FTAI Aviation Ltd. (FTAI) Earnings Call Transcript & Summary

[Audio Gap] and Infrastructure, very pleased to be joined by Joe Adams, who is the Chairman of the Board and CEO of the company. We also have Alan Andreini hiding in the back there, who does, I think, probably a little bit of everything for Fortress. We'll call him IR for the time being, but he's more than that. But wanted to maybe kick off, Joe, I'll kind of pass to everyone. First off, thanks for joining us, and then I'll kick it over to you, if you could kind of maybe give a quick overview. The business has evolved, it continues to evolve. And so if you can kind of give us a little bit of a lay of the land, and then we'll just kind of jump right into questions from there. Well, thanks for joining us.

Thank you, Chris. Thanks for having me back again. I always enjoy this conference. It's a great group of investors. So I appreciate being included. Just to set the stage, FTAI, which is what we call Fortress Transportation and Infrastructure, and it's also our stock symbol is in 2 businesses, so it hasn't evolved too much since the original construct that we put together, and we ended up focusing on 2 of our favorite things in transportation, which is, one was aviation, which goes back to our days at Fortress of having invested in Aircastle, which was just successfully sold to the Japanese; and then rail and port terminals, which we got into that business originally at RailAmerica and Florida East Coast, both of which have been great investments. And we love that space. So today, the portfolio is -- those 2 segments, the aviation business is really think of us as the engine people. We have focused on commercial jet engines since inception. It's a business that I -- every time I look at and think about it, it gets better and better. And so the macro is good. Our industry position is good. The dynamic for investing is good. So very pleased with where we are. Generates lots of cash flow. We get rent under contracted lease payments. But we also collect one of my favorite things in the world, which is maintenance reserves. So people pay you in advance for the maintenance that you will do to that piece of equipment in the future. And it's really an option for you to invest that capital, not an obligation. So terrific cash-generating business. Average returns in the 20s on an unleveraged basis. So exceptional profile. And I think it's quite sustainable. We've built a presence in the market to be one of the largest owners of engines. And we're looking at one of the biggest engine markets in the world as our principal focus over the next 10 to 20 years, which is the CFM56 engine. And we also have proprietary products, which is extremely rare in the leasing business and the leasing world to be able to do something that other people can't do. And we started investing in that with a joint venture that began 3 years ago, and we expect to have 2 products commercially available this year. So it will be a big year for us. In that sense, the culmination of a lot of years of effort, and we think that, that's going to provide a significant additional income as well as a really huge competitive advantage. The other side of our business, as I mentioned, is port and rail terminal and infrastructure, and we have 3 of those properties that we currently own. We used to own the Central Maine and Québec railroad. But we have 3 port rail terminals. The biggest is Jefferson in the Beaumont, Texas area. And I was just there yesterday visiting with Exxon. And the expansion Exxon has underway is -- well underway, and our terminal is booming. So we're very full -- very busy, very full and it's come a long way and very well positioned in the market. We also have a terminal in New Jersey on the Ohio -- on the Delaware River across in the Philadelphia airport that will be operating in the natural gas liquids market for export by the end of the second quarter, early third quarter this year. So I'm very optimistic about the growth potential there and the significant development. There's also opportunities to use the land on -- above ground in addition to the storage that we have underground. So I think that is a terrific long-term asset, very well positioned in a growing market. And then we have a property in Ohio that is a -- developing, building a power plant. We sold a 50% interest in that. We're also doing a lot of frac sand this quarter, which is surprising to me that, that's growing, but it is. And we're actively seeking data center customers. So all of these businesses are, from a macro point of view, are well positioned in good, strong, growing industrial locations. They have excellent logistics, high barriers to entry, and we think will command significant growth in EBITDA and significant value creation. So from a corporate point of view, we have the best of both worlds, in my mind, and that we have strong free cash flow generated from aviation, and we have great investment opportunities in the -- both aviation and infrastructure. So dividends plus growth is a great formula in any market environment. And we're also very well capitalized. We just got our corporate debt rating raised by Moody's to Ba3, which is where we want to be. We'll be pro forma for -- some of these asset sales under 50% debt to total cap and BB rated. So we have access to the corporate bond market to the preferred markets and many other -- and we just also did a project finance, debt refinance at Jefferson, highly successful municipal finance, 15-year and 30-year bonds at 3.5 and -- 3.625% and 4%. So it's a tremendous execution, tremendous testament to the value. We had 10x oversubscribed on that offering. So capitalization is great, and the businesses are all well positioned and clicking.

Great. That was a fantastic overview. So let's dig in on aviation because, obviously, there's a lot of interesting things happening there. So I guess, you've been deploying capital at a sort of rate, I guess, close to around $400 million or so. How do you think about sort of the go-forward in the aviation leasing as you're accumulating assets? Let's put the joint venture aside for a moment if we can and then think about sort of engines and airframes. What's the opportunity for you to grow that investment on an annual basis?

Yes, I think it's improving, actually. I think when I look at my favorite chart on Page 4 of the slide deck, which I have up, and the opportunity set that we're looking at is the 5B/7B engine market, which is 100% of the 737NGs that fly have a CFM56-7B engine on it, and 60% of all A320s have a CFM56-5B. So in total, it's 22,000 engines. And our goal from, really, from the very beginning, many years ago, has been to be the dominant player in the aftermarket for leasing and maintenance of those engines. And so the reason I'm excited is, a, it's the largest market in the world; and b, the blue line is the aftermarket servicing of these engines. So initially, when an engine is sold with an airplane, it comes with a guaranteed service contract, a power by the hour deal. But after 10 or 12 years, those engines almost always end up being served -- serviced in the aftermarket because the warranty programs get expensive. They're hard to transfer. They don't travel well, as they say. So those -- that's the blue line. And so effectively, we're looking at a market opportunity that's almost doubling over the next 10 years. So you're starting off with the largest engine market in the world, and it's going to double. So in terms of investing, that means our investment opportunity set is growing. And we have -- you're correct, we've been investing $400 million to $500 million a year in new assets, new investments for FTAI. And I think it's a reasonable assumption going forward. But I would say that we're seeing more fleet deal opportunities. So if you want to acquire a lot of airplanes, one place to look is airlines. And we did an Avianca deal in the third and fourth quarter. We acquired 14 aircraft from them. They wanted cash to help finish the restructuring with airlines in some form of financial need and distress, which always seems to happen and probably is going to happen a little more now. They will be more receptive to selling assets to generate cash. And so I see the opportunity to move from simply doing a regular way, onesie-twosies to potentially doing more bigger fleet deals. So that's why I'm optimistic about -- and always preserving our returns. We're not going to force an investment just to generate a certain target. We do it only if the deals meet our thresholds. And we've been successful with that. And then if you look to the right, and you think, well, so look at the 2022 average market shop visit cost projected to be $6.2 million for a CFM56 engine. So that's what people will be paying for a shop visit. With our portfolio of our joint venture products, our other PMA providers, our ability to source used serviceable material and our ability to manage shop visits, we can get that number to under $3 million. So it's a huge market opportunity. And so if I'm looking at a cost of 3 and other people are looking at a cost of 6, we will win more than our fair share of business and generate better returns. So putting all that together, I think the outlook for the next 10 to 20 years for this engine alone is fantastic.

Yes. Certainly, seems like it. So let's sort of take that in a couple of different pieces. So let's first talk about the potential for fleet deals and sort of what that would look like. You've always had a preference, it appears, for engines versus airframes. How did the economics of the fleet deals look in that respect because, obviously, the engines have historically been more valuable than the frames? So how do you separate those two?

So they're very similar, and it's actually a way of creating engines at a cheaper price, when you boil it down. So if you take the Avianca deal, for example, it was 10 A318s and 4 737s -- 4 A320, sorry. So 14 aircraft, the A318 is an extremely hard asset to lease today. It's not in favor. There are very few of them. It's a small number of seats. So the obvious thing for that airplane is to part out the airframe and keep the engines. The great thing about that is that, that airframe with 2 engines on it trades cheaper than A320 but it has exactly the same engines. So the same engine that flies the A318 flies the A320. So it's just a cheaper way to create engines. So what we'll do on all of the 10 A318s is we will sell off the airframe into the part out market and put the engines into our leasing program. And they're all CFM engines. So they fit right into this niche market. There are other deals that we could do where there would be a -- what we call a stub leasebacks. So you might buy a fleet from an airline that's looking phase out of that fleet over the next 2 to 3 years, so you can have a stub lease for 2 -- some 6 months, some 12 months, some 18 months, some 24-month leases, so that the airline can control the return and the downsizing of their fleet with -- as they match it up with airplanes that are coming in. So we could do a purchase leaseback, and then we will be looking at an airplane at that point, which could -- we could do the same thing, part out the airframe and lease the engines. Effectively, every time we buy an airplane, we're basically underwriting the future engine. The airframe is almost -- is not irrelevant, but if you pay $10 million for an airplane, the engines are worth $8 million and the airframes worth $2 million.

So what can you get -- what are the returns like on parting out the plane? I mean, is that just -- you're just trying to look to cover costs at that point? Or how do you think about that?

So in that example, we'll underwrite a value of $2 million for the airframe. And when we look at the returns, we're looking at a net investment of $8 million. So we might generate a 20% or 25% return on that $8 million investment. If we get lucky, and we have -- lately, it's been -- we have been lucky, we might get $2.5 million for that airframe. And so then the returns on the engines just go up.

Yes. Okay. So that's the way you think about the economics there, all focused on the engine.

Yes.

Got it. Okay. And then just sticking with that for a minute before we get to some of the aftermarket and some of your opportunities on the shop side. What do you think -- you're a fraction of the 22,000 engines there. How many of those engines are going to continue to be sort of owned by the operators? And how many are going to be in the lease market? And then how do you think you can grow within the lease market?

So overall, across all of aviation, about 50% of assets are leased and 50% are owned by airlines. However, when you look at older assets, as they age, that mix goes in favor more of leasing. So as people -- then the leases tend to get shorter, the planes get older, and the percentage leasing goes up. So it's above 50% of that fleet. So when we think about 22,000 engines and you see that blue line going from 10,000 up to 20,000 over the next 10 years, if you figure half of those are going to be owned and half leased, you're still looking at a market of between 5,000 going to 10,000. And so it's not crazy for us to think about. Today, we own -- if you look across our fleet, and you say, how many CFM56 engines do we own, pro forma for a deal or 2, it's about 250 engines. I could see that easily growing to between 500 and 1,000. So anywhere from 2x to 4x. It's sort of funny, when we started the company, we arbitrarily said, "Gee, wouldn't it be great if we owned 100 engines?" And then we got 100 and we say, "Okay. What's -- how about 300, wouldn't that be cool?" And so the market is so big, and our advantage is so wide. I don't think it's -- there's no limit, but we're not going to make it a pie-eating contest. We're just going to -- we're going to do that, which makes us the most money.

Got it. No, that certainly makes sense. Okay. That's helpful. And then if I think about -- let's talk a little bit about the opportunity to do more on the maintenance side. So how do you generate the differential, right? How do you generate the sub-$3 million shop visit relative to the $6.2 million, that's sort of the going rate now.

So there's 2 parts -- there's 3 parts to it. And we're looking actively at all 3 happening this year. The first way is the joint venture. And so we have 5 commercial parts in development, 2 of which will be -- we expect to be commercially available this year, and the other 3 by 2022. And the timing of those is perfect. Those parts will cover about 80% of the airfoil cost of that shop visit. And our cost -- our joint venture partner will make those parts. We own 25% of the joint venture, but we also have the right to buy those parts from the joint venture at cost. And that cost is roughly about 1/3 of what the OEM charges. So if you think of a part that might cost $15,000 hypothetically, our cost basis would be $5,000. So there's $2 million of savings right there. The other -- the next biggest part of it is sourcing parts from the used serviceable material market. Parts -- every time somebody does a tear down of an engine, there's parts that are recycled and put into existing engines. So there's a used serviceable material market and we've gotten pretty good at sourcing some of that used serviceable material at very, very attractive discounts, sometimes 25% or 30% of what the OEM cost is be. That could be another $0.5 million. And then we will be in the parts business because as part of our development of the joint venture, we will be putting in new parts and taking out old parts. So we're going to be entering the parts business in a way this year, late this year or early next year as a profit generator for us. That's not in any of these numbers. And then the third part is managing the shop visit. We have a lot of buying power. We will probably be managing over 60 shop visits this year from our fleet alone. So that's a pretty big number. And we will -- we're actively looking at investing in and setting up our own MRO shop, maintenance and repair organization, either solely or with a partner, most likely with a partner, such that we can control that shop visit more carefully, given the numbers that we have and the priority, you don't want to be put at the end of the line and have it take 6 months. And we're also looking at some ways of standardizing those shop visits to shorten the cost of a shop visit because one of the big expenses is, if a shop visit takes 6 months, you have to pay for all those months while that engine is in this -- with the replacement engine. If we can shorten that to 2 months, which we think we can, that's another source of savings. So there's probably another $0.5 million or $0.75 million there. So all 3 of those add up to more than $3 million of savings. The part of it that is exclusive to us is the joint venture. No one else has that deal. No one else can ever have that deal. We are sole and exclusive on that. So that's a competitive advantage no one can replicate. The other 2 things could be replicated. Other people could do them. But it takes time and it takes focus and a market presence. So we're constantly thinking of the next one. By the time somebody copies one of them, I'll have another one next year. So I think we've got all of that in place. All of that will happen this year, and then savings will be material and meaningful. So the profits from the joint venture, if we look historically at penetration rates for those similar types of products, it's not crazy to think of getting 5% to 10% of the aftermarket. So if we own 25% as part of our investment, we own 25% of that JV. If that JV achieves 5% to 10% market penetration of aftermarket shop visits, our profit from that JV is worth $50 million to $100 million per annum. Our total investment was $30 million. So that's onetime $30 million versus $50 million to $100 million every year. Secondly, if we do have a fleet, let's call it, 300 engines, CFM engines, 60 of those will be shopped every year, roughly 20%. And if we save $2 million from the JV parts, that's another $120 million a year in savings. So that $130 million investment, we think, will generate between $50 million and $100 million of EBITDA and $100-plus million of savings per annum.

Okay. So those are pretty good returns when you start to think about that. So...

And it's not all of it either. There's more, but I'll leave it at that [indiscernible] more than that.

It's okay. Fair enough, fair enough. So let's talk about the process, right? So I think you mentioned 2 products commercially available this year 2020. So where do we -- we start there, can you give us a rough timing within the year when we should expect to see some of that? And then how quickly can you then start to ramp, so we can start thinking about the 5 to 10 because obviously you're starting from a much smaller base?

Yes. So we expect 1 product to be available, commercially available, at the end of Q2, and the other 1 at the end of Q4 this year. And production of those parts and repairs can begin immediately. So the actual -- the JV partners is looking at generating production immediately upon approval. Really, there's like no lag. So it's very exciting. It's very real. This is a combination of 3 years of effort, and we obviously wouldn't be speaking this confidently if we thought there were issues that were -- that we thought could slow that down. So it's very close and very imminent.

And anything -- the FAA approval process, is there anything for us to think about in that?

Well, I think about it all the time but probably not.

Meaning, are there any wrinkles that we should be thinking about there? Or is it relatively straightforward?

You don't know what you don't know. But I just -- as I just said, we wouldn't be talking this confidently if we didn't think that we've been working very carefully on that hand-in-hand all the way. So there's nothing at this point that is troubling.

And so when we think about this business, because I want to come back to the $400 million to $500 million of capital deployed within the aviation broadly, but when we come to think about this business, this is a $30 million investment once. What's the ongoing? Is there an ongoing investment or any cost associated with it?

No, 0, 0.

So it's $30 million once.

Yes. We're not manufacturing anything. We are just owning a 25% P&L. Think of it that way. There's no ongoing CapEx. All of the money that we invested upfront was for engineering, design and approval processes. Those are over.

Okay. So now going back to think about that $400 million to $500 million, and understanding that fleet deals can be lumpy, you have the law of large numbers where you've made the incremental investments. And so growing as a percent of the total asset base becomes a little bit more challenging and so you incorporate things like the fleet deals. But is there a way we can kind of smooth that out if you were to think about this over the next, let's call it, 3 to 4 or 5 years, does that $400 million to $500 million number annually on a look-back basis, look something more like $600 million or $700 million? Or is it potentially more than that?

That's a very -- I've always told investors that we don't try to budget investments. So I never start the year telling our team go invest $1 billion this year because, my god, they'll do it. It's just not a good way to run an investment business. So we try to stay away from saying we're going to invest this much this year because then you're going to vary the returns. And I would rather keep the returns at a certain level and see how much you do. But having said that, we've actually been pretty consistent in investing $400 million to $500 million without these products and before the market sort of is really growing. So I do see the opportunity for fleet deals to be bigger than it has been in the past.