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

Good morning, everyone. I'm Brandon Oglenski, transportation and airline analyst here at Barclays. Welcome to our 39th Annual Industrial Select Conference. For the second session here today, we have Fortress Transportation and Infrastructure Investors. And with us from the company is Joe Adams, CEO. He's been the CEO, I think, since we IPO-ed back in 2015.

Correct.

And a lot going on since then on both infrastructure and the aviation leasing business, which we'll get into in just one second. If this is your first session of the conference, there's a QR code right in front of you. And I think if you're on the webcast, there's an interface. We do have 6 audience response questions. We ask everyone to participate in the survey, the more that you do, the better responses we get there. But you should be able to read them when you scan the QR code. But Joe, thanks for coming down. Really happy to have you and to be back in person, back to normal.

Yes.

You guys have done a lot during the pandemic, especially on the aviation leasing side. I know we're going to talk about the CFM56 engine. But I think maybe even more top of mind, recently, you guys have said we're potentially going to split this company into 2, take the infrastructure side, make that self-sustained and have a stand-alone aviation leasing business. So can you give us an update where are we on that process?

Yes, and thanks very much for having us back again. It's great to be here. And obviously, great to be in person, and that's good for air travel as well. So we're seeing that across most of the airlines we cover, looking to increase their fleets, and that has -- that's based on advanced bookings being pretty strong. So it looks -- the outlook is pretty good there. But yes, we talked about -- if you go back to the beginning, we formed this company. I started this company in 2012, then we had a robust debate as whether this should be 2 companies or one company, and we decided to go with one company to build up the critical mass, and it worked out well. We were able to start both businesses, grow them to scale. And then last summer, we acquired Transtar, which was the U.S. Steel rail operations, and that added a lot of contracted cash flow to the infrastructure side to some of the development projects that we had coming online. So we decided it was a great time to have the children move out and be free. So we've been working on the split, and we've filed with the Form 10 with the SEC. We've received some comments. We will put audited financials submitted in March, and we would expect that things go according to the normal schedule that we would be able to distribute the share of FTAI Infrastructure to all investors in April. So then that's the point, we would have 2 companies, 2 stock -- 2 tickers and 2 stocks to trade.

Okay. And just remind me, I think the expectation was that you'd put a little bit more leverage on the infrastructure side. Is that correct?

Well, it's basically trying to allocate the debt because when you spin out the infrastructure, all of the corporate debt is staying with aviation. So think of it as effectively us moving $500 million debt from aviation over to infrastructure. That's what we're in the process of doing right now is raising $500 million of debt in infrastructure, which will be proceeds back to aviation. And then in addition, we're looking to raise $300 million of an equity-type instrument at infrastructure, which would also be remitted back to aviation. So that balances out the debt for each company, allows us to maintain the rating in FTAI aviation and pay down debt and also gives infrastructure good access to capital and liquidity as well.

Yes. And I think you guys were talking about looking at all sorts of opportunities for that equity investment. Is that correct?

Yes, yes. So we're talking about some of the larger fund managers, infrastructure funds, have raised a lot of capital and are interested in these types of opportunities. So we have a process that we're looking at right now and we have other alternatives as well. But lots of demand for infrastructure investments. And so we think that will turn out to be a good opportunity for an investor and also good for us to recapitalize the infrastructure business.

Okay. And you think prospects for raising that incremental -- or transferring the $500 million of debt and the incremental $300 million are pretty high?

Yes. But the spin is not subject to that occurring. So we can still do the spin. It's not -- doesn't have to be simultaneous with the spin happening.

Okay. Can you give us an idea of where you would target leverage then for both of these businesses post spin?

Yes. We're targeting on leverage on aviation is really to maintain a BB rating, and that's what we've done with the capital structure. Infrastructure most likely will be a strong B-rated company. So as opposed to a debt to cap, it's a little more oriented towards debt-to-EBITDA. So I would say that the target for us is to maintain ratings in those areas.

Okay. Talking about the aviation business, you guys have put together a pretty unique platform specific to individual jet engine, so the CFM56. And for those that don't know, that powers the past generation 737 fleet as well as about half of the prior generation A320 family aircraft. So this is what, about 7,000 or 8,000 aircraft that are active in the fleet?

7,000 737 NGs and another 4,000 of A320. It's about 60% of the A320 market. So 11,000 aircraft, which is 22,000 engines, the CFM56-5B and 7B. And most of the parts between the 5B and 7B are interchangeable. So it's a huge engine market. It's the biggest one probably we'll ever see in our lifetime.

And I think this all started a couple of years ago when you had a -- when you started a joint venture with Chromalloy to develop parts.

Well, it goes back even further. We started -- we did a lot of investing in the CF6-80s engine, which is the engine that powers the 76 and the 74. And at that point, we were working with Chromalloy for refurbishment of engine. We use their PMA that they have available, and they've been very successful on that engine. And we had a maintenance partnership. And so we put all the pieces together for that aircraft, but that is a smaller aircraft and more -- and it's aging. So at some point, that will run out. And we realized that the biggest opportunity was the CFM56, and we could do the same thing basically we did there for this engine. And so that's where we put together a partnership to manage the maintenance for us with Lockheed Martin and also gives us the ability to exchange modules. So the engine is actually very nicely wonderfully designed because you can change a fan, a core and a low-pressure turbine between engines. So you can swap modules from one engine to another, which creates a lot of efficiency and opportunities. So we did that with Lockheed Martin. We expanded the portfolio -- the product line with Chromalloy on developing PMA parts for that engine. And there's 5 parts in development for that engine, which encompasses about 80% of the airfoil components. And then we realized if we're in the module business, we're going to have modules that we would not want to -- would not be economic to overhaul. And so the best way to realize the value out of those is to part them out. So we formed a partnership with the leading aftermarket parts distribution company in the world, AAR, to basically be our partner to sell the parts for those modules we decide not to overhaul. So we really built a whole portfolio of products that gives us an enormous cost advantage in managing that shop visit over anybody else. And all of those arrangements are exclusive. It's exclusive with Chromalloy, which is perpetual 7-year deal with Lockheed Martin, exclusive, and an exclusive 7-year arrangement with AAR. So at this point, it's -- I can't see anybody being able to replicate what we have in any meaningful way, and we don't see anybody doing that. So it's really what we want to be as the leading provider of aftermarket power for the CFM56 engine, which is, as you know, the initial engine maintenance is done by the OEM, the manufacturer under contract. After 10, 12 years, just like if you had a Mercedes that had its 5 years of service and when it's 8 years old, you don't get a service plan, you do it yourself. So that's typically what happens in the engine market, and that's the market that we really target. The recent win we had with Lufthansa Technik was a good example of how that module factory has manifested itself and that we can provide, as a subcontractor to Lufthansa, the low-pressure turbine exchange. So we can sell them effectively a refurbished or 10,000-cycle LPT that give us back a 5,000-cycle LPT, and that enabled them to lower their cost to WestJet, which allowed them to win the bid for the engine maintenance program. So that's a 10-year deal, great names to be associated with. And we did that, and we won that business without any PMA. So it's a testament to the value of the products as a portfolio, which we think will only get better over time.

And so just can you dig deeper on that? Because it was just announced -- so you guys are effectively going to be providing refurbished modules to WestJet through Lufthansa. Is that correct?

Yes. Yes. And used serviceable material. So there's 2 parts to the deal what we provided to Lufthansa. And that was -- it was better for them because it was -- what we provided them is less expensive than having the LPT overhauled. So the bid that they were able to provide to WestJet was improved. Our economics work very well because we make money on both the sell and the buy and on the used serviceable material.

So then effectively, you're out there sourcing engines for this program. Is that correct?

Yes. So we have about 250 engines, CFM56, today on the way to 300. I'd like to own probably 400, 500 ultimately.

And how many of those are on wing and leased at the moment?

Well, there -- I would say 2/3 of those are on aircraft that are on lease.

Okay. So where you're going to source this from then is more...

Well, but you do -- so one of the products we provide is -- for instance, Avianca, ITA, the deals we just did, if an engine is due for a shop visit, it's on an aircraft that's on lease, when it's due for the shop visit, the airline returns it to us and we give them a new engine. So it's essentially an exchange program or like a power by the hour program that you guarantee that they'll have a certain engine and certain thrust, but you don't tell them exactly what engine it is. So it's extremely efficient for us. It's very efficient for the airline. They don't have to go out and get a spare engine. They don't have to manage a shop visit. It's effectively an outsourced function for them, and it saves money. And we make money. So it's -- that's the purpose of commerce.

Right. And is this a standard arrangement? Or is this a new type of lease arrangement?

It's new. It's developing. I'd say we have several of those products we've started this year, and we see doing a lot more of that. We also have the opportunity with some of the airframe we just bought to sell the aircraft to some other leasing companies and have them on the airframe and us retain the service agreement for the engine. And so that's a real win-win and that we get to take our capital out from an aircraft that we have bought and put on lease at a gain and then retain what we think is the best part of the deal, which is the engine contract. So it's -- there's a number of different developments. The nice thing about the way we're approaching that market is so we can provide services of value to everybody in the ecosystem, be it the MRO and Lufthansa Technik, be it the airline, be it the leasing companies, so we can access really the entire market with our products. And that was what we talked about, I think, over a year ago with the module factory is that's the beauty of it. If you look -- airlines -- if you're a big airline today and you own your own MRO shop, you do this internally anyway. They do swap modules. But if you're a medium-sized airline with 100 aircraft, then an aircraft, if it needs work on the low-pressure turbine, the whole engine goes into the shop and sits there and waits for the LPT parts to arrive and then it comes back. It's very, very inefficient. So this gives medium-sized and airlines that don't have their own maintenance shop access to that opportunity.

I guess in those circumstances for a small airline that maybe doesn't have access to their own shop but they lease their fleet, are there any roadblocks in those lease agreements that say, you can't just swap out a module? Do you have to go renegotiate some of those deals?

Yes. Yes, there are impediments to swapping engines with other people's leased fleet. So that's something that we'll have to, over time, break through. But as I mentioned, we're doing deals right now where we're looking at selling the aircraft on lease to a leasing company and we are going to be the designated service provider for the engine. So we're selling that successfully today. It's not obviously -- you're not going to sell it to everybody immediately. But over time, if you can save people money and you derisk that process, we think it's very compelling. And the whole argument about whatever we do with parts and other things, the engine affects the residual value, which, a, I don't believe is true; but b, if it is, it's our risk. So we own it. It's not -- you don't have to sell another leasing to say don't worry about it, we underwrite it.

Okay. Can you remind me, talking about 2022 and the outlook for aviation EBITDA, I think, but I might get this wrong, is $500 million to $550 million just from core lease activities? So that's aircraft you own and engines you own on leases. Is that...

Yes, what we've been saying is we're targeting $550 million of total EBITDA this year, of which we expect between $50 million and $100 million will be coming from the services components, the 3 parts that I just described. And as soon as we hit a certain level of contribution, we'll start breaking that out separately so that people can see the service business, how that grows versus the asset-based leasing business.

And I guess what is the strategy? Would you rather still be acquiring aircraft, putting them on the lease? Or would you rather just be in the engine business?

Well, the -- I think the 2 products go very well together. So my goal would be to maintain probably $2 billion of assets and be at 400, 500 to CFM56 engines is enough, turn it more frequently. And if you get $2 billion invested and we generate a 25% EBITDA margin, that's $500 million of EBITDA from leasing. And then I would like to grow the services business to $500 million of EBITDA also so that we could balance the 2. And as I said, the products go very well hand in hand. If you can provide an airline a sale-leaseback opportunity, then resell that aircrane, retain that leasing company, you just -- you're recycling the capital faster, and you're not going out every year saying, well, now I'm $2 billion, next year I got to be $2.5 billion, I have to be $3 billion, I have to be $4 billion. That's very hard to do. So I think turning the portfolio and maintaining that level of capital invested is a good goal while growing the service business.

Okay. Recently, though, it seems like every quarter -- and I cover airlines, well, you know it, but the recovery gets pushed out. Maybe 3 months ago, we thought we were in the clear outside of Delta, then Omicron came. I think your portfolio is a little bit more overexposed in Europe, if that's correct?

Yes. Well, I wouldn't say overexposed, but we're 50%...

Relatively more exposed, I should say.

Yes, yes. Relative to the population of the world, yes.

So what's it going to take to get back to proper levels of utilization for your fleet?

Well, I mean, if what's happening now continues, we will be back there. I mean the airlines is -- as we see, the airlines are all looking to grow their fleets now, which is a very positive sign. And it probably would have started in the fourth quarter, but with Omicron hitting and everything stopping again, what we saw in the portfolio was if airlines were planning to fly 350 hours or 400 hours with an aircraft, they only flew maybe 200 or 150. And so that affects our maintenance reserve collections and our revenues negatively. So the level of activity just didn't -- with the Christmas holidays and the expectation of a lot of travel, it flattened out, frankly, and we didn't expect -- we didn't see Omicron coming. But now the forward bookings are very strong in Q2 and Q3. So airlines are saying, I'm going to have to -- if I need additional capacity, I have to be getting it now. You have to line it up. So that's what we see happening. We see it happening across both aircraft and engines, narrowbodies in particular. So really, what we need is to maintain the path that we're on. And hopefully, no new variants or no more deadly variants, I guess, is the key. We'll probably have variants, but most countries other than China have opened less than travel restrictions. And people really want to go somewhere this summer. I know I do.

Well, it's good to be back in personal events like this, too. So hopefully, we're turning the page. Well, appreciate all that on aviation -- give us an update on infrastructure, especially with the addition of Transtar, which I think was pretty meaningful.

Yes. It's a great business. As you remember, we owned RailAmerica and Florida East Coast in our private equity days, and we love the terminal business where you have -- we always said the best railroad was the shortest railroad with the highest number of carloads as you have the most revenue, most cash conversion and you have the lowest operating costs. And so that's what we had in our portfolio on a development basis. We have Long Ridge, Repauno, Jefferson are all rail terminals that connect with water, so you can transload and store and land and provide value-added services. And then U.S. Steel Transtar is a -- the rail services. In addition to transloading the volumes out to the Class Is, we also run inside the plants. So it's a critical function for Gary and the Mon Valley. And so that has a very -- it's basically a 15-year contract. It's more likely perpetual. It's really hard to unwind it and has a lot of downside protection for us, and it has a very high cash conversion component to it. So as a matter of fact, in the first year, we will have more cash than EBITDA because we have excess railcars that have been stored up that we're liquidating. So very good cash conversion, very down -- a lot of downside protection. And then on top of that, we got 4 railroads that they had in the portfolio that we're not operating are basically doing nothing: one, West of Cleveland; one on Detroit- Zug Island; one in Longview, Texas; and one in Alabama. We just hired Gary Long, who was at Genesee & Wyoming. He's going to be the CEO of Fortress Rail. He's looking to build the transloading opportunities, right-of-way income, conversion of third-party business, other things that come into the steel belt that aren't on rail today, and then industrial development opportunities where there could be some big development opportunities in that portfolio. So we're very excited about the ability to grow the non-U.S. steel component of that business. And really, that was kind of the big risk factor in the deal was we had a single customer. So if we can diversify, grow the other non-U.S. Steel business, it becomes a great short-line railroad with very high cash conversion.

Can you remind us the revenue contribution and EBITDA contribution it should bring?

Yes, the revenue -- the EBITDA should be around $75 million for this year. It is a little bit of softness, as I was mentioning to you earlier, because the automotive business is not producing cars. So a lot of the steel shipments went out of the steel mill on the railcar, and then they're sitting there waiting for somebody to take it off. So we get the [ nourish ], but we don't get the same churn on the cars. That will rectify itself when they find enough chips to build those cars. And right now, you get the lots all over the country, they're empty. So filling up those lots should, in and of itself, be several quarters of good volume. But in the first -- fourth and first quarter, it's a little soft, not huge numbers but a little bit.

I think very understandable, every railroad is going at to -- go from Union Pacific. So...

Yes.

And by the way, if there's any questions in the audience, just raise your hand. I think we can get you a mic or there's also a QR code, so like the question here.

I just had a question. You mentioned the financing, the debt and equity. It's not tied to the spin. But is the plan to try to raise that before the April time frame that you suggested? Or is it planned to do after? How is the timing around that? And then the second question I had is since you made the announcement, it seems like this -- the initiatives you have should highlight the value in terms of the sum of the parts, and the share price really hasn't moved much. Is there -- is the leverage that Brandon mentioned that's the problem? Or what's the feedback been since you've made the announcement?

Yes. So the goal is to have the $800 million funded around the time of the spin-off. So around the same time. It doesn't have to be that that's what we're shooting for. In terms of the share price performance, it was doing quite well up until Omicron. And really, without knowing exactly what everybody is thinking, but it was our impression that, that was kind of what took the wind out of the sales at the time, and the stock recently has held up relatively well compared to other companies. But obviously, it's off the all-time high. So...

And I guess -- by the way, if you're on the webcast because I think that's why you can type in a question, I can read it here as well. So Transtar's definitely been a positive for infrastructure. I think, at least from my perspective as an analyst covering you guys a long time, the disappointment has been Jefferson. A lot of capital has gone in down there. It just seems like oil spreads are never where you need them to be to get that asset really up and running. Can you talk to me about the future of Jefferson?

Yes. It has been challenging because we started as a crude by rail terminal in 2014 when oil was, whatever, $120. And then I still remember the Thanksgiving events when it went from $120 to $20 and from the Saudis [ to that ]. So we basically had to repurpose the terminal and broaden out the product offerings. And what we focused on is Exxon refineries directly across the river. And they have -- they announced at the time -- around that time they were going to expand that refinery from 360,000 barrels a day to 620,000 barrels a day. That is underway and it will be done next year. And then Motiva had been part of Shell. But then once they split up, they form their own sourcing group and own trading group, so we said those are the 2 customers that are really likely going to fill the terminal up. So we did invest a lot of capital. We built pipelines, some Motiva pipeline to Exxon, pipelines from Cushing. We have more storage tanks. We've added refined products capabilities. So we've added a lot without the commensurate volume yet. We are effectively probably about 1/3 utilized this year. And we're working very hard with both of those counterparties to take more products and more volumes through the system. And we're seeing that in the first quarter, some shipments that are coming in by ship for Motiva of crude and we've got a number of different products on the schedule with Exxon to add. In addition, we won the Exxon export terminal expansion. So when they finish the refinery next year, they're going to be exporting more refined products. And so we won a 10-year deal to provide that export terminal capability to them. So that starts in 2023. So it has been frustrating. It's been frustrating for me to sort of not be able to show the EBITDA, but the value of the terminal and the relationships and the optionality that we provide is outstanding. And so it's our job to fill it up, and it's going to happen. It's just a question of when.

I think there's a question upfront here, whoever has the mic. Thank you. And while we bring the mic up, I guess we've heard about the Exxon contract, but does it provide you with any minimum guarantees? Or...

Yes, yes.

Because you're obviously spending a lot of capital on this one.

Yes, we financed all of that with tax-exempt bonds that had great time. We did $200 million at roughly under 2%, 15-year money. So it's a great -- when you put that together with a 10-year contract, it's really attractive. But yes, there are minimum volume commitments for the entire 10-year period that are meaningful.

Quick question. I know Pemex has had some significant production challenges. Just wondering if you can talk to how that is affecting the refined products demand out of the Jefferson area.

Yes. They have -- it's not really Pemex, it's been AMLO that has been shutting some of the terminals down. And so Exxon has been somewhat affected by that. Their volumes are down probably 1/3 in the last month of December and January because they've announced their auditing terminals. And the audits just start and the terminal shuts down and then there's no resolution. So they don't know when they'll reopen and how that will happen. So they have seen a reduction of volume. I think it's mostly targeted towards the trading companies, and they are hopeful that they'll get that volume back over the coming months, but they have been affected in Kansas City, so I'm sure it sees it. We've seen it in the short term. So -- but the counter is that what they're doing at Pemex is they're producing more fuel oil as an intermediate, which is unprocessed, it's not refined. So they have an imbalance. And so actually Motiva is bringing in fuel oil -- Mexican fuel oil by water and then refining it and then sending it back out. So it's possible that the way that they have -- Mexico is set up, it doesn't alleviate the need for refined products to be brought in. This is a question of -- it's more of a question of labeling.

Joe, we're almost up with time, and I have a lot more questions to get through, but...

That's why we're splitting the company.

Correct. Well, I guess that's where I want to leave it. So what's the incremental opportunity from here for an investor today? The structure should get a lot simpler in the future. Both -- the idea is to move both entities into a C Corp. Is that right?

The infrastructure company will be a U.S. C Corp. The aviation business will be a foreign corporation but no K-1s. So that's what -- today, we have no indexed investments, no ETFs, no -- we're not in any indices, so 0. So you've seen other companies that have converted and got rid of K1s, they convert to C Corps. You've seen a positive reaction from the stock market just because people have to put it in their portfolios after you do that. So we think that that's -- the history suggests that that's a big positive that people will see. And as you mentioned, it's just the complexity. We always do -- both companies have a lot going on, and it will be a lot simpler and easier for analysts, easier for investors to say, okay, I just want to focus on this one now.

All right. Well, Joe, thank you so much for coming down to our conference. Very happy to have you.

Thanks again.

Yes. Thank you.