In tough economic times, a high debt load can cripple a company.
But when business is good, that debt can actually be a real
benefit. That's because equity comprises just a small part of the
(market value plus debt minus cash) and profits can become quite
large relative to that small equity base. But investors remain wary
of debt-laden companies, recalling that these were among the stocks
that appeared to be headed toward bankruptcy when the
started heading south two years ago.
As a result, shares of companies that buy and then lease airplanes
to the major airlines, all of which carry lots of debt, are among
the cheapest in the stock market. Yet if the global economy stays
aloft and can finally grow, then these companies could see
impressive profit and
Right now, the stars are aligning for this industry. Airline
traffic is up +10% from a year ago, banks have become very
supportive by providing very low interest rates for asset-backed
loans for airplanes, and the key players are generating strong
that is helping to reduce debt levels. Most importantly, a glut of
unused airplanes that sat idle are returning to service, and with
fewer airplanes available, lease rates are rising.
The industry is dominated by the finance arms of
. But investors can play the sector through smaller players such as
Aercap Holdings (
), FLY Leasing (
Willis Lease Finance (Nasdaq: WLFC)
. And as this table shows, all of these stocks appear quite cheap
on a price-to-earnings basis:
2011 P/E Est.
|FLY Leasing (
|Willis Lease (
But these stocks are also inexpensive relative to their assets.
For example, the value of Aircastle's fleet of planes, even after
subtracting the company's debt, is around $1.02 billion, more than
50% above the company's $661 million
, according to analysts at Citigroup. They think shares should
reflect that value and trade up to about $13 from a current $8.40.
In a recent note to clients, they wrote that "with its share price
trading as almost half of
, and given more demonstrable evidence of a rise in aircraft market
values, it is possible that Aircastle could spend surplus cash on
buying back shares or raising the dividend."
As long as these stocks remain below book value, share buybacks
make plenty of sense. And that's what FLY Leasing is doing. The
company's fleet of planes (minus its debt) is worth more than $17 a
share, well above the recent $12.50 share price. Of course, any
weakening in the economy would change that equation. (In 2008, when
the economy was sliding, airline lease rates fell sharply, dragging
down the value of planes, so FLY Leasing's book value then was just
$12 a share.)
Action to Take -->
If the economy weakens anew, then these debt-laden stocks would be
especially vulnerable. But all signs now point to a healthier
airline industry. Lease rates should continue to rise as demand for
new and used planes exceeds production from Airbus and
. If you're in search of dividend yields, then Aircastle and FLY
Holdings should hold great appeal, as these firms look set to hike
their dividends further in 2011 as cash flow rises. Aercap is
likely the most stable name in the group due to its relative size,
which helps it to arrange special banks loans on especially
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
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