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.
WHY TO BUY
BABCOCK & BROWN AIR LIMITED (NYSE: FLY, $9.36)
� Less leverage than peers
� Strong financial footing
� Air travel rebounding in Asia