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 debt securities that are backed by commercial jet aircraft. As of February, 2008, Aircastle owned 130 passenger and cargo aircraft, currently valued at $5.7 billion. ^[1]. 90% of Aircastle's aircraft are passenger planes and only 10% ^[2] are freighter planes as Aircastle mainly leases directly to commercial airlines.

The performance of the aircraft leasing industry is mainly influenced by the supply and demand of aircraft, which is affected by the overall health of the airline industry. This is in turn affected by factors including the general economic outlook, consumers' demand for travel and fuel prices. Aircastle leases their airlines on an operating lease basis, which means that they are responsible for maintaining the planes and must recruit and pay for maintenance staff. Aircastle's clients pay them a regular monthly fee as part of a long-term lease that usually lasts from 3-12 years. Operating leases are often used by airlines that need greater flexibility in their fleet (whether in type of planes or number of planes) and have capital constraints (thus making it harder for themselves to acquire and maintain a fleet). Aircastle's largest clients include U.S. Airways, Sterling Airways and Swiss International Airlines. ^[3]

Business Financials

Aircastle's revenue mainly comes from aircraft leases to airlines. The firm has a very high customer concentration, where their top clients are responsible for up to half of the revenue. As of December 31, 2007 the company's two largest customers alone, U.S. Airways and Sterling Airways accounted for more than 19% of total revenue. ^[4]

As seen in the revenue vs. operating chart below, Aircastle has experienced significant growth in the past 3 years. From 2005 (when the company was founded) 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. ^[5] As the aircraft leasing industry itself is growing at an average of 6% annually ^[6], Aircastle's growth rate is much faster than the industry average. This is caused by their ability to both acquire second-hand planes at relatively low costs and to quickly score key clients.

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 less vulnerable to the volatilities in the U.S. domestic airlines industries. One of the key performance metrics for the airline leasing industry is measured by the operating margin. Aircastle has an operating margin of 56.59% (as of 2007), which is high compared to an industry average of 26.26%. ^[7] This is because their operating expenses excluding depreciation to their fleet are fairly low.

Key Trends and Forces

• Continued problems in U.S. airline industry will aversely affect Aircastle

Post 9/11 concerns for air travel safety and consistent flight cancellations and delays in the U.S. has lead to lower consumer confidence and lower demand for flight services. This coupled with the economic slowdown, increasing overhead (as airlines need to allocate bigger budgets to deal with increased security measures) and rising fuel costs has lead to four US airline bankruptcies in April 2008 alone. The main commercial airlines also face decreasing revenues and profit margins due to increased competition caused by deregulation of the airline industry. This leads to lower demand for leases from U.S. airlines, which will affect Aircastle's revenues.

• 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. The decreasing government protection for state-owned airlines in certain countries in Europe and Asia has 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, as smaller airlines often do not have the capital to buy their own planes and would rather pay a regular monthly fee as part of a long-term lease.

• Rising fuel costs continues to impact airline industry negatively

Rising fuel costs, which have increased 74% in the last year alone,^[8] lead to decreasing profit margins for most airlines, especially in the US. This is because fuel costs can take up to 30% of an airline's operating expenses. As most airlines' profit margins are already fairly small, rising oil prices can eliminate many airlines' profits. This leads to lower aircraft leasing demand and fees, which has 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 ^[9] and late deliveries from Boeing and Airbus are forcing more international airlines (that are less affected by the U.S. economy slowdown) to lease aircrafts at higher fees. As Aircastle's aircrafts are mostly bought from second-hand sources, they are unaffected by this supply constraint. Therefore they can potentially benefit from this through increased revenue.

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

Demand for leased aircraft from airlines in emerging markets, such as Asia, continues to grow 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, including China and India, where the total number of aircrafts is expected to grow by 49% this year. ^[10] As Aircastle already has significant exposure in these regions, this trend will lead to more growth for the company.

• 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 ^[11]. This trend is expected to continue (expected at least 6% average growth annually) as airlines strive to free up capital for expansion, to maintain a constantly modern fleet of aircraft, and to deal with more fluctuations in travel demand. As demand for air travel changes over time, leases give airlines more flexibility in their fleet and the ability to limit excess capacity. This trend is also due to the increasing number of many private and smaller airlines that do not have the capital to acquire and maintain their own fleet.

Competition

Globally, there are more than 260 airlines and 450 leasing companies, carrying a total inventory list of 19,000 airplanes. ^[12] 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. Their 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.^[13]
• IFLC: A subsidiary of American International Group, IFLC is the second largest aircraft operating lessor with more than 900 aircrafts in assets. ^[14]
• GECAS: A unit of General Electric, they are the largest aircraft operating lessor. They own and manage 1,405 aircrafts. ^[15]

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)^[16]

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References

1. ↑ AYR 2007 10-K, Item 1: Business, page 1
2. ↑ AYR 2007 10-K, Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operation, page 46
3. ↑ AYR 2007 10-K, Item 1: Business, page 5
4. ↑ AYR 2007 10-K, Item 2: Risk Factors, page 11
5. ↑ AYR 2007 10-K, Item 6: Selected Financial Data, page 40
6. ↑ AT Kearney Perspectives: Fast Growing Aircraft Leasing Industry
7. ↑ Yahoo Finance: Aircastle LTD, Direct Competitor Comparison
8. ↑ The Associated Press, "Airlines Face New Cash Challenge", Apr 10 2008
9. ↑ The New York Times, "Latest Delay Puts Boeing’s Dreamliner a Year Behind", Apr 9 2008
10. ↑ The Economic Times, "India, China to fuel Asia Pacific's air traffic growth", Apr 12 2008
11. ↑ Allco Financial Group: Aviation industry and outlook
12. ↑ Bear Stearns Equity Research: "Aircastle Limited", Sept 18 2006, page 10
13. ↑ http://www.aercap.com/default.asp
14. ↑ IFLC Press Release: "Aerosvit leases one Boeing 767 aircraft from ILFC", Dec 4, 2007
15. ↑ http://www.gecas.com/mansolutions.asp
16. ↑ Bear Stearns Equity Research: "Aircastle Limited", Sept 18 2006, page 18