As the airline industry benefits from an economic recovery and emerging markets continue to form new opportunities for aviation expansion, aircraft leasing companies could make good investments over the next few years.
With a major acquisition expected soon, AerCap Holdings (NYSE:AER) offers aircraft leasing investors the opportunity to capitalize on the creation of the second-largest aircraft leasing company in the world.
As American International Group (NYSE:AIG) implemented a strategy to divest non-core assets, the insurance giant's aircraft leasing subsidiary, International Lease Finance Corp (ILFC), was on the auction block. Despite calls for ILFC's sale beginning almost immediately after AIG required billions in government aid, ILFC failed to attract anything better than lowball offers. A sale was arranged to a Chinese consortium but the latter failed to gain financial backing, putting the deal in limbo.
Instead, AerCap will acquire ILFC in a deal beneficial to AerCap and AIG. AerCap will purchase ILFC for $5 billion paid in cash and newly issued AerCap stock. As a result, AIG will own 46% of AerCap and with the boost the ILFC deal gave to AerCap shares, AIG should be able to get even more for its AerCap stake when it likely sells the shares in the future.
A new AerCap
The ILFC deal transforms AerCap into the second-largest aircraft leasing company in the world in a move that triples the size of AerCap's fleet. Although General Electric (NYSE:GE) will remain the largest aircraft leasing company through GE Capital Aviation Services (GECAS), GECAS is one of many parts of the GE giant. Because of this, AerCap makes a better pure play on large aircraft leasing companies.
AerCap will assume ILFC's $21 billion in debt in a move that is already putting AerCap's credit rating at risk of a downgrade. However, a growing aircraft leasing market and the synergies realized from the merger should give a boost to cash flows mitigating much of this debt-related risk.
AerCap shares are already up more than 50% from the pre-announcement share price but further upside could still be in store. In a December 16 presentation to investors, AerCap noted it expects run rate pro forma earnings of $4.00 or more per share. Of course, this relies on a lot of assumptions by management so I will discount this estimate by 10% to be more conservative. But even at $3.60 per share, AerCap would trade at less than 10 times earnings in an industry with significant future growth potential.
AerCap also benefits from having a quality order book in a time where airlines are in an arms race to acquire the most fuel-efficient jets. With some aircraft having years of wait time, AerCap holds an advantage in securing delivery of the most demanded aircraft. If this airline industry trend continues to grow as more profitable airlines plow their larger profits into new equipment, AerCap stands to gain from this supply and demand situation.
The ILFC acquisition fundamentally transforms AerCap from one of many aircraft leasing companies to the world's second largest. When I weigh the expected future growth of aviation leasing and the current multiples for AerCap, the company appears undervalued based on industry potential. With GE being far from a pure play on aircraft leasing, I see AerCap as the best way to invest in large aircraft leasing companies.