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

Okay. Are we live? All right. Thank you. Good morning, everyone. I'm Brandon Oglenski, Transportation and Airline Analyst here at Barclays, and just welcome to our second day of our 37th Annual Industrial Select Conference here in South Beach, Miami. Really appreciate everyone coming out and the continued support for Barclays. We do a lot to make this good an event for your process. Joining us today is actually Fortress Transportation and Infrastructure Investors. Joe Adams, CEO of the business, is here. And Joe, you've been with Fortress for over 15 years?

15 years, yes.

Okay. And have done a lot...

Not 37, but 15, yes.

Yes. Done a lot on the transportation side, running the gauntlet from aviation to railroad assets and infrastructure, so definitely going to have a good chat. We normally pull the audience here. So we'll just see whoever is here with ARS questions. If you guys keep coming down, we'll do this every year and give you a time series. For those in the room, do you currently own the stock? And Alan, you can definitely chime in here. All right. Question number two, the general bias towards Fortress right now: Positive, negative or neutral? [Voting]

All right. And then question number three. In your opinion, through-cycle EPS growth Fortress will be above peers, in line with peers or below peers? We should have made this free cash flow, by the way.

Yes, that's true. But that's good, anyway, EPS. [Voting]

All right. I appreciate the response. So Joe, I know you had a few moments of remarks that you want to make. So appreciate it.

Sure. Thanks very much, Brandon, and thanks for having us again at this conference. I didn't realize it was a 37-year tradition, but it's unlike any other, sounds great. And really pleased to be able to present today. I'll start with a little overview of Fortress Transportation and Infrastructure, which we call FTAI, which is also the symbol is, -- in 2 -- effectively in 2 main businesses. One is equipment leasing, which is almost totally commercial jet engines. And so when you think of us in the aviation space, think of us as the engine people. And then the second business is infrastructure, and that is principally port and rail terminals in North America. And as Brandon mentioned, our background of Fortress prior to this company was investing through our private equity funds, and we started a company called Aircastle, which was recently announced being sold to the Japanese, but it's aircraft leasing. We also were big in container leasing, a company called SeaCube and then invested in railroads pretty significantly, started in 2005 with RailAmerica in Florida East Coast. Railroad right here in the state of Florida that runs down the East Coast. And we're currently building a passenger rail from Miami to Orlando through our private equity funds, not through this company. So we've a long history of experience in those 2 areas. And not surprisingly, that's what we're doing in this company today. So just flipping over to aviation and engines. We got interested in the engine business back at Aircastle. But inside of a large leasing company, it's very hard to get everybody to focus on what is a relatively low ticket item compared to $50 million, $60 million, $70 million airplanes and engine will cost $3 million, $4 million, $5 million. But engines are very interesting. They're more technically complex. And every 5 to 6 years, an engine that comes off wing goes through a major shop visit, a major overhaul. So there's 2 things about that. One is when that engine is in the shop, you need another engine called a spare engine, and so we own a lot of those. We own over 150 of those that we lease to aircraft as a single asset. And then that shop visit entails lots of decisions. So it could cost $5 million, $6 million to put that industry to shop, which is effectively almost the same price you pay to buy the engine in the first place. So you have a lot of choices. So you need good knowledge, good people. And you can also create products as we have, that will allow us to be more efficient, effective and do that -- perform that shop visit cheaper. So that's the business, the return profile is amazing. It's a great business. We generated 25% EBITDA to invested capital, it's been our target from the beginning and a 15% ROE unleveraged, which is very different from traditional aircraft leasing company. And it's very sustainable. So we have a great outlook going forward in the business and one of the best opportunities of the lifetime is ahead of us in the CFM56 engine, which is the largest single-engine type in the world. Speaking of that, this is one of my favorite charts, in that the growth opportunity I just alluded to, the CFM56 engine is the largest single-engine type in the world. It's 22,000 engines flying around the world every day. It is on 100% of all 737NG aircraft, of which there are about 7,000 of those, and it's on 60% of all A320 aircraft. So it's the workhorse of the industry. When an aircraft gets delivered initially, that engine maintenance will be covered by the original equipment manufacturer, the OEM, under a power-by-the-hour deal. But as those power-by-the-hour deals run off typically after 10 to 12 years, many of those maintenance events then occur in what we call the aftermarket with independent maintenance shops like MTU or Delta TechOps. And that's our opportunity because that's where you can manage that shop visit and create savings for the customer and higher returns for us. So you see the blue line on this chart. As the fleet ages and this is a fleet that's already built, more engines will be served in the aftermarket, starting today. Roughly half of those engines are aftermarket served about 10,000, and that will grow to almost 20,000 over the next 10 years. So it's -- even though the fleet is not growing, our market opportunity is going to effectively double over the next 10 years. The other thing that happens with engines and one of the reasons it's a very good investment is it's comprised of parts and labor. And every year, the manufacturers raise those prices because that's their business model and they have effective near monopoly, so they're able to do it. So if you look at today's shop as a cost of almost $5 million, it's projected if prices continue to increase as they have historically to almost double again to $9 million over the next 10 years. And that is an opportunity where we have created a series of products and practices that would allow us, for example, in 2022 instead of a $6.2 million shop visit for us to manage that and perform that for under $3 million. So it's a huge competitive advantage, a huge barrier for anybody to be able to do what we do. And it also gives us an opportunity to win more than our fair share of business. So we're extremely excited about that. 2020 is a big year for this -- for the introduction of these -- some of these products. And the best 10 years is coming right down the pike. So a terrific opportunity. We're extremely well positioned to take advantage of. Turning over to the infrastructure side. You see this beautiful picture which the management team refers to as the Hershey Kiss. This is the Jefferson Terminal in Beaumont, Texas, and the rail tracks are on the outside and the tanks are on the inside. And then above that, in the foreground is the Exxon refinery. This is one of the largest refineries in the country, and it will become the largest refinery in the country in 2022 when Exxon expands from 325,000 barrels a day capacity to over 600,000 barrels a day. Down the river, about 10 miles away, is today the largest refinery in North America, which is Motiva's. And these are our 2 biggest customers. So we process, we store crude that comes in by rail. And this year, we'll be storing crude that comes in by pipe and water. And we will also ship outbound refined products. We deliver for Exxon refined products that they ship to Mexico, principally on the Kansas City Southern railroad. So it's an amazing location, which is very important in this business and it's tremendous amount of growth ahead of it. Today, you see it's about 4 million barrels on the site there in that photo. We have the capacity to grow the main terminal here to 8 million barrels, so effectively double that. We can also -- we have a south terminal under option where we could add another 10 million barrels. So a total of over 20 million barrels of storage, which is a good metric for how you -- how much capacity and how much money you can make. So a terrific business, a big transition year for that. And then the other 2 assets we have under development, Repauno's on the East Coast on the Delaware River. It is a natural gas liquid storage terminal. And this year, in the third quarter, we'll begin exporting by ship, propane and butane. And then Long Ridge Energy Terminal is in Ohio in the Utica, and we are building -- we have under construction a power plant. It's a great area for power and that natural gas prices are probably the lowest almost anywhere in the world. So very significant development opportunities that are well advanced also in these 2 assets. So just wrapping up, we also have a strong balance sheet. We've targeted debt-to-total cap of 50%. And pro forma for some asset sales, we just completed, we will be below that. And we were just upgraded by Moody's to Ba3. So we have a BB rating, also with FID. So we have access to strong access to the public debt markets, also the retail preferred market. So strong access to capital, which I think is always an important aspect in any business to be able to take advantage. As you can tell, we are somewhat opportunistic in our approach to investing, and we don't like paying high prices. So having firepower when others don't is really a key strategic advantage for us. So that's the prepared remarks and happy to entertain questions.

Yes, sure, Joe. Thank you for that, by the way. So can you give us just a breakdown to -- of funds available for distribution? Because, obviously, you guys pay pretty attractive yield in the market and consistently have. And I think a lot of that's come from the aviation portfolio, which we'll talk about infrastructure later, but definitely, we want to focus there, too.

Yes. So we -- what we calculated as we call FAD, funds available for distribution, and it's EBITDA minus interest expense and debt service basically. So generally the bulk of that, over 100% of that is coming from aviation. We are at a run rate of about $350 million of EBITDA and growing. And then when you back out interest expense and SG&A, our dividend coverage is about -- was about 1.8x. Our targeted ratio is to be 2x coverage, and then we would be able to increase the dividend, which Jefferson turning positive EBITDA this year should cause that to go over 2.

Okay. And on the aviation side, I think you guys talked about a joint venture on the maintenance side of the business. Can you talk a little bit more about that and the opportunity that presents in the market?

Yes. So 3 years ago, we identified the opportunity for the CFM56 engine. We approached a company that is actually in the business of making engine parts and repairs. And there's a program, you're going to apply for the FAA to get permission to do that, but it takes a process of -- it takes approximately 3 years to get approval. So we're at the point now where we're expecting approval of the first part in the second quarter of this year, 2020. And the second part in the fourth quarter. We also started in the second quarter last year an additional investment in 3 more parts. So we have a total of 5 underway. So the first commercially available parts will be this year. The -- and effectively, the joint venture has 2 components to it from our point of view. One is that we own 25% of the profits of that joint venture. So when the products are available and sold, they will be sold at a profitable margin. And we estimate that if -- history is a guide that achieving 5% to 10% market penetration is very doable. And that would provide -- that 25% profits interest would provide us with between $50 million and $100 million of profit per year, EBITDA per year. Our total investment in the JV is $30 million. That was a onetime investment. So obviously, a very, very profitable opportunity. The second part of that is for our own engines, the engines we own, we have the ability to buy those products from the joint venture at cost. And cost is roughly 1/3 of original equipment manufacturer list price. So a huge competitive advantage. That makes up about $2 million of the $3 million of savings I mentioned per shop visit. So the next few years, as you can imagine, is very big for that engine. There's -- a lot of programs are transitioning from OEM to aftermarket, and it's big for us. We own pro forma for a couple of deals, we own about 250 of those engines today. And there are a number of opportunities for us to acquire, particularly through some fleet deals, a larger number of those. So with 22,000 engines out there, we could easily see ourselves owning 500 to 1,000 engines in the not-too-distant future.

Okay. It's really interesting. And what -- is there a competitive risk here because that sounds like a pretty compelling investment to me?

Well, when you search the world and you try to find a company that is not OEM affiliated that has the capability to make parts and repairs for the hot section of the engine, you'll find that there's only one. I've only found one, and that's our partner. And also, our arrangement is exclusive. So in other words, we have the only arrangement. All of the intellectual property is contained inside of that joint venture, and we're the only party that will ever have the opportunity to buy those at cost. That's exclusive to us. So 1 company, 3-year head start and exclusivity, I don't think there's -- I can't imagine anybody being able to copy this.

Do you think there's any competitive threat though from the OEMs? Would they...

Always, always. They're not -- they've experienced this in the past. If you look back at some other engines, the CF6 engine -- CF6-80 engine, Pratt 4000, the RB211, the Pratt -- the CFM56-3C1, they've all had this happen to before previously. That's why I say if history is a guide, a 5% to 10% market penetration is not -- is very much in line with past experience. So for -- if a manufacturer is going to give up 5% to 10% of the market, they're not going to adjust pricing across the board for the entire product line. So it's typically something that is understood that there will be competition in this way. But it's not -- it doesn't make economic sense to sort of -- to swat a fly with a hammer.

I know you understand this business very well with Aircastle and the history there. And you guys definitely generate better returns in maybe your average aircraft whatsoever, which is dealing more with initial purchase aircraft to place them in the market. But are we just maybe at the top here given that half the global growth fleet is granted via the MAX? There's a lot of aftermarket activity. Is that maybe inflating numbers right now for you guys? Or do you think this is more of a sustainable business, that you think of a growth of 500 to 1,000 engines?

Yes. Well, that's out of a -- so if you think about the workhorse of the industry is -- and one of the reasons we focus on the 737 and the A320 is that, that is the core of almost every airline's fleet. And it is the most liquid, most stable, most predictable part of the market. If you look at pandemics, which starts with -- a good example of it, now we have coronavirus. A lot of the impact on that was long-haul flights and wide bodies. So you had -- and it lasted for like 3 to 6 months and then it returned to a sort of more normal growth rate. So the positive case for aviation is that there's 7.5 billion people on the planet and a very small number of them travel. Americans travel disproportionate amount, but those billions and billions of people who live in countries, and they take a trip, they want to take another trip. They don't want to -- they don't say I'll never do that again. So there's a tremendous demand for people traveling and flying. And so if you take the most liquid asset, the most profitable asset for the airlines, even if you had no growth in the industry, you'd still have tremendous demand for those airplanes for the next 20 years. There's no technological risk in that time period either. There are talks about electric and hybrid and all that, but it's 15 to 20 years from now if you start to get that in service. So what -- and then the other thing you have with the 737-800 is, you have an airplane that can be converted to freighter. So if you look at the history of the 757, which has probably been the most profitable asset ever in leasing because it just keeps on giving, if you think about what matters to us is that people are going to be flying that aircraft for a long time. So they're still making 737-800s today. So you figure 20 years in passenger service and then another 10 to 15 is the freighter. There's a tremendous window of opportunity here even if the industry is not as good as it has been. So I'm not worried about the downside case really on that.

And why do you think you haven't faced more competition on the engine side?

Good question. I mean I worry about it. I've been worrying about it since we started the company. I always think somebody is going to do what we're doing. One, as I mentioned, the big leasing companies, I think it's just very hard internally to get anybody to spend a lot of time. If you have $10 billion of airplanes, having your best people in the company work on a $3 million engine doesn't happen. And I tried it at Aircastle. It's just almost impossible. So the big leasing companies are out of it. Other people come into the business, and they typically will raise a fund or they'll go get some money, and the deal is -- I'll turn it into 1.5x, and I'll give it back to you in 3 years. So they become more traders than investors. So we created -- we hired the best people in the business, and they're not a huge number of them. We have the right capital structure and that we don't have that requirement that you have to flip everything and then we focus. We just said we're not going to get distracted. We're not going to go buy Embraer's next year. We are focused on the engine, and in particular, the CFM56, and that's what we think about every single day. So that's been the formula. Why doesn't somebody do it? I don't know. But every year, we're going to come up with something that is harder for people to copy. When we first started, we said, wouldn't it be great if we own 100 engines, that would be kind of cool. Now we own 300 engines, and we're saying maybe wouldn't it be cool if we own 500 engines. So it's going to get harder and harder for people to match us. And then we have proprietary products that people can't copy.

And do you see any duration risk here, right? Because your average lease is very short term, right? Is that correct?

Well, the aircraft portfolio is about average of 3, 3.5 years, which is fairly typical.

Right.

The engines tend to be on a shorter-term lease because if you're managing for a shop visit, you're looking at potentially 6 months. So the engines technically are short term in duration. But a lot of those engines, once it's in an airline system, many of those engines stay in the system. We've had engines that were on a 1-month lease that are still there after 3 years. So you don't get any benefit from lowering the rate to try to get people to keep it. You might as well charge the full rate, and they end up staying anyway. So the need is there. That's really what matters. And the great thing about aviation compared to other equipment leasing that I've been involved with is that when you have an excess of equipment or surplus equipment, people stop doing shop visits. So if you have every 5 to 6 years you have to put an engine through the shop, that's 20% of the inventory, somebody is making a decision, do I want to invest $5 million in that engine. If the demand isn't there or it's weak or the part prices are high, it gets parted out. So there's a natural attrition in the supply in the engine business that you don't see in many businesses. And therefore, excess goes away very quickly. So that's one of the reasons I love it.

Yes. And this has been a super cycle in aviation, too, so...

It has -- I have to admit it these are good times. I can't say and we didn't anticipate the MAX, and the MAX has helped tightened the market up also for our assets. It also -- the idea, when the 787 was introduced first, everyone told me you should sell your 767s now because the 787 is going to crush it. And it takes a long time for new technology, and the 767 is still being made today, and it's still a great asset. So I'm a believer that these things have longer lives than people really expect.