Air Lease Corporation (NYSE:AL) Q4 2023 Earnings Call Transcript

Air Lease Corporation (NYSE:AL) Q4 2023 Earnings Call Transcript February 15, 2024

Air Lease Corporation beats earnings expectations. Reported EPS is $1.89, expectations were $1.1. AL isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good afternoon, my name is Greg, and I will be your conference operator today. At this time, I would like to welcome everyone to the Air Lease Corporation Q4 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] I will now turn the call over to Mr. Jason Arnold, Head of Investor Relations. Mr. Arnold, you may begin your conference.

Jason Arnold: Thanks Greg and good afternoon everyone and welcome to Air Lease Corporation’s fourth quarter and full year 2023 earnings call. I’m joined today by Steve Hazy, our Executive Chairman, John Pluger, our Chief Executive Officer and President, and Greg Willis, our Executive Vice President and Chief Financial Officer. Earlier today we published our fourth quarter and full year 2023 results. A copy of our earnings release is available on the investor section of our website at www.airleascorp.com. This conference call is being webcast and recorded today, Thursday, February 15th, 2024. And the webcast will be available for replay on our website. At this time all participants to this call are in listen-only mode. Before we begin please note that certain statements in this conference call including certain answers to your questions are forward-looking statements within the meeting of the Private Securities Litigation Reform Act.

This includes without limitation statements regarding the state of the airline industry, the impact of aircraft and engine delivery delays and manufacturing defects, our aircraft sales pipeline and our future operations and performance. These statements and any projections as to our future performance represent management’s current estimates and speak only as of today’s date. These estimates involve risks and uncertainties that could cause actual results to differ materially from expectations. Please refer to our filings with the Securities and Exchange Commission for a more detailed description of risk factors that may affect our results. Air Lease Corporation assumes no obligation to update any forward looking statements or information in light of new information or future events.

In addition, we may discuss certain financial measures such as adjusted net income before income taxes, adjusted diluted earnings per share before income taxes, and adjusted pre-tax return on equity, which are non-GAAP measures. A description of our reasons for utilizing these non-GAAP measures as well as our definition of them and the reconciliation to corresponding GAAP measures can be found in our earnings release in 10-K that we issued today. This release can be found in the Investors section and Press section of our website at airleasecorp.com. As a reminder unauthorized recording of this conference call is not permitted. I would now like to turn the call over to our Chief Executive Officer and President, John Plueger.

John Plueger: Thanks very much, Jason. Good afternoon everyone, and thank you for joining us on our call today. I’m pleased to report that during the fourth quarter, ALC generated record quarterly revenues of $717 million, up approximately 19% relative to the same quarter last year, and we achieved $1.89 in diluted earnings per share, up 56% from last year’s fourth quarter. Revenue for the full year of $2.7 billion was also an ALC record. Strong continued expansion of our fleet, increased sales activity at healthy gains, and higher end-of-lease revenue were the primary drivers of upside to revenue as compared to the prior year quarter. During the fourth quarter, we purchased 22 new aircraft from our order book, adding approximately $1.2 billion in flight equipment to our balance sheet, while we sold eight aircraft, totaling approximately $440 million in sales proceeds.

The utilization rate on our fleet remains very strong at 99.9% for the full year 2023. In addition to revenue expansion during the fourth quarter, we also benefited from approximately $67 million net from the insurance settlement we received on four aircraft seized in Russia in the prior year, plus the equity interest in our managed fleet. We continue to vigorously pursue further insurance settlements as well as our insurance claims and litigation, but given these are largely legal matters, there’s not a lot of extra color we can add on this topic. I will note that we believe strongly in the validity of our claims and continue to pursue all available options for recovery. Global air traffic continues to gain altitude, and there are no signs on the horizon of volumes weakening dramatically.

Steve will expand upon this in his remarks. We’re also seeing in recent months a rebound in the cargo and air freight markets, owing largely to cargo ship traffic risk, time delays, and concerns from the Middle East. We believe that this uptick in air freight trend will continue given geopolitical realities in the Middle East. This bodes well for our order of seven A350 freighter aircraft, as does further and impending additional orders for the A350 freighter from airlines such as Cathay Pacific. Demand for fuel-efficient aircraft, meanwhile, continues to be very strong across both new and used aircraft. At present, we are 100% placed in our forward orders through 2025, and we’ve placed 65% of our entire order book. Given Boeing and Airbus are practically sold out through the end of this decade and that we have $22 billion to deliveries pending through 2028, which will likely slip into 2029 as well, we are being patient with additional order book placements to further bolster the upward trend in lease rates you’ve heard us regularly highlighting.

These delivery slots hold immense value, and we’re very cognizant of the position of strength we’re in. As to our current fleet, we are taking advantage of the market lease rate increases on our lease extensions, although we do not have a high number of lease expirations or extensions this year. We are still experiencing a very high rate of lease extensions as most airlines are anxious to keep their aircraft given a short supply of aircraft. Used wide body lease rates including A330-200 and 300 and Boeing 777-300ERs are accelerating from the supply-demand imbalance with single-aisle 737-800s and A320 and 321 CEOs reaping the highest premiums for prior generation aircraft in the used aircraft marketplace. During the fourth quarter, our $1.2 billion of deliveries came in higher as compared to our expectations for the quarter and for the full year deliveries came in at $4.6 billion.

As you may recall, third quarter deliveries were lighter than expected, so some of the pickup in the fourth quarter came from those delivering while others that we thought might push into 2025 were brought forward into December. Looking forward, the supply of new commercial aircraft remains highly constrained both by the supply chain as well as aircraft and engine production quality issues. Delivery volumes have improved over the past couple years following the pandemic, but challenges persist around the pace of improvement and the ability of both Boeing and Airbus to ramp up and achieve production goals. The recent action by the FAA to limit Boeing’s max production rate is a main reason why we at ALC are forecasting a relatively wide range in our 2024 new aircraft investments of between $4.5 billion and $5 billion.

Prior year’s history also provides some uncertainty on our total Airbus deliveries for 2024. We expect around $1 billion of those deliveries to occur in the first quarter of 2024. That said, I do think it’s important to point out that at the low end of the range, deliveries would provide significant fleet growth, representing approximately 17% of ALC’s 2023 year-end fleet, which would be even higher after aircraft sales and depreciation are taken into account. We are continuing to see lease rates catch up with interest rates in the marketplace. As to the impact on lease yields, let me remind you that the increase in lease rates we are seeing on new placements will primarily benefit our results in subsequent years as our new aircraft placements generally occur two years prior to delivery.

Our aircraft sales activity remains healthy in the fourth quarter and we continue to see strong sales demand for our aircraft. Important to highlight in our business is the fact that the earning cycle on every aircraft is not complete until it’s sold. So earning a healthy gain on exit is a critical part of the investment cycle as well and bolsters our profit margins and return on equity. Healthy gains also demonstrate the value of our strategy of purchasing aircraft at the best possible prices from the OEMs. ALC sales pipeline totals $1.5 billion as of today, inclusive of roughly 600 million of aircraft classified as held for sale and 900 million subject to letters of intent. As for 2024 sales expectations, we currently anticipate approximately a billion and a half of aircraft sales.

As a reminder, the sales proceeds from letter of intent to deal closure takes time and is dependent on a number of factors outside of our control. So sales volumes tend to be lumpy in any given quarter as a result. Based on sales activity so far this quarter, we would expect closing around $200 million in sales for the first quarter of 2024. Now switching gears to a different topic, there has been much publicity and commentary on the recent Alaska 737-9 MAX incident along with Boeing quality control and regulatory oversight. Let me just say that ALC is a believer and supporter of the 737-MAX and of the Boeing company. We are keenly aware of Boeing’s intense 24/7 efforts to rectify and address quality controls, enhance safety measures, and restore confidence to the flying public, their customers worldwide, and the regulators.

We fully believe that Boeing will be successful in these efforts and will be a better company for it. The 737 MAX is a core component of global airline fleets and will remain so. We do not believe that the MAX residual value is diminished whatsoever. We continue to see very strong lease demand for the MAX as well as high demand from buyers for the MAX. We’re also encouraged by Airbus’s perspective on the Alaska 9-MAX matter with Guillaume Faure recently commenting that it, “makes us very humble”. It is a strong reminder to all OEMs and suppliers to always put quality and safety first, never at the expense of production rate or economic goals. We all want our aircraft on time but without compromise on quality. Quality and safety must take precedence over all other considerations.

So while extremely unfortunate, we believe the Alaska-9 MAX incident serves as a reminder to all OEMs and their related supply chains as to what is most important. In closing, let me just summarize that the dynamic of strong aircraft demand, constrained supply, and ample fleet growth is a robust and prevailing tailwind for our business here at Air Lease. And we see these factors offering continued support for aircraft values and lease rates for the foreseeable future. As such, we see a strong flight path ahead for our business. Now I’ll turn the call over to Steve Hazy who will add some additional commentary. Steve?

Steven Hazy: Thank you, John, and thank you to all of you listening in on the Air Lease call today. I’d like to begin by congratulating, from deep in my heart, the Air Lease team on achieving several key records, including the highest revenue and sales proceeds as well as exceeding $30 billion in assets for the first time in our history. We’ve certainly come a long way from our start in 2010 when we had aspirations but no aircraft and only a handful of employees. ALC was built from our collective vision that airlines will require the newest technology, fuel efficient commercial aircraft release, and that these aircraft would be needed well ahead of any availability from the OEMs. Right now, we’re observing both of these trends in a position that has rarely been so positively skewed in our favor.

Airlines are in immense need for the highest demand new aircraft, and both Boeing and Airbus are practically sold out through the end of this decade. Our volume discount pricing on our fleet and order book was achieved well before the recent spike in industry orders and pricing, and gives us a tremendous advantage that few others possess. These factors also continue to support positive upside to lease rates and aircraft values in our fleet. Global airline traffic volumes remain very robust. Full year 2023, IATA traffic figures released earlier this month continue to show very strong expansion with total volumes rising 37% year-over-year. Domestic traffic was up 30%, and for example, domestic China in particular up a significant 147% versus the prior year.

And most markets rose at very healthy pace. In fact, global domestic traffic hit all new highs in December with several markets like the U.S., India, Australia, and Brazil achieving mid-to-high single digit year-over-year growth rates in the month. Total international volume meanwhile rose a substantial 42% for the year with all major markets rising at double digit growth rates relative to 2022. Similar to domestic traffic, the biggest gainers were in the Asia Pacific region again, which rose more than 100% year-over-year in international travel in that region. And there’s a continuation of resumption of normalized international traffic patterns in Asia. Wide body aircraft demand has really picked up pace as a result of economic strength in Asia as well as growing international demand globally.

We continue to foresee strong growth in the Asian market ahead, particularly opportunities in the Asia to North America and Asia to Europe routes, but we also see strong continued expansion in a number of other markets as well. Major traffic flows such as North America to Europe and North America to South America, for example, continue to expand significantly. Many domestic markets worldwide also illustrate strength and further growth momentum. Passenger load factors also continue to climb, coming in at 82% in the latest month as reported by IATA. And in a number of markets, it’s already exceeding these levels. This is putting pressure on the airlines to find additional aircraft capacity to satisfy robust air travel demand. And we would anticipate load factors to go up even higher in the year ahead, given the limited supply of commercial aircraft and OEM delivery constraints.

IATA is expecting industry load factors to reach 83% in 2024, which is in line with record highs, but a number of markets are either already well above their highs or are expected to meaningfully exceed these industry average levels, and these could certainly go higher. Continuation of this trend would further increase the need for more new commercial aircraft. Airline health, meanwhile, continues to improve overall, with airline industry revenues expected for the first time to hit a record of $1 trillion in 2024. Strong traffic volumes and yields have also been a key to this expansion over the last few years. Profitability of the industry is expected to achieve $25 billion or so in 2024. We recently had extensive conversations with many of our airline customers while in Europe over the past few weeks.

Each of them have echoed the view that operating conditions are attractive overall, and all of these airlines were asking us for more aircraft. On the credit front, we selectively avoided doing business with some of the larger airlines that went bankrupt over the last year, including Gol of Brazil, Go First in India, and Viva Air in Colombia. In addition to being selective with our customers, I would like to remind you that our fleet is very geographically diverse, with 119 customers in 62 countries at the end of 2023, with about 1% average exposure position per customer. So our conservative portfolio management strategy further reduces risk to any individual airline. We also maintained significant cash security deposits and maintenance reserves as added installation from customers that could run into challenges.

You can see this in our balance sheet at around $1.5 billion at year-end. This is a meaningfully large number almost 6% of the net carrying value of our fleet. These funds are paid into Air Lease by our airline customers for our benefit and effectively reduce our net interest expense and provide us meaningful credit protection. Returning to ALC’s fourth quarter results, we delivered 22 new aircraft from our order book period, consisting primarily of narrow-body aircraft along with 2 Airbus wide bodies. We delivered 6, A220 aircraft in the quarter, 5 were delivered to ITA Airways in Italy. And one A220-300 was delivered to a growing airline in Southeastern Europe. We continue to see the A220 gaining traction globally with both new and existing customers given its attractive economics and fuel efficiency.

We delivered one A320-200neo aircraft to SATA based in Azores as well as 8, A321-200neos, 2 going to ITA, joining the 5, A220 deliveries I just mentioned; 2, to LATAM Airlines, the largest airline in Latin America, and the first 2 deliveries of total A321s will be delivering to that airline. In addition, we also delivered one A321-200neo to each Air Astana based in Central Asia, SKY airline based in Chile and Sunclass Airlines in Denmark as well as the first Airbus A321neo to Transavia in the Netherlands. On the Boeing side, we delivered 5 new 737s during the quarter, including 2 737-8 to Malaysia airline and one 737-9 each to Aeromexico, Alaska Airlines and Corendon in Netherlands. Lastly, we delivered 2 new A330-900neo widebodies, one to ITA and one to Sunclass Airlines in Scandinavia, joining their narrow-body sister ships, which were delivered in the quarter that I just highlighted.

Lastly, I would like to emphasize a point from John’s section on the value of our fleet and forward order book. Simply looking at our consistent gains on aircraft sales. It is clear that there is significant value embedded in the aircraft in our fleet as compared to the depreciated cost basis held on our books. With all that said, I’ll now turn the call over to our CFO, Greg Willis, for his more detailed comments on our financial performance in 2023.

Gregory Willis: Thank you, Steve, and good afternoon, everyone. During the fourth quarter of 2023, Air Lease generated revenues $717 million, which comprised of approximately $644 million of rental revenues and $73 million from aircraft sales, trading and other activities. The increase in our total revenues was driven by the growth of our fleet $59 million in gains recognized from our sales activities and $60 million in end of lease revenue stemming from the return of 7 aircraft. Let me remind you that the earnings model in aircraft leasing includes not only the base rental payments that we recognized on a straight-line basis over the life of the lease, but also includes the earnings that we generate from Interlease payments and maintenance reserves as well as the gains that we record from the ultimate sale of the aircraft.

These additional income streams serve to enhance the overall earnings profile of the business. Sales proceeds for the fourth quarter totaled approximately $440 million from the sale of 8 aircraft. As I just mentioned, these sales generated $59 million in gains, representing a 14% premium to our carrying value, which was higher than our long-term average of 8% to 10%, further demonstrating the strength of the market and the underlying value of the aircraft that we have in our fleet. I do want to point out that our gain on sale margins will vary somewhat quarter-to-quarter based on aircraft sold and market conditions. But it’s also worth highlighting that we have a robust aircraft sales pipeline aggregating $1.5 billion for future aircraft sales at accretive valuations.

This pipeline not only further reinforces the underlying value of our existing fleet, but also provides a meaningful addition to our liquidity position and is a catalyst to help us reduce our financial leverage, which I will discuss later in my remarks. Moving on to expenses. Interest expense increased by $35 million and was driven by 70 basis point increase in our composite cost of funds to 3.77%, along with an increase in our debt balance. We have significantly benefited from our largely fixed rate capital structure, which has helped to moderate the effects of the current interest rate environment. You should note that we ended the year with 85% of our debt — debt at fixed rates. Depreciation expense continues to track the growth of our fleet.

With regards to SG&A, our ratio of expenses to revenue remained in line with the prior year and on an absolute basis, they increased along with the expansion of our leasing activities. It is also important to note that we disclosed in our 8-K filing in December, we recorded $67 million from a Russian insurance recovery as a benefit against our Russian write-off line item in our income statement. This recovery was helpful along with our aircraft sales activities to help us reduce our financial leverage. All of these activities, along with the quality of our fleet, helped us to generate strong financial results in the fourth quarter and for the year ended 2023, which ultimately has resulted in the continued expansion of our adjusted pretax return on equity since 2021.

Our cash flow from operations for the full year 2023 rose 26% relative to 2022, benefiting from our continued strong airline customer cash collections. These healthy cash collections further our ability to reduce our debt balance and fund aircraft deliveries. Transitioning to our financing activities. We raised $3.6 billion in committed debt financings during 2023. Much of this financing was completed in the bank market, which provides us with a substantial amount of flexibility as compared to the bond market. We did return to the bond market in the fourth quarter when we raised CAD 500 million maturing in 2028 at a rate of 5.9%, inclusive of the effect of our currency swaps. Then in early January, we returned to the U.S. bond market and raised an additional USD 500 million maturing in 2029 at 5.1%, marking our lowest coupon in approximately 2 years.

We are highly focused on maintaining our strong investment-grade balance sheet, utilizing unsecured debt as our primary source of financing, maintaining a high ratio of fixed rate funding and utilizing a conservative amount of leverage and targeting a debt-to-equity ratio of 2.5 times. Our liquidity position remains strong at $6.8 billion at the end of the fourth quarter, and our unencumbered asset base of $29 billion is a source of strength on our balance sheet. Our debt-to-equity ratio at the end of the third quarter was roughly 2.68 times on a GAAP basis, which net of cash on the balance sheet is approximately 2.61 times. As I mentioned previously, we continue to utilize the proceeds from aircraft sales and Russian recoveries to pay down debt and to help us reach our long-term target debt to equity of 2.5 times over the medium term.

Echoing the key observations made by Steve and John, we feel very positive about the positioning of our business in the current environment, and we believe our fleet and order book of the newest and highest in-demand commercial aircraft remain a key strategic advantage. We continue to foresee these high-demand assets and the market supply-demand imbalances as enhancing our performance in the years ahead. With that, I’ll turn the call back over to Jason for the question-and-answer session of the call.

Jason Arnold: Thanks very much, Greg. This concludes our commentary and remarks. [Operator Instructions] Operator, please open the lines for the Q&A session.

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Q&A Session

Operator: Thanks Jason.[Operator Instructions] It looks like our first question today comes from the line of Catherine O’Brien with Goldman Sachs. Catherine, please go ahead.

Catherine O’Brien: Hey good afternoon, everyone. Thanks for the time. Totally understand that quarter-to-quarter, we should expect that gain on sale to bounce around, of course, but had a solid gain this quarter, up from last quarter. With everything that’s going on with the MAX and GTF, should we expect supply to remain tight or maybe even get tighter as we move to this year? And should that translate to potentially keeping that gain on sale higher than the historical average. Just any color there on both the supply and demand side and thoughts on the gain that Air Lease could enjoy in that environment would be super helpful. Thanks.

John Plueger: Thanks, Catie. The answer is yes. We do believe that the supply will remain constrained. As to the impact on forward sales gain, I really can’t comment too much. We’ve got a robust pipeline of $1.5 billion. All these things are taken into consideration. But I think there’s no question in our mind that the supply will remain constrained.

Steven Hazy: For every airplane that we have for sale, we have multiple buyers. So it’s been a very dynamic market. And it’s led to a high level of liquidity in the secondhand market for aircraft and Air Lease is having a high-quality fleet will continue to enjoy significant gains when we dispose of these assets.

Catherine O’Brien: Okay. That’s great. And then I was just hoping to get some more color on the returned aircraft and the end of lease revenue. I’m not sure if you can share this, but obviously, which airline and what type of aircraft would be helpful. And then just how should we think about the turnaround of getting those aircraft back out the door as you just spoke to, I’m sure there’s plenty of interest and taking those aircraft off your hands. But what’s MRO capacity like? Is that still pretty tight just in terms of the time line to get reconfiguration work done to get the back out of the quarter.

Steven Hazy: Your question is really two parts. Let me explain the first part. We have two types of leases. Many of our leases, the airline pays a monthly overhaul maintenance reserve for the usage of engines, airframe components, landing year and so forth. So there’s a monthly cash inflow over and above the rental. And then we have some leases where that compensation comes at the end of the lease. So it’s kind of a catch up. And so some of these transactions that you referred to was simply where the leases had come to an end or where we agreed by mutual agreement with the airline to recover the aircraft. And then we were able to obtain additional funds, keep all the security deposits and in effect, get the present benefit of the maintenance reserves that accrued during the life of the lease.

And then the second question, MRO capacity is very tight. So we try to keep those transitions to an absolute minimum, and we try to lay off those expenses on the next airline rather than having to use ALC’s resources.

John Plueger: Let me just add, Catie, that where we do have an expiration in my prepared remarks, I highlighted the fact that we have a very high rate of lease extension and that continues to be the case. There’s not a lot many this year, but we have — our historical average is 75% of our leases — first run leases get extended. I don’t know what the current percentage is today, but I would strongly imagine it’s well north of 90% to 95%.

Steven Hazy: And just by way of example, one of the aircraft that was in this category was an A321 and the new lease that we signed with another airline as a follow-on, is paying us a higher rental rate than the original lease and the other aircraft being a 737-800, we had the same phenomenon with a new lease, had higher lease rates than at least that just expired.

Catherine O’Brien: That’s great. Yes, I guess I was assuming those maybe were early returns, but wasn’t factoring and maybe some of that was just coming to their natural end. That’s all super helpful. Thanks for the time.

Steven Hazy: Thank you Catie.

Operator: And our next question comes from the line of Jamie Baker with JPMorgan. Jamie, please go ahead.

Jamie Baker: Good afternoon everybody. First one, probably for Greg on Russia. If you look at what you initially wrote off, not what the insurance claim was, but what you wrote off, where are we in terms of aggregate recovery inclusive of the $67 million disclosed in the fourth quarter? I mean if you were to express recovery as a percentage of book, we’re hearing around $0.65, $0.70 on the dollar elsewhere. Just wondering if the Air Lease metric is consistent with that.

Gregory Willis: I think to date, we recovered about 10% to 12% of our $800 million charge that we took last year. I can’t really comment about what the market is for claims in the marketplace. And ultimately, we’re kind of limited about how much we can actually talk about our recovery efforts on the call.

Jamie Baker: Okay. Well, that’s helpful. And then second, if I back out sale proceeds in the end of life revenue, it looks like lease yields are uninspiring. So at or near the lowest level since 2021, which seems, I don’t know, a little inconsistent with how bold up everybody is on aircraft leasing. So what Mark and I were wondering, are lease extensions to blame for this? Is that what’s potentially leading upside on the table relative to how strong market rates reportedly are?

Gregory Willis: No, I think it’s really being driven by, as you sell off older airplanes. They typically are at the highest point of their yield in our life cycle. And as you layer on younger airplanes, they start off at their lowest and then as they age, the yield goes up. I think that is putting probably the main driver where it is because you’re right, as John mentioned in his prepared remarks, we are seeing lease rates really start to get going.