AerCap, Aircraft Leasing, & Auto Dealer Business Models

Aircraft Leasing

In 1970, only 17 of 4,000 commercial aircraft globally were on lease. Today, over 40% of commercial aircraft (~25,000) are leased by airline operators and there are no signs of growth slowing. The two major publicly listed lessors, AerCap and Air Lease share attractive characteristics: both are run by owner operators, consistently grow their fleet and market share generating a healthy amount of earnings at ~12% ROE. However, for one reason or another, the market doesn’t assign much value to either company beyond the tangible book. We interviewed a Former CFO of Air Lease who has over 30 years experience in the industry as a lessor, lender, and an airline customer to explore the AerCap / GECAS deal and whether such assets are undervalued by the market.

Leasing is a simple spread arbitrage business. Lessors borrow capital to acquire aircraft forward from OEM’s and then sell operating leases to airlines for a marginal spread. This leasing income is also relatively predictable. We know how many planes Boeing and Airbus are making 10 years out and ~75% of the lessors’ revenue is typically booked up to 5 years out. After adding a few turns of leverage, lessors earn a sustainable 12-15% ROE depending on the age of the fleet.

The return on equity is mainly driven by two variables:

• The age of the fleet
• Leverage

A typical commercial aircraft has a 25-year life which depreciates to a 15% fixed residual value. This amounts to 3.4% depreciation per year throughout the life of the plane. The depreciation curve is steepest in the early years of fixed assets which reduces the return relative to later years where depreciation is slower. The older the lessor's fleet, the lower the depreciation relative to the leasing income which drives a higher ROE for every turn of leverage.

Historically, lessors have earned 10-11% lease yield plus 1% maintenance revenue. After deducting the 3.4% depreciation and SG&A, the public lessors have earned around 6-7% ROA. After adding a few turns of leverage the ROE is sustainably over 12%. So given the structural tailwinds, advantages of buying planes at scale, and the sustainable economics, why do the public lessors always trade at a discount to book? Even Buffett agrees and called aircraft leasing a ‘scary business’: