AerCap Holdings N.V. (AER) Earnings Call Transcript & Summary

We have a lot to talk about. Some interesting news, as I've mentioned yesterday. People are still going to be coming into the room, but I do want to get started because there's plenty to talk about. I'm very pleased to introduce the first session of our afternoon, a man who, as with many of our presenters today, requires no introduction, so I'll be brief, Mr. Aengus Kelly, Chairman and CEO of AerCap, the largest lessor in the world. A couple of modest acquisitions or so over the last few years, very interesting progression and growth of fleet, lots of stuff going on and some interesting news yesterday. So I don't need to say any more. Let's turn it over to Gus Kelly to give an update on AerCap and maybe expand a little bit on what we heard or read yesterday. Gus?

Well, Doug, yes, first of all, thanks very much for having us here today, as always, at the premier conference in the sector. Are you okay?

Yes. Sorry, apologies. I was just thanking you, though.

Yes, yes. No, it's a fantastic conference. Thank you for having us all here. The attendance is great. Thank you for all coming along to us. So for these things, I think it's much better with Q&A. I can stand up here and say how many airplanes AerCap has and how many we leased. I don't think that's particularly additive to you learning much about the industry. So just ask me whatever you want. Please go ahead. You must have some questions. We have a couple of brief slides. Why don't we stay here?

So people talk about supply/demand. So what's happening out there?

We have seen, for a long period of time, a supply-demand imbalance. We don't believe that supply-demand imbalance will come into equilibrium for probably the best part over the 5 or 6 years. And even when it does, you never really see periods of significant oversupply in this industry. You'll see regions where you may have operators that have issues. But on a global basis, you won't see any extended period of oversupply in the industry, we never have. Now why is that? Boeing and Airbus, of course, just want to produce as many airplanes as they can. They don't care about the aircraft when supply is over the fence. The sooner they can make one to replace it, the better. That's their business model. There's nothing wrong, it's not a criticism. But there is a handbrake in the whole industry, which is the engine guys. Boeing and Airbus get paid 100 cents on the dollar when the airplane flies over the fence. The engine guys get $0.30. They get the rest of it over 20 years of maintenance. So every year, there's a fight between Boeing and Airbus and the engine guys saying -- Boeing and Airbus will say, we want to produce 150 aircraft. The engine guys will say to themselves, well, if we do 150, we think the market is 100, the extra 50 that come in, they will cannibalize the most lucrative part of our business, which is the last engine shop visit on an 18- to 20-year-old aircraft. So that's the -- the least profitable part of an engine manufacturer's business is selling a new engine because they lose cash. So they'll never ever let the system get too out of balance. So even though, I think, we're going to be in a situation of significant undersupply, both narrow and wide, for the next 5-odd years on a global basis, you'll never have that situation. We've never had us where you get a massive oversupply of aircraft for a sustained period. And as I said, a lot of that goes back to the engine guys. But specific to this particular period, what we have here is the levels of aircraft that just weren't built because Boeing stopped production of 787, effectively the MAX also, Airbus drastically reduced 320 production, their wide-body production. So even if we could get back to the production levels at Airbus and Boeing or RASK for 2018, there'd still be a significant shortfall in the industry because of the gap that has to be made up, let alone before we get to growth. And then we have the engine issues as well themselves, which are causing less aircraft to spend less time in service. The engine durability issue will get better over time, but it will take a fair period of time. And so that, again, will mean that there will be less seats in service than the airlines want, which will increase the demand for aircraft. Sales activity is something that is reflective of that because it's easy for me to stand up here and say, lease rates are up, et cetera, demand is up. But one thing that really shows it to you is the buyer base. What's happening on air -- we're the biggest seller of aircraft in the world, of used aircraft. And what we're seeing over the course of the last 3 years is that the airlines have become the major buyer of aircraft from us. Why is that? Because they know the delivery schedules from Boeing and Airbus won't happen. They know that they have to have the lift in place for the long term if the airlines felt that this was a 12-, 24-month issue. And it's not fair to just blame Boeing and Airbus because they know that the engines are spending much longer in shop. As the biggest engine leasing company in the world, we have an unrivaled visibility into what's happening to every CFM and GE engine every week. We know. We're in the shop. What would -- how long they were spending in the shop, what the turn times are. And given that we have just so many engines in our own fleet, we monitor all of those engines going through the shop. We can see the turn times are longer. Again, that means the airlines need to have additional lift. They can't just rely on Boeing and Airbus because even if they delivered on time, they know those airplanes won't operate for as long -- the aircraft will have to come off. The engines will have to come off for maintenance more frequently than expected. So all that means is that airlines know they're going to be short in capacity. So we have sold a couple of hundred airplanes, 18- to 20-year-old airplanes to airlines because they know it's a long-term issue. They never thought they'd be buying these aircraft. They fully expected when they ordered the MAXs and the neos that they would be the airplanes they'd be operating, not 18- to 20-year-old 737s, 700s, 800s, A319s, A320s, but that's the reality of where we are. So we'll come to Q&A in a sec. But as I say, look, overall in the supply-demand dynamic, supply is very tight. It's going to be tight for a long time to come. That's driven by the time on wing of these engines, how long they can last. If the engine doesn't stay on wing as long as expected, then you need a replacement aircraft, you need replacement capacity or you need replacement engines. There's a scarcity of spare engines in the world today. That won't change either anytime soon. More and more of them are needed to support that in-service fleet to keep that flying. But overall, I would say, as we look out at the moment, I don't see the supply-demand dynamic changing for the best part of this decade. And even when it does, as I said, the engine guys will keep a lid on the amount of supply that Boeing and Airbus can put into the system. And some of you then will probably want to understand what happened with our insurance claim in Russia. I can't say a huge amount about it. What I can say is that, that was a long process over the best part of the last 12 months that a lot of people worked on with a lot of different entities in different parts of the world to make it happen. I always told you that we would receive a lot of money at some point in the future. Still, I'm -- we will receive more whether it will -- when we'll get it, by format, it will come from, I don't know. But I was never in any doubt that we would receive significant funds. It may well come through the insurance courts in the U.K. -- or I should say the courts in the U.K. for the insurance claim or other ways. But I have no doubt that a significant sum will be received over time.

Okay. Great. I'm joined on the stage by my equity research colleague, Hillary. This time seems like a debt conference, but it is also an equity conference. We're very pleased that we have the public aircraft lessors here as well, AerCap, the largest of them. So I'll turn it over first to Hillary to ask a couple of questions with an equity slab.

So I do have a question regarding the settlement yesterday. So just go over the background, you mentioned 12 months. How did the discussion start? Who started it? What was the motivation behind -- for the Russian insurance company to get this done and just kind of a background?

Hillary, we can't say too much about all of that. What we can say, there's an awful lot of hard work by a lot of committed people to make that happen. As you can imagine, you had to deal with issues in Europe, U.S. and other parts of the world, including Russia, to get everybody there. But I mean it's an important first step. Of course, the reinsurers were involved as well. But the point of the matter is that, as I said, when we -- when this issue happened with the seizure of our aircraft, we always knew that a lot would come. The avenues that the funds will flow from, they can be varied, but I have no doubt that they will come.

Just one more question following up, and then we can switch topics. Do you think this is a one-off event? Or do you think there are other Russian insurance companies that would be willing to do the same?

I can't say, Hillary.

Can I try one follow-up? And there's [ IR premises ]. Why these airplanes? I guess, personally, the first thing I did was check my old GECAS aircraft ABS transactions. And why these airplanes? Why not others? What's the thinking on their side? What about my planes?

Your planes?

Well, I'm possessive towards my ABS...

Oh, sorry. I have to ask your manager about that, Joe. But sorry, Doug. No, I mean, look, a lot of it comes down to presence, capability, what can you get done. What can, realistically, the largest player in the world do versus others, there's a big difference. Now that's true of any aspect of the business.

Well, we'll leave Russia then for a moment. Back to Hillary.

Okay. So the $645 million proceeds, what's the most likely thing you would do with the extra cash?

Well, I think, look, if you look at the leverage of the company today, we're down to 2.5x. So I think we've taken that well below our debt/equity target at 2.7x. So I don't think it would make sense probably to put more of us to reducing leverage further. So I suspect, we think that our share offers incredible value at the moment. We've been able to sell our own older airplanes at very significant premiums. We're -- I think so far this year, I think we're selling at 180% of book and buying back our shares at 82% of book. I think that's a trade you got to do all the day. The cheapest airplane -- if we can consistently sell our less-desirable assets at significant premiums and buy back our stock at a discounted book, they're the cheapest airplanes in the world. Boeing and Airbus would not sell me an airplane, any work folks to where I can buy my own.

Yes. So -- and then -- and you -- to that point, you're selling all the aircraft, 17-, 18-, 19-year old, and you've mentioned that airlines are buying them. How does that compare versus historically?

Historically, they would have bought less. They would have bought 15% to 20% as opposed to 50%. There's still plenty of financial buyers out there. But at the moment -- and a financial buyer is very sensitive to the funding cost; in airline, not so much because if you look at an airline's cost structure, of course, they want every cost to be lower, don't get me wrong. But having the mettle is far more important than whether there's a slight increase in ownership costs because if you look at that airline P&L, fuel, labor, there are multiples and multiples of ownership costs. But if you don't have the mettle, you've got problems.

I wonder if I could interject a strategic question. You had the nice time line showing the various acquisitions. I'll go back in time and conference years, acquisition of GECAS, announced March 2021. I think it was in September of 2019, I asked you up on stage, you're at about 1,000 airplanes, ILFC acquisition went well, everything integrated, at what point do you get diseconomies of scale? And what might be too big a number to simply manage? And the answer you gave back then was somewhere around 2,000 airplanes, which happened to be about 200 airplanes more than AerCap plus GECAS. So I'll ask the same question now that you've had 2 successful integrations, much bigger in scale relative to a bigger market even. Where are the diseconomies of scale, if any? And how many units is too big?

Look, it's worked out pretty well, Doug, so far. I mean, if you just step back and put it all aside in a sec, as I said, we can stand up here and say demand is very strong, my values are great, I'm making margins. But as a debt investor and equity investor, you just step back and say, November '21, we closed the GE transaction for $30 billion. It is worth noting that a private equity shop was bidding $40 billion for the same platform prior to the COVID. And indeed, when we announced the transaction, it was at $28 billion. The only reason it got to $30 billion was that one of them is stocked. But what happened since then, we put on a lot of leverage to do that. Objective #1 at that time, we have to make sure, operationally, we can cope with this amount of aircraft. Our IT systems, internal autos, your technical team, the engine management business, that all of this can be dealt with. The capability had to be there. That's the most important thing because if you do a great deal, but if you can't keep the trains running on time, you're going to run into trouble sooner or later. So you have to have a very -- a huge amount of focus went into making sure that the operations were capable of dealing with that quantum of aircraft, which they have been. And then the outcome of that was we beat every target we gave The Street. We delevered much faster than expected, got to our target ratings much faster than expected. And then even despite having to take a $2.5 billion charge direct to the equity line when the Russian invasion started, we were able to overcome that as well, recoup that $2.5 billion through the operating earnings of the business of the company in a position where just this year alone, in addition to having done all that, delevered the business, taken the $2.5 billion Russian hit, we're still in a position to do $1.5 billion of buybacks this year as of June 30. That was all done in a space of 20 months. So I think rather than me saying, were we able to cope with it? Anecdotally, that's the hard reality of it, that we were able to do something like that on a balance sheet of that size and a company of that scale.

So there's like a couple of large portfolios which would have allowed a step-function increase. Presumably, the pitch books made their way to AerCap House. As you look forward or even looking back at those 2 opportunities, perhaps, what might have been attractive, what wasn't unattractive, your leverage certainly allowed something to be done if you chose to, strategies going forward, just expand on other possibilities.

Look, I think you always want to have a strong balance sheet. That underpins everything. As I said, our debt/equity ratio is 2.5x. COVID, we kept it low as well. And that gives you the position of strength. And then when you have that position of strength, you're able to do things like take advantage of opportunity. At the moment, of course, look, at the leasing business, buying back our own shares is a no-brainer. There's no way any airplane, Boeing and Airbus, are going to sound -- make any sense, given where our share price is, given that we bought ILFC at enormous discounts. We bought GECAS at enormous discounts. That's the planes I'm buying. There's no way in the world that they can match that Boeing and Airbus. So from my perspective, at the moment, we have tremendous value in the company, going to harvest that value, but as I said, keep the debt/equity ratio in the right place and then use that capital to buy our own shares. Now -- and you can see, of course, in the private market, as always, these platforms trade at significant premiums to book. We saw last week a reasonably small platform get purchased, $3.5 billion size or about 1.35x book, which is consistent with most of the historic private trades. And as I said to you, historically, we sell it again and say we're about 1.35x book, give or take, on our gain on sale, and that's our less-desirable assets. So while we can continue to sell our assets at a big premium, private transactions for platforms are going at significant premiums to book. But yes, we can buy our own shares in the market at significant discounts. That's just the way forward. Like we're not here to be big for the sake of being big. The idea here is to make as much -- to create as much value as possible for our stakeholders within appropriate risk tolerances.

You made a comment, I think it was on the last earnings call that you don't want to be the one lining up at the chalet to place orders in a very hot market, which certainly it seems we're in now with people placing orders out to 2029 and perhaps even beyond. But I guess, what happens? You've got 300 airplanes on order. Ultimately, they deliver, admittedly, with delays. Is it a matter of just having to wait until, forgive me, the next crisis to place an order? How do you avoid just having the backlog diminish and just lots to do rather than replacement?

I never cared much about a backlog, one way or the other, to be honest. You'll always get -- I mean this industry grows all the time. There's always opportunity. We've grown more than anyone in the industry has ever even thought possible. I couldn't care less about backlog. If there's a good deal to be done with Boeing and Airbus, we'll go into it. The last time I ordered airplanes from Airbus was March 2020, nobody was there. That's the time to buy. No one else in the world came next nor near them. That's when you buy. We bought the GECAS deal in COVID with that order book. We bought the ILFC order book in COVID. The original business was bought out of distress from the German owners [ of the places ]. Look, Boeing and Airbus know our price targets. If they don't get there, I don't care. There's plenty of opportunity in this business as we've demonstrated. It could be sale leasebacks. It can be our engine business, which we've grown quite a lot, and we'll continue to grow our engine business as well. And then, of course, we have our own shares. I mean the objective here is to create value for you. You are the people who pay me. You are the people who put the money into the business. That's all I care about. I do not care less about Boeing and Airbus' shareholders. I care about you. That's all we care about. I couldn't give a damn about being at an air show making an announcement; more is the fool if you do it. You do it when it's right because you pay me, not Airbus and Boeing. So Doug, you know what, if the opportunity is there, we're going to do it. But if it's not, this is who pays my wages.

We've talked a lot about airplanes. You talked about engines. There's also freight. I guess, if I were to play the old game of which of these things is not like the other, it would be helicopters. I'm wondering, experience with helicopters, what you're thinking there? How does it fit in with the rest of the portfolio? And are there synergies? Or is it something that's just different, but has to fly up in the air like everything else?

The helicopter business, of course, is not as germane to the business as, obviously, engines and the freight business. But the helicopter business has done extremely well. It was, 7 years ago, the 85% oil and gas. Today, it's about 55%. It's a bit smaller now today, but it's doing very well. We've got a great team there that are running it. And as we see what's happening globally, as it comes to scarce resources and energy and also on the supply side, what's helped a lot there is that the 2 main manufacturers of commercial helicopters, Airbus and Leonardo, have a very big focus now on military production. For those production lines, we've seen less supply in that sector. So...

The freight, your acquired organization, GECAS, was the initiator of the 777-300ER conversion program; now one of, call it, 3 conversion lines that are in some process of development. What's going on there? And then we heard comments earlier today that with the strength of the passenger market, are you going to be converting quite as many as you thought? Is there a better opportunity simply flying people rather than boxes?

Well, certainly, the freight market was on fire, of course, 2, 3 years ago, and it was never going to be the case that you were going to have the same levels of yield. They weren't going to last. But by the same token, while it come all for course, the advent of e-commerce has opened up a very different freight demand than we had 12, 13 years ago when it was focused on kind of around things like gold bullion and drill bits, pharmaceuticals. So there's a much bigger market out there. And the 777 program is seeing that. We have leased nearly all of the 777s that we designated for the program already, and they'll start delivering in the near future. But that freight business, it does -- it's still a profitable business. Right now, of course, look, the passenger market is very strong. So the business case to put more into freight is harder to get there than it was previously when the freight market was high, and the pax market wasn't in demand. But freight will always be a part of our business. That was the GECAS, a big expertise in that for a long time.

Right. Hillary?

Yes. I asked this question to the other lessor earlier today about just the -- oh, I asked this question earlier today to another lessor. Just on a high level, currently, lessors own about 50%, I guess a little over 50% of the total global fleet. Do you expect that number to continue to go up? Or have we kind of plateaued, do you think?

I'd say, by value, it's well above 50%, Hillary. And I think that was -- the value number, I think, will continue to increase. I think that's the case. It's a bit like Hilton Hotels don't own any hotels any longer. I just think that's a reality as we go forward for a myriad of reasons why airlines will continue to own, on a global basis, less and less. Of course, there'll be a few outlier airlines that will own a disproportionate amount of their fleet. But I think more and more will see that just trend away. It's been going up for a long time. The numbers are very big, though. When you think of the quantum of deliveries that are coming into the market every year, I mean, okay, the last couple of years, they've been less, but I'm sure we're going to get up to a situation where we'll deliver Boeing, Airbus maybe $100 billion plus of commercial aircraft, just to stand still, then the lessors have to come up with $50 billion. That's a lot. That's a lot. Now with Deutsche Bank here behind us, that's not a problem, is it, Doug?

Not at all. Always here to support our clients and customers. A follow-up on that. You said certain airlines will always want to own and prefer not to lease, [ AATC ] market, one avenue of finance. I guess, though, also is the fact that there are certain aircraft types that lessors probably shouldn't be playing in or should only be playing in very cautiously. Would you like to place an order or do an SLB on a 777X or, if launched, an A350-1100?

Look, I think you've got to be careful about that. I mean you, first of all, confuse a young aircraft with a good aircraft. That is not the case. If you took -- say you have a 330 or a 777, they choose investors, look out and say, oh, it's young, it's a 2017 build, 2016 build, you're going to lose your shirts on that. That airplane will have great, good, strong economic demand out until probably 2031, 2032. At that point in time, it's going to be replaced in enough numbers by the 350s, by the 787s, if there won't be much demand. So you're sitting on an asset there. You may have only consumed 60% of its life, so then the 40% is gone. But a lot of people bought those assets in 2015, '16, '17, '18 because they wanted to show a young portfolio, get some decent yield in the near term. So it's much more nuanced, Doug, than just saying, would I buy a 777? Would I want to buy a 6-year-old 737 or a 20-year-old one? I'll buy a 20-year-old one any day. It's a much better bet. There's no way you're going to get another 18 years out of a 6-year-old 737, but you're definitely going to get the 5 years out of your 20-year-old one. You might get it through the value because ultimately, at 20 years old, an airplane is an engine stand. That's all it is. The value is all in the engines. And so in that regard, when you're trying to create value and look at money, I mean I know a lot of guys in this room will say young is good, young is good. And it is, but it's got to be far more nuanced than that. And so again, when you come to assets that you think of a big user base, it's not just about ones that clearly -- it's a user base for the longer term. So you mentioned some assets there, like very large assets. Traditionally, very large assets have very small user bases, and it's harder to get your head around those. But you'll also have variance within the smaller aircraft types as well where the asset -- the user base can be declining rapidly. Look, if you look at how things have trended, I mean, a tailwind for Airbus was the up-gauging of aircraft into the 321, where at the heart of the market was 160 to 180 seats really suited the 737-800. But then as we saw slight restrictions around the world, just here in the U.S., the ability to build additional gates at any major airport where people want to fly to is extremely restricted. Get us -- build a new runway in Europe is a nonstarter. And so there's just been this up-gauging, which has certainly helped significantly on the development of the neo program with the 321 getting up to 230 seats. And then on the opposite of that, as you see, the 319 size, the 700 really struggling quite a bit. So it's fairly nuanced, and you have to think about the long-term demand. But as a general rule, Doug, to be fair, you're right, I mean, if aircraft does have potentially a very limited user base or shorter economic life, you have to be very careful.

I want to make sure we have time for audience questions. Any questions from the audience? My back left, please?

I remember, last couple of conferences, there's a focus on net spread and managing the liability side of the balance sheet. Any thoughts on the current rate environment?

I mean, look, what we're seeing at the moment is lease rates have tracked interest rates. That's evident on the newer airplanes because it's just tied to the contracts. But on the used aircraft, too, I mean, you're seeing a -- it's not a daily mark-to-market. But if you were to say, over the last 12 months, what is the 7-year or, say, the 5-year treasury average and looked at that at what we were getting on lease rates for the same airplane, say, 5 years ago, you will have passed on that interest rate increase. But that spread is a curious one because clearly, as you sell older high-yielding assets, because the assets might be on a 12-year lease. If you're getting $300,000, $400,000, whatever, $300,000 on day 1, you're getting $300,000 in year 11, too. So when you sell that asset, of course, that reduces your net spread. But by the same token, if you sell -- take those proceeds, sell that asset that's less desirable, take those proceeds, buy your own stock back at a discounted book, the EPS is a lot better and the business you've bought the shares in is better, too. What you want to do here -- it will be a fool's gold if I was to tell you, I'm selling all my brand-new neos 350, 787 to create capital. I have a worse business afterwards. Yes, I've got a gain on sale, but I've given away the future franchise of the business, which is stupid. So what you want to try and do is when you sell assets, on average, the average quality assets you sell, but hopefully, in your mind, be a slightly inferior quality to the average asset that's left in the business, sell the inferior one at a gain and buy the superior one at a discount, and that's what we're doing at the moment. And that's what we'll keep doing to drive that EPS number and create a lower risk proposition on the balance sheet to the quality of the portfolio.

There's a lot more to talk about, both Hillary and I. I suspected lots of additional questions, but I do want to make sure that we remain on schedule. So Aengus, thank you so much for your time, for your insights, for your thoughts and for the news yesterday. Congratulations. Thank you.

Thanks, Doug. Thanks very much. Thanks all. Take care. Bye.