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Published: September 23, 2010
In tough economic times, a high debt load can cripple a
company. But when business is good, that debt can actually be a
real benefit. That's because equity comprises just a small part
of the company's total
enterprise value (market value plus debt minus cash) and
profits can become quite large relative to that small equity
base. But investors remain wary of debt-laden companies,
recalling that these were among the stocks that appeared to be
headed toward bankruptcy when the economy started heading south
two years ago.
As a result, shares of companies that buy and then lease
airplanes to the major airlines, all of which carry lots of
debt, are among the cheapest in the stock market. Yet if the
global economy stays aloft and can finally grow, then these
companies could see impressive profit and
dividend growth.
Right now, the stars are aligning for this industry. Airline
traffic is up +10% from a year ago, banks have become very
supportive by providing very low interest rates for asset-backed
loans for airplanes, and the key players are generating strong
cash flow that is helping to reduce debt levels. Most
importantly, a glut of unused airplanes that sat idle are
returning to service, and with fewer airplanes available, lease
rates are rising.
The industry is dominated by the finance arms of GE (NYSE:
GE) and AIG (NYSE: AIG). But investors can play the
sector through smaller players such as Aercap Holdings (NYSE:
AER), Aircastle (NYSE: AYR), FLY Leasing (NYSE: FLY) and
Willis Lease Finance (Nasdaq: WLFC). And as this table
shows, all of these stocks appear quite cheap on a
price-to-earnings basis:
|
Company |
Recent Price |
Market Cap |
Enterprise Value |
Price/
Book |
Div. Yield |
2010 P/E |
2011 P/E Est. |
Aercap
(NYSE: AER) |
$11.93 |
$1,420M |
$4,811M |
0.8 |
none |
6.3 |
6.1 |
Aircastle
(NYSE: AYR) |
$8.32 |
$661M |
$2,860M |
0.5 |
4.7% |
9.1 |
9.1 |
|
FLY Leasing (NYSE: FLY) |
$12.48 |
$353M |
$1,468M |
0.7 |
6.5% |
7.8 |
10.1 |
|
Willis Lease (NYSE: WLFC) |
$9.83 |
$92M |
$742M |
0.5 |
none |
28.9 |
5.6 |
|
But these stocks are also inexpensive relative to their assets.
For example, the value of Aircastle's fleet of planes, even
after subtracting the company's debt, is around $1.02 billion,
more than 50% above the company's $661 million
market value, according to analysts at Citigroup. They think
shares should reflect that value and trade up to about $13 from
a current $8.40. In a recent note to clients, they wrote that
"with its share price trading as almost half of
book value, and given more demonstrable evidence of a rise
in aircraft market values, it is possible that Aircastle could
spend surplus cash on buying back shares or raising the
dividend."
As long as these stocks remain below book value, share buybacks
make plenty of sense. And that's what FLY Leasing is doing. The
company's fleet of planes (minus its debt) is worth more than
$17 a share, well above the recent $12.50 share price. Of
course, any weakening in the economy would change that equation.
(In 2008, when the economy was sliding, airline lease rates fell
sharply, dragging down the value of planes, so FLY Leasing's
book value then was just $12 a share.)
Action to Take --> If the
economy weakens anew, then these debt-laden stocks would be
especially vulnerable. But all signs now point to a healthier
airline industry. Lease rates should continue to rise as demand
for new and used planes exceeds production from Airbus and
Boeing (NYSE: BA). If you're in search of dividend yields,
then Aircastle and FLY Holdings should hold great appeal, as
these firms look set to hike their dividends further in 2011 as
cash flow rises. Aercap is likely the most stable name in the
group due to its relative size, which helps it to arrange
special banks loans on especially favorable terms.
-- David Sterman
Staff Writer
StreetAuthority
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