Aircastle (AYR)

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Susan Lin

Aircastle (NYSE:AYR) acquires and leases jet aircraft to commercial and cargo airlines. Aircastle also invests in other aviation assets, including debt securities backed by commercial jet aircraft. As of February, 2008, Aircastle owned 130 passenger and cargo aircraft, currently valued at $5.7 billion. ^[1]. All of Aircastle's aircrafts are high utility, as they are generally modern, operationally efficient jets with a large operator base and long lives.

The aircraft leasing industry is mainly tied to the supply and demand of aircraft, which is affected by the overall health of the airline industry. Aircastle leases their airlines on an operating lease basis, thus retaining the benefits or bearing the risks of the residual aircraft value upon expiry of the lease. Operating leases are often used by airlines that need greater fleet flexibility and lower capital commitment. Aircastle's largest clients include U.S. Airways, Sterling Airways and Swiss International Airlines. ^[2]

Business Financials

Aircastle's main revenue derives from operating leases and has a very high customer concentration. As of March, 2006, the company's four largest customers (U.S. Airways, Hainan Airlines, Swiss International Airlines, Air India) accounted for more than 50% of total revenue. ^[3]

As seen in the revenue vs. operating chart below, Aircastle has experienced significant growth in the past 3 years. From 2005 to 2007, the company grew its revenue by an average of 330% annually, and increased its operating income by an average of 509% per year. ^[4]

The bulk of Aircastle's business comes from outside the U.S., with Europe and Asia accounting for 47% and 27% of total revenue respectively. As North America only accounts for 10% of total revenue, Aircastle is slightly less vulnerable to the volatilities in the U.S. domestic airlines industries.

The key operating metric for the airline leasing industry is the lessor lease margin performance. Aircastle has an operating margin of 56.59% (as of 2007) compared to an industry average 26.26%. ^[5]

Key Trends and Forces

• Changes in government regulations will affect aircraft lessees

The air transportation industry is heavily regulated and any changes in airline regulation will significantly impact Aircastle's clients. Further changes in safety measures for U.S. airlines will negatively influence consumer confidence and the demand for flight services, lowering demand for leases. Commercial airlines in Europe also face decreasing revenues and profit margins due to increased competition caused by deregulation of the airline industry. However, the decreasing government protection for state-owned airlines in certain countries in Europe and Asia has also lead to an increasing amount of privately-owned carriers, many of which are low-cost carriers. This will stimulate the demand for aircraft leasing in these markets.

• Rising fuel costs continues to impact airline industry negatively

Rising fuel costs coupled with an economic downturn, have lead to decreasing profit margins for most airlines, especially in the US airline industry. This leads to lower aircraft leasing demand and fees, which have a negative impact on Aircastle's future revenue.

• Delays in the production of aircraft boosts the demand for aircraft leases

Delays in the production of A380 and 787 airplanes ^[6] and tight supply forces more airlines to lease aircraft at higher fees. As Aircastle's aircrafts are primarily sourced in the secondary market, they are mostly unaffected by this supply constraint and can benefit from potential increased revenue.

• Increased travel demand in developing countries lead to growth opportunities for Aircastle in Asia

Demand for leased aircraft from airlines in emerging markets, such as Asia, where Aircastle has significant exposure continues to be strong so far and has been resilient to the economic slowdown in the US. This stems from the increasing demand for air travel from growing middle classes in emerging markets such as China, India, Russia and Eastern Europe.

• Airlines show general trend towards increasing usage of operating leases

The total number of aircraft on operating leases worldwide in 2001 was 3,760, representing 24.9% of the world’s fleet. By the end of 2005, this had increased to 5,526 aircraft, representing 30.1% of the world’s fleet. ^[7] This trend is expected to continue as airlines strive to release capital for expansion, improve financial ratios and maintain a constantly modern fleet of aircraft.

Competition

The aircraft acquisition and leasing industry is highly competitive and fragmented. Globally, there are more than 260 airlines and 450 leasing companies, carrying a total inventory list of 19,000 airplanes. ^[8] The companies compete in the leasing and re-leasing of aircraft, as well as in aircraft acquisition and sales. Thus Aircastle competes with airlines, aircraft manufacturers, other aircraft operating lessors, aircraft brokers and financial institutions. They main competition includes:

• CIT Group :CIT Group is a global commercial and consumer finance company, that is involved with vendor financing, factoring, equipment and transportation financing, Small Business Administration loans, and asset-based lending.
• AerCap :AerCap is a global aviation company involved in aircraft and engine leasing, trading and parts sales and owns 316 aircraft. They also provide aircraft management services and performs aircraft and engine maintenance, repair and overhaul services.^[9]
• IFLC: A subsidiary of American International Group, IFLC is the second largest aircraft operating lessor with 866 aircrafts in assets. ^[10]
• GECAS: A unit of General Electric, they are the largest aircraft operating lessor. They own and manage 1,405 aircrafts. ^[11]

Aircastle differs from its competitors in that it mainly focuses on seeking out high utility used aircraft and does not pursue manufacturers for new orders.

Market Share

The market share in the aircraft leasing industry calculated below for each company is based on their number of aircraft for lease (in relation to the total number of aircraft on lease globally, which is 5600 as of 2006)^[12]

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References

1. ↑ AYR 2007 10-K, Item 1: Business, page 1
2. ↑ AYR 2007 10-K, Item 1: Business, page 5
3. ↑ Bear Stearns Equity Research: "Aircastle Limited", Sept 18 2006, page 10
4. ↑ AYR 2007 10-K, Item 6: Selected Financial Data, page 40
5. ↑ Yahoo Finance: Aircastle LTD, Direct Competitor Comparison
6. ↑ The New York Times, "Latest Delay Puts Boeing’s Dreamliner a Year Behind", Apr 9 2008
7. ↑ Allco Financial Group: Aviation industry and outlook
8. ↑ Bear Stearns Equity Research: "Aircastle Limited", Sept 18 2006, page 10
9. ↑ http://www.aercap.com/default.asp
10. ↑ Bear Stearns Equity Research: "Aircastle Limited", Sept 18 2006, page 10
11. ↑ Bear Stearns Equity Research: "Aircastle Limited", Sept 18 2006, page 10
12. ↑ Bear Stearns Equity Research: "Aircastle Limited", Sept 18 2006, page 18