Last week, AerCap (NYSE:AER) posted a lower-than-expected adjusted profit for the third quarter. The leading aircraft leasing company also recorded a hefty impairment charge to write down the value of certain older aircraft that are falling out of favor with airlines.
Nevertheless, investors have flocked back to AerCap stock this month, particularly following positive COVID-19 vaccine-development updates from Pfizer and Moderna. At the end of last month, AerCap shares were down 60% year to date, but they have surged more than 60% in November, recently rising above the $40 mark.
With vaccines seemingly on the way, is AerCap stock bound to keep rising to pre-pandemic levels? Or does the stock remain a risky bet on a quick recovery? Let's take a look.
A mixed earnings report
AerCap's total lease revenue fell 13% year over year to $988 million last quarter. Management attributed the double-digit decline to lease restructurings (reducing aircraft rent for troubled customers), airline bankruptcies, and an increase in the number of aircraft not on lease.
This revenue decline had a disproportionate impact on net income, as depreciation and interest expense -- both more or less fixed -- account for the vast majority of AerCap's costs. Adjusted net income fell to $158 million, or $1.24 per share. That was down from $270.3 million ($2.01 per share) a year earlier. It also fell short of the average analyst estimate for earnings per share of $1.43.
Additionally, AerCap took a $915 million asset impairment charge, primarily related to reducing the estimated value of its Boeing 777 and Airbus A330 fleets. It also wrote off $58 million of goodwill. As a result, AerCap posted a loss of $850 million ($6.66 per share) under generally accepted accounting principles (GAAP).
It wasn't all bad news, though. Despite its big asset impairment, AerCap ended the quarter with book value per share of $69.06: essentially even with the prior-year mark of $69.24. Moreover, cash from operations increased 76% sequentially, as many airlines that had stopped paying aircraft rent during the peak of the crisis this spring have resumed making lease payments.
Management is extremely bullish
During the Q3 earnings call, AerCap said it didn't expect to incur any further asset impairments. Management also expressed confidence that the relatively small number of aircraft not on lease or likely to be returned by bankrupt airlines could be released on acceptable terms.
Much of that confidence stems from AerCap's strategic shift to next-generation aircraft models. As of Sept. 30, the average age of its owned aircraft fleet was just 6.3 years and 62% of its net book value was attributable to new technology aircraft (mainly the A320neo and 787 Dreamliner families). AerCap also noted that its average remaining lease term is 7.3 years. Indeed, less than 10% of its leases will expire by 2022, which should help minimize the impact of the current downturn on AerCap's lease rates.
Finally, AerCap executives see a return to growth on the horizon. Airlines will need to refresh their fleets as demand returns over the next few years and will rely more on leasing as they work to repair their balance sheets. Meanwhile, institutional investors that flooded into the aircraft leasing market in a hunt for yield in recent years may pull back after running into trouble during 2020 because of a lack of operating experience. AerCap is stockpiling cash to capitalize on growth opportunities over the next few years.
Plenty of risk remains
Despite these positive factors, AerCap stock is riskier than management seems willing to acknowledge. AerCap's biggest weakness is that 39% of its net book value is tied up in Boeing 787 and Airbus A350 wide-body jets. While these are "new technology" aircraft and will remain the backbone of the global wide-body fleet for many years to come, wide-body demand is depressed because of weak international travel demand. With longer-range narrowbodies becoming available, many airlines may continue to deemphasize wide-bodies in their fleets.
Many of AerCap's 787s and A350s are leased to bankrupt airlines like Norwegian, LATAM, and Aeromexico. (The first two were among AerCap's top five customers entering 2020.) Norwegian in particular is nearing collapse.
If AerCap has to repossess a large number of wide-bodies in the year ahead, it could take quite a while to find new customers in the current environment. Few analysts expect international travel demand to snap back quickly, even after COVID-19 vaccines become available. Furthermore, reconfiguring wide-body jets can be incredibly expensive, and the new lease rates are likely to be lower than what AerCap was getting previously.
Many airlines are facing a bleak winter. Investors should probably wait to see whether that leads to a big wave of airline bankruptcies and fleet reductions before making a bold bet on AerCap stock.