With COVID-19 turning out to be a black swan event, the markets have witnessed a knee-jerk reaction. Further, some stocks and sectors have been more impacted than the others. As an example, the airline, travel & tourism and energy industry have been significantly impacted.
Within the broad airline industry, air leasing companies are also among the severely impacted players. Air Lease (AL) touched a 52-week high of $49.96 in the beginning of 2020. On March 18, 2020, the stock touched a 52-week low of $8.41. The sharp decline is an indication of the extent of panic.
However, with aggressive expansionary monetary policies coupled with a $2 trillion stimulus package, the markets have seen some respite. Air Lease stock has trended higher to $18.9. However, I believe that it’s too early to opine that the worst is over. While I have been bullish on Air Lease in the past, I believe that investors need to stay cautious.
This article will elaborate on the positives and the concerns. Overall, it’s a good time to pick quality stocks, but gradual exposure is advisable over the next few quarters. There can be more pain for the markets in the foreseeable future.
The Concerns for Air Lease
It’s important to note that growth in the air leasing industry is largely backed by debt. This is a major concern for Air Lease in the current crisis. To put things into perspective, Air Lease reported total debt of $13.6 billion as of December 2019. With a debt-to-equity ratio of 2.41, the company has a leveraged balance sheet.
In addition, the company has delivery of 46 aircraft in 2020, 76 aircraft in 2021 and 92 aircraft in 2022. Therefore, in these challenging times for the airline industry, the company’s debt is likely to increase.
Before I talk further on the potential credit stress for Air Lease, I want to discuss the outlook for the airline industry amidst the current crisis.
According to IATA, the passenger revenue for the airline industry “could plummet $252 billion or 44% below 2019’s figure.”
Further, a slower than expected recovery is likely. Even after the virus is contained, consumers will be cautious on travel and holidays. It’s likely that the slowdown for the airline industry will extend well into 2021.
The government in the United States has provided an initial bailout of $50 billion for the airline industry. However, I believe that it’s likely to be insufficient. To put things into perspective, the Airlines Passenger Experience Association has called for $250 billion in government support to tackle the COVID-19 crisis.
So a likely scenario is further increase in bailout. It might also not be surprising to see few casualties in the airline industry globally over the next few quarters.
Even for Europe, IATA estimates that nearly 5.6 million airline jobs can be at risk, which will impact $378 billion in GDP.
The point I am making is that the airline industry has more pain ahead and this will impact air leasing companies.
Just as an example, Credit Suisse analyst Moshe Orenbuch believes that “there will likely be multiple airlines failures in 2020 and lease rates could decline due to supply/demand imbalance.”
Potential default on lease payments or airline companies seeking discount on lease payment are also scenarios that will impact Air Lease, among other players in the leasing industry.
With the depth of the crisis still uncertain along with uncertainty on a potential time-line for COVID-19 containment, it makes sense to remain on the sidelines.
Air Lease From a Credit Perspective
With Air Lease having $13.6 billion in balance sheet debt, it’s important to look at the potential credit stress the company might face in 2020.
For 2019, Air Lease reported $1.9 billion in EBITDA and total cash interest expense of $442 million. This translates into an EBITDA interest coverage ratio of 4.3. Clearly, even with higher debt, the company’s debt servicing metric is healthy.
For 2020, I am assuming a bear case scenario where lease rental inflows decline by 50%. Therefore, the EBITDA can be assumed to be $1.0 billion. Even if interest expense increases to $500 million, the company’s EBITDA interest coverage ratio will come to 2.0. Therefore, I don’t see debt servicing as a challenge through 2020. This is a key positive.
Another point to note is that the company has 46 aircraft deliveries in 2020 and 76 aircraft deliveries in 2021. This will require further leveraging since the cash buffer or operating cash flows will be insufficient to cover for the payment of new deliveries.
The positive point here is that $6.0 billion in unutilized lines of credit and cash, $20 billion in unencumbered assets. Therefore, delivery of new aircraft is unlikely to be a concern. Further, 100% of 2020 deliveries and 82.9% of 2021 deliveries have already been leased.
The challenge will arise if airline companies seek to defer the date for lease commencement. In such a scenario, cash flows will not increase even as the total debt increases.
Coming back to the total debt, the company has 88.4% of total debt at fixed rate. With interest rates at near-zero levels, a possible strategy is debt refinancing to lower the cash interest burden.
Overall, from a credit perspective, Air Lease is positioned to navigate the crisis for the next few quarters. If the crisis goes deep into 2021, I would be concerned.
However, the impact on leasing rates and the overall airline industry would be long-term. Therefore, I don’t expect valuations to reach pre-crisis levels even in the next few years.
Concluding Thoughts on Air Lease
Air Lease stock is already higher by 125% from recent intraday lows of $8.4. I would therefore stay away after a sharp bounce back.
With COVID-19 at its peak in U.S. and Europe, there can be potential broad market corrections and Air Lease can witness a renewed decline. For now, the stock can be considered for trading than long-term exposure.
Further clarity on the impact of COVID-19 on the leasing industry will dictate the long-term trend for the stock.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.