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

Okay. Good afternoon, everyone, and welcome to the last session of the first day of Barclays 38th Annual Industrial Select Conference. I'm Brandon Oglenski, airline and transportation analyst. And I'm very excited here to close out the day with Fortress Transportation and Infrastructure Investors, and joining us from the company is CEO, Joe Adams; as well as Head of Investor Relations, Alan Andreini. Really excited to have you both here. And for those of you that maybe are not as familiar with Fortress Transportation and Infrastructure, the company owns around 80 aircraft and another 160 or 170 jet engines. I'm sure we're going to talk a lot more about the CFM56, which is the majority of their portfolio empowers all the prior generation 737s and the majority of the A320s that are out there. So we'll talk a lot about that as well as some pretty interesting infrastructure investments in Texas with some crude facilities as well as power and other port investments. And Joe, very glad to have you here. I think he's been with Fortress now for around 20 years. Is that right?

Yes, correct.

And has done a lot on the transportation aviation infrastructure side, was involved with the prior IPOs like SeaCube, Aircastle and RailAmerica. So very excited to have you guys. And in the past, when we're down in Miami, we do have the audience response questions. So anyone listening into this webcast, please take the survey. If you are an investor, we'd love to get the feedback for Fortress and really any of the webcast at this conference. And if you have questions, while we're doing the slide, please feel free to hit the Question button. We'll try to read them here anonymously or you can just e-mail me. So Joe, I know you wanted to start off with a couple of minutes to talk about the company.

Thanks very much, Brandon. Sorry, we're not together in Florida again, but next year, we will be, and I appreciate you taking the time and inviting us. Just to give a little bit of a recap, FTAI is in 2 different businesses that we've been investing in through Fortress private equity for many years. Be it the aerospace side with our focus on commercial jet engines and using leasing and now a focus on lowering the cost and saving airlines and saving ourselves on the maintenance side, the maintenance of those engines being a big cost -- a big operating cost for airlines. And we have a lot of unique products and partnerships that we've been working on for many years. And as Brandon mentioned, we're focused on what I think is the most exciting part of aviation, which is the CFM56 engine, which is our largest engine category in the world and one that's going to grow dramatically over the next 10 years, and we couldn't be better positioned to take advantage of that opportunity. So the aviation business, obviously, with airlines still struggling with flight levels being reduced, had a more difficult year than we anticipated this time last year. We thought everything was going to be wonderful in 2020 and turned out to be a bit more of a struggle, but it's -- we see the light at the end of the tunnel, as they're saying, that the businesses will recover, I think, fairly quickly with rebound, particularly in narrow-body fleet, which is where most of our assets are and also is doing quite well on the cargo side, which was a business that we didn't talk a lot about previously, but there's been a real star in the portfolio this year. So a differentiated model, which with the way we can save people money and share that with people and provide a service as opposed to purely leasing and trying to get the highest rent. We actually do save airlines money and can. The second part of our business is the infrastructure business. And we've always been -- we've been an active investor in railroads for the last 20 years, and found that the port and rail terminal business is one of the most interesting parts of infrastructure and where you can have some -- where you can add a lot of value, create a high barrier-to-entry business and really have a lot of different avenues of growth. And we have 3 terrific properties in North America, 1 in Beaumont, Texas; 1 in Eastern Ohio, in the Utica; and then 1 on the Delaware River right across from the Philadelphia airport. So great logistics capability, you all have rail connectivity, water connectivity, road connectivity, and they're in industrial areas where there's a lot of activity. I think with the new administration, the focus on infrastructure. We are well positioned to be able to grow and take advantage of some of those programs, given that presidency only last for 4 years, you really have to be in the business to be able to participate. So you can't be doing permitting. And so we've been investing in the last few years in these properties because we have a lot of available areas for growth. And I think the investment in industrial America and the -- particularly in the rail and the port side, I think will be a very exciting period for us. So we think this model is a great economic model and that we generate lots of contracted cash flow from our ownership of aviation assets and lease to those at very high returns, 25% EBITDA to invested capital, and we will see -- we see that returning this year. And the infrastructure side, we monetized a couple of assets last year before COVID and posed some substantial gains, including the Central Maine and Québec Railroad, which was about an $80 million gain on a $40 million investment. So we've done it before, and we see the tremendous value creation materializing on that side and EBITDA growth. So the combination, I think, has worked well for us, and we see 2021 is really -- is going to be a fun year, I think.

Well, Joe, I appreciate that introduction. And I think the fear early on last year was that you could do -- you can hear me right, Joe?

Yes.

Okay. Great. So thanks for that intro. I guess if we go back a year, I think the fear in the pandemic, at least the initial stages is that you could see very aggressively reduced utilization of your aviation assets and capacity in the U.S. is still down 40% or 50%. But you have actually outperformed on your aviation portfolio, the utilization of your assets, can you talk to the performance through the pandemic? And I guess what gives you excitement because you do have some pretty lofty goals on EBITDA targets for that segment this year?

Yes. So we always focus on the engine and think of those as the engine people and engines perform differently in a downturn and in a recovery. And that -- during a downturn, most airlines will defer putting engines through a major shop visit because it requires a lot of cash, and it's -- if you have a lot of assets on the ground, why would you spend money in repair one that doesn't need to fly right away. So they do what is called burning off the green time. So we've always felt that like other downturns and recoveries, this one would perform similarly. And we see that happening now is that particularly with the narrow-body fleet, which is probably 70% of our investments in the A320 and 737NG fleets with the engines, that there are -- there's less availability there, and it's going to be the first market to recover. So we see airlines already lining up to take engines now for 2021, and when they're seeing probable increases in flying in the summer in the second and third quarter of this year for sure, and it could be quite strong. So you don't want to miss the opportunities by not having availability. So we have people who've taken engines on lease this year already to sort of position themselves for that. While at the same time, the supply of engines is decreasing because, as I mentioned, people are not putting a lot of engines through the shop. The other portion of our portfolio, which is done very well, as I mentioned, is the cargo business, the cargo business is been booming because of e-commerce and the vaccine and other things in -- global trade is actually at record high levels. And so airfreight, which a number of our engines, we own the CF6-80 and the Pratt 4000 engines, which are the engines that fly 747s and 767s, and people say, "Oh, aren't those wide-body aircraft?" Well, they are wide-body aircraft, but they're flying in cargo configurations. So most of those engines we have, when we get an engine now CF6-80 or Pratt 4000 back, we have waiting lists of people wanting to get those. So that portion of the business has performed very well. As I mentioned previously, probably the hardest part of our portfolio has been passenger configured 767 and 757, which is about 15% of the portfolio, and that's because most of those are operated by charter carriers and charter airlines flying internationally is not exactly a robust business right now. Most of those charter carriers think that April, May, they're going to start seeing bookings again that has a lot of pent-up demand for people to get out of those -- out of their countries and fly back to the islands and go to the all encompass the resorts they went to. So we expect that business to pick up in the second and third quarter. And as well, the beauty of the 75 and the 76s, those are convertible to cargo. Those planes can be converted to cargo. So to the extent that there's too many of them, they're going to -- they're already seeing a lot of people buying 767s and converting them into cargo configuration. So the residual values, I think, are underpinned by that. And we do see the recovery, I think, coming for that in the summer. But it's been a tough stretch for that segment of the market for sure. We now have quite a bit of our portfolios with sovereign-owned airlines. So as airlines have gone out of business, one source of staying afloat is to get money from your government. And so our largest customer today is Air France. We've had other sovereign carriers that we have in the portfolio, and as well, we have a couple of large deals that we're working on that would increase that even further.

Appreciate that, Joe. And I guess can you speak to the -- I guess it's a little counterintuitive because you would think you'd go through your own engine time first. But in reality, it's a lot cheaper to leasing engine from you guys from a cash perspective than it is to go overhaul your owned engine. Is that correct?

Yes. And so once you use up a lot of green time -- most of the green time and you pick through the engines, you're going to run-up -- they're going to run-up against limits. And you can't just do a shop visit in a week, it takes a month, and you have to preplan and you have to order, you have to pay a lot of money and you have to find another engine while your engine is in shop. So there's a lot of costs that go into managing a shop visit. So -- and when all of that -- when the crisis hit, people shut all of that down. So it takes a while before that flywheel starts going again. In the meantime, people start looking around saying, "Well, I need something. I need an engine. I need somebody to partner to be able to supply me with power for a period of time." And some of the deals we've done with sale leasebacks and with some of the airlines, we've actually provided leases of other engines to them as well. So it's a relationship that I think after we go through this crisis, we're going to come out of this with probably a better quality of company that we have as partners that we would not have necessarily been able to access pre-COVID. Everybody has opened the business now and everybody's open saving money and cash.

Yes. And along those lines, you guys put out an 8-K last week, I believe, talking about how with your joint venture partner, you got approval for some aftermarket parts for the CFM56. So can you talk to you a little bit more about that? And is it just for internal overhaul costs for you guys? Is this something you can more broadly bring to market?

Yes. We hope to be able to provide it as a value-added service to airlines that we can save airlines money and make money for ourselves as well as for our own fleet. But this is a combination of many years of the work. We started thinking about the CFM56 engine. A while ago, it is the largest engine category in the world. And many of the original equipment manufacturer power by the hour deals are coming up for -- expiring now. So a lot of those engines will transition from a manufacturer program into an aftermarket maintenance program. And that's where we can actually apply these products and save money. So the first of what is a series of products that go into the hot section of the engine, which is where the highest cost you incur and shop visitors in replacing parts in the hot section. The first of those was approved by the FAA under PMA program, parts manufacturing authorization. And essentially, that -- because we funded the development cost of that first part years ago, we have a preferential price for our own equipment to own that, to put in our own engines, which is about 1/3 of what the original equipment manufacturer charges for that. So it's a significant discount, which is for what is the largest item in a lineup item in the shop is at cost. The second part of it is we own 25% of the joint venture, which will sell parts to other airlines around the world who want to put those engines -- put those parts into their engines. And so that mean, if history is a guide, and we think it will be 5% to 10% market share of the largest engine market in the world that, that 25% ownership should provide us with -- between $50 million and $100 million of EBITDA for our interest per annum on an original investment of $30 million. So we have 2 ways to really win. And then the third way, as you mentioned, is we're working on how can we apply all of our products, which include the ability to manage modules and inventory at Lockheed Martin, which is we signed a joint venture, a partnership agreement using the Montreal facility of Lockheed Martin is a maintenance hub for us. And there, we can break an engine into 3 different modules and have a safe time on a shop visit. So instead of an engine having to sit and wait for 1 component of the engine to be repaired, you could actually swap out a module that you have in inventory and shorten the shop visit from 6 months into 3 -- 30 days. So there's substantial cost savings there with that. It also gives us the ability to control our own engines and manage the shop visit there with them. And then lastly, when we signed an agreement -- we also -- some of those engines we're going to decide not to overhaul, particularly when you have modules, you can be more flexible and potentially parting out 1 module, will be in the parts business and generating both parts that we want to sell as well as a supply of used to service raw material, which is pretty important for every airline in the world that wants access to do service on material, and we partnered on that with AAR, is the largest player in the world on that. So we have the 3 legs to the stool. We'll have our own parts, which through a joint venture with Chromalloy, will have a preferential maintenance shop to do our work and to create module inventory for us, and we'll have an ability to monetize spare parts that it gives us full access to all the value and creates a valuable stream of another way for airlines to save money. So all of that is in place now. The Chromalloy agreement is exclusive to us and that it's in perpetual and in duration. The Lockheed Martin runs for 7 years, and the AAR deal is exclusive for us with AAR and the CFM engine, and it's 7 years in duration as well.

I mean, Joe, it's pretty interesting, the folks that you've got lined up here between Lockheed, AAR and Chromalloy. When you talk about the $50 million to $100 million that you could get, is that including future parts that you think are going to get approved? Or is that just the one that's already been approved by the FAA?

Yes. That's -- there's 2 parts that are advanced: one is approved and one we expect to be approved very soon. And then there's 3 other parts that we started in 2019, which we expect approval in 2022. And it's about 50-50 in terms of the ones this year versus the ones in 2022 in terms of the savings.

Okay. And can you speak to like the motivating factors for Lockheed or AAR to partner with you guys? It's probably a nontypical market for Lockheed outside of the defense business or contract the business that they have.

Yes. So we started -- we realized that we would likely need or wanted to have a maintenance partner in this business because we wanted to be able to put PMA into our own engines and not have anybody interfere with that. And we also had this vision of creating modular inventory -- modules in inventory. So we've -- we started looking for MRO partner 2 years ago, and pre-COVID, it was difficult because many of these shops were very full. Maintenance capacity was limited and they weren't very flexible. But once COVID hit, it changed the dynamic rather dramatically. As I mentioned, a lot of aftermarket activity slows down and maintenance shops feel the pain because people stop putting their engines to shop visits. So Lockheed has a beautiful facility, 300,000 square feet in Montreal. It's a former Air Canada facility, and it didn't have a lot of commercial business, they have some military business. So keen to build that up. And we will generate between -- right now between 40 and 50 shop visits a year. So it's important to have a predictable flow of business that helps you keep your employees busy and active and trained. And they can use that as the base to expand and thought the rest of the facility, the total facility can handle about 300 shop visits a year. So it's a predictable flow. It's not the margin that they would like, but it's a start towards getting to the margin they would like and being able to build off that. But in return for doing that, we got preferential pricing, and we also have access, and we also can control our parts to a much greater degree than is typical. So I think it worked well for both of us. Both priorities are happy and excited about it, and we've already got engines in the shop there in creating inventory. The AAR deal is used service raw material and we've gotten quite a good reaction from airlines now as is something that's very desirable. Everybody is trying to get the supply of it, and there isn't that much are available. And so there's many airlines that generate, we'll use it in their own fleets rather than sell it to other airlines. So having this ability, and we've targeted tearing down 20 engines a year, which makes us a pretty big supplier of USM right from the get-go, and that could grow. And so for AAR, it's a way of them getting in a good flow of parts business from one of the biggest players in that CFM engine. And we've committed to that volume to them for 7 years and in return they've committed not to compete with us. So it also works to both of our advantage. We can supply them the product without them having used the balance sheet and the capital. And they supply -- AAR supply us with hundreds of people that are in the business of selling parts every day that we don't have to try to replicate.