahead, we've already seen about 4.5% of the world's commercial aviation fleet retired. That number is likely to go up as airlines get a better read on future demand trends and decide they will not need planes that have been moved to storage to provide optionality in the event of a sudden demand spike.
Meanwhile, Boeing and Airbus (OTC:EADSY) have announced production cuts that will mean a 30% decrease in new plane supply in the years to come. The combination of retirements and production cuts should, over time, add to the value of newer aircraft that are more fuel-efficient and have modern technology.
More than half of AerCap's fleet are those newer planes less than three years old.
The pandemic has already had a profound effect on aviation, and that effect will continue to linger through 2022 at a minimum. But I remain convinced that the trends driving growth prior to the pandemic, including the emerging global consumer class, will outlast COVID-19. Airlines in time will soar again, no matter what happens to individual names in the next few years.
I can't tell you with absolute certainty that any single airline will definitely survive this crisis. But if you believe the industry will recover in time, AerCap looks like a good bet to be a major beneficiary when that happens.