Thoughts on Air Lease Corp?

I am feeling pretty bullish on Air Lease Corp, does anyone have any strong contrarian views on the stock? I am planning to write an SA article on the topic

I cover the sector. The bear case (which I agree with) goes like this:

Boeing and Airbus are currently working off 6 year backlogs of aircraft primarily earmarked for the Asian markets based on capacity estimates put together by consultants. These new (inexperienced) Asian airlines are loading up preparing for this surge in traffic. Nearly every time you get a long lead time on supply additions combined with a capital intensive commoditized business model (read agricultural commodiites, metals & mining and oil) coupled with hubris over rising demand you wind up with a drastically oversupplied market that goes through restructuring. This has actually occured in the airlines several times in the developed world and the playbook will in all likelihood be no different for Asia. Analysts have begun to put these peices together and combined with the fact that Asian growth has slowed and most of these orders were placed (with contractually binding commitments and large deposits) years ago, the math is not good.

Enter the leasing companies. They run an even more capital intensive business model that basically operates using high levels of secured leverage to purchase aircraft with asset lives of about 30-40 years and lease these things to airilnes on multi year contracts. Airlnes pay a little extra to operate a marginal number of routes with leased aircraft viewed as insurance for flexible capacity. If demand contracts and the market becomes oversupplied, they will dump their leases as they roll off rather than sell aircraft into a flooded used market at heavy discount prematurely junk good assets and take write offs. So these heavily levered (almost bank like) leasing companies are left holding all the aircraft with no actual plan to deploy them as they’re basically an airline with no routes.

The leasing companies tell you that’s the glory of their model, their assets are highly mobile so they can instantly redeploy them anywhere in the world in the event of a regional slowdown in demand. Sound familiar? It’s not too far off from the story told leading up to 2008, MBS debt was lock tight barring a widespread slowdown. The stupidity of this is that in todays aircraft market there is no such thing as a regional slowdown. Expansion of the Middle Eastern airlines coupled with slowing regional growth pushed those aircraft into the European markets, which have caused overcapcity which has begun to seep into the North American markets as European operaters in turn redeploy their own aircraft into markets with more balanced capacity. Similarly, major overcapacity in Asia (particularly among subsidized operators) will surely spread globally.

As aircraft are sold, the GLOBAL used market for these highly mobile assets will be flooded, which will put pressure on new model prices as well, particularly in a sub $80 oil regime. At the same time as the leasing companies are left with these aircraft without airlines, the backside of their business model (which assumes they can sell aircraft at favorable valuations near the midpoint of their service lives) will be punished as these prices are not realisable. They are in fact already struggling with this as Delta has made an art out of headhunting amazing deals on used aircraft then publicizing those deals to add pressure to the market.

http://www.bloomberg.com/news/articles/2015-10-14/delta-bargain-hunt-puts-boeing-777-on-used-jet-shopping-list

This is why the leasing companies are all pricing around NAV rather than earnings multiples, which if the bear case were to be realized would actually be considered a rich valuation.

^ This is bearish for the manufacturers too then, no? What is the upside for Boeing if there are too many planes in the pipe?

It’s bearish for them as well, but not quite as bad.

More in depth on the impact to the plane producers, I saw Airlease and Aercap at a conference a few weeks ago and someone finally came out an brought up the issue of industry overcapacity to Aercap. They basically answered that although the Boeing orderbooks might possible be as much as 20-25% overbooked versus demand (keep in mind these are 40 year assets so the oversupply carries magnified effects), in the past they found themselves in this situation on a smaller case when Virgin Airways was in trouble. They allowed Virgin to restructure their orderbook and reduce obligations because a healthy customer worth far more to them than a dead one. They said this would serve as a possible template and then made other weaker excuses.

The issue here is that one carrier in this situation is not the same as an industry in this situation. Particularly if you think many of the customers will fail anyhow due to overcapacity, then you’re incentivized to get the deliveries out the door before the other shoe drops. Moreover, the airlines are building capacity to unprecidented levels at a cost and winding down these production lines prematurely and eating 10% of their order book while trimming long term guidance would be painful. So in that light, Boeing and Airbus are probably not the best buy’s right now from a risks perspective. I also wonder what the impact will be to Bombardier as orders have slowed significantly across the industry following the initial deluge.

Air Lease down 10% from March 16th when I called it (still more downside), SPX is up 7%.