Taking Flight


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Airlines have faced tough times, but historically the industry has proved surprisingly resilient. Since 1959, global air traffic has grown at an average rate of 5.1 percent and contracted in only four years, all of which coincided with major dislocations such as war or surging fuel prices. Nevertheless, airline stocks are usually foolhardy investments, more prone to bankruptcy than profits. But aircraft lessors stand to profit handsomely when travelers and commerce once again take flight.

As businesses have slashed travel budgets and consumers increasingly vacation closer to home, the airline industry has taken a slash-and-burn approach to fleet management, sharply cutting passenger capacity. To reduce costs, airlines increasingly rely on leasing aircrafts rather than owning them outright. Many carriers will need to add planes when the recovery in air travel picks up steam.

All of Babcock & Brown Air�s ( FLY ) 62 aircraft are currently leased--the average term is 4.9 years--and generate about $220 million in annual revenue.

The bulk of the firm�s business comes from North America and Western Europe, but just less than half of lessees are based in the developing markets of Eastern Europe, Asia and Latin America. And unlike most of its competitors, Babcock & Brown Air has a presence in Africa.

Over the course of its relatively short history, Babcock & Brown Air has built a track record of shareholder-friendly activities. Since its initial public offering in 2007, the company has repurchased almost 10 percent of its outstanding shares and wound down almost $170 million in debt.

As the fifth-largest player in the space, Babcock & Brown Air is a potential takeover target. There�s been heavy consolidation among aircraft lessors over the past few years; many are seeking to maximize economies of scale. But with plenty of cash on the balance sheet, Babcock & Brown Air could also grow through acquisition.

Shares sold off sharply in 2008 after economic weakness prompted management to cut the dividend from 50 cents per share to 20 cents. But based on the company�s ability to generate cash flow and conservative payout ratio--roughly 20 percent of available cash flow--the dividend is secure even if revenues decline further.

Such a drop appears to be an outlier scenario, as air traffic should stabilize this year and grow modestly in 2011. And air traffic is expected to grow at an annual rate of 6.2 percent over the next decade, bolstered by 10.2 percent growth in the Chinese market.

Financially, Babcock & Brown Air is on excellent footing. Selling, general and administrative expenses fell to 6.6 percent of total revenue in 2009, and the company has about $80 million in cash. The company is also less leveraged then many of its peers; no major debt payment is due until late 2012. And it paid $7 million last year for the right to purchase $100 million of its outstanding notes at 48 percent of par value. Any buyback would likely occur by year-end.

Babcock & Brown Air has access to a significant loan facility that it could use to pay for additional aircraft--an important advantage. With most airlines cutting routes to control costs and scheduling longer flight times to improve on-time arrivals, airlines and other aircraft lessors are expected to offload excess aircraft over the next few years. In many cases, these planes will likely be newer, narrow-body aircraft. Ultimately, most of those additional aircraft will likely find their way to Asian operators.

There�s some risk that the uptick in air traffic may stall if the global recovery loses steam. But given the stock�s dividend yield of 8 percent, investors will be paid to wait for the recovery to take off.


� Less leverage than peers
� Strong financial footing
� Air travel rebounding in Asia

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Article Republished with permission from <a href="http://www.KCIinvesting.com" rel="nofollow">www.KCIinvesting.com</a> and <a href="http://www.rukeyser.com" rel="nofollow">www.rukeyser.com</a>

This article appears in: Investing , Stocks
Referenced Stocks: FLY

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