(By Chris Mayer) One of the great growth global trends going on in the world is the growth in air traffic. And there is any easy way to play it, without owning an airline…
I was in Mongolia most recently. The airport in Ulaanbaatar is small, but growing. There has been much talk about building a new airport some distance away. The current one suffers from high winds and a short runway unsuitable for 747s and larger aircraft.
Whether that gets done or not, it's clear air traffic is pushing up against capacity. Year-over-year air traffic, including airfreight, is up 30% from a year ago. And if you look at a longer-term trend going back to 2006, you see air transport had nearly doubled through 2011.
In short, it's booming.
But what's particularly interesting about this story is that it is not all that unique.
Air traffic globally is on the rise — with most of the growth coming from Asia and the emerging markets. Passenger traffic grew nearly 6% overall last year. Most industry forecasts expect it will double in the next 20 years.
The key investment angle here is that the airlines increasingly do not own the planes. They are leasing them.
Leasing was practically nonexistent in 1970, but has since surged. Now nearly 40% of aircraft are leased. A sizable industry of airline leasing companies now exists to purchase aircraft and lease them to airlines.
Just a week ago, Intl. Lease Finance Corp. — which is a subsidiary of AIG — announced the delivery of a Boeing 737 to Eznis Airways, which is Mongolia's largest privately owned airline. (Aero Mongolia is the other private airline. Mongolian Airlines (MIAT) is the state-owned airline.)
Why is leasing so popular?
One reason is that airline leasing companies can get better financing deals than the airlines. (For some airlines, leasing gives them access to aircraft they wouldn't get otherwise.) The airline business is a very up-and-down business, as you know. As a result, it's expensive to borrow money. But an airline leasing company with a good balance sheet can borrow at much more attractive rates. An airline leasing company can also spread out its risks among different airlines and markets. So its earnings are far less volatile.
For an airline leasing company, it can also redeploy a plane. If, for example, an airline doesn't need a leased plane, it can get out of the lease by working with the airline leasing company. The airline leasing company gets some financial consideration. And such deals are contingent on the leasing company finding a new lease. But at the end of the day, the whole thing works more smoothly than if the airline owned the plane outright.
An aircraft is kind of like real estate. It is something that is durable and tends to holds its value. An aircraft typically has a life that exceeds 30 years. (Most of the time, we don't fly them that long.) You can sell an aircraft with a phone call, much like commercial real estate. There is a ready pool of buyers. As with retail space or an apartment, a leasing company can find other "tenants." The cost of operating the aircraft falls to the airline, or the tenant. This includes maintenance and insurance.
As with real estate, lease terms are for a number of years (three-12 being common). The lease is paid monthly in advance. There are security deposits, which provide protection for the "landlord."
Leasing companies, in a way, are like REITs with wings. REITs are real estate investment trusts that pay out much of their earnings to shareholders. Leasing companies also tend to deliver great yields.
Now, in the crisis of 2008, these REITs with wings got killed. Capital was cheap before the crisis. Investors got very excited about the whole thing, and as usually happens in such cases, the deals got bubbly. A wave of REITs with wings went public in 2006 near the top of the market, and investors did poorly as markets cracked afterward. The initial valuations on the stocks were far too rich. The stocks traded for multiples of two times book and greater. Growth expectations were too high.
When these expectations were not met, the stocks fell big-time. But today's valuations have gone too far the other way. They are very sober. The companies have also learned some things. They are more conservative in their structures, for example. It's the usual boom and bust of markets that create and destroy opportunities.
All in all, I'm bullish on the industry. It's a bet on two clear trends — the rise of global passenger miles and the increasing popularity of leasing the planes.
Sincerely,
Chris Mayer