Clearly FLY Leasing has a good story to tell and is primed for growth but it is also clear that the market has yet to catch on, judging by its book value. That was also reflected in the frustration expressed yesterday as the company reported net income dropped precipitously in the first quarter from USD16.6 million to USD2.8 million on a decline in operating lease revenue.
The decline in total revenues was primarily attributable to a USD12.5 million pre-tax gain on the sale of an option to purchase notes payable in 2010 coupled with a USD6.6 million decrease in operating lease revenue in the first quarter of 2011. This was partially offset by USD1.2 million of equity earnings from unconsolidated joint ventures.
The decline in operating lease revenue from USD54.2 million in 2010 to USD47.6 million in 2011 was primarily attributable to USD3.6 million of end of lease revenues on aircraft with lease expirations in 2010 and USD2.9 million in operating lease revenue from the four aircraft that were sold during 2010. This was partially offset by USD1.6 million in revenue from two new Boeing 737-800 aircraft purchased in late 2010 and early 2011.
FLY Leasing reported total expenses also declined from USD47.1 million in the 2010 first quarter to USD46.2 million in the 2011 first quarter. CEO Colm Barrington reported that lease revenues were negatively impacted by five transition aircraft which are now in place with new lessors although they did experience significant down time. The company took a USD1.5 million hit.
Frustrated analysts and execs
Executives had a protracted conversation illustrating the frustration of analysts on the fact that shares are trading so low with respect to book value which was also evident in executive remarks. However, the company gained marks for the several initiatives - including its share buy-back programme and dividend - that have created shareholder value.
BBam CEO Steve Zissis began the conversation in his opening remarks acknowledging FLY shares were trading below book value.
“We’ve proven our aircraft can be sold at premiums to book value, 100% of our portfolio is on lease, we are generating positive cash flow, paying dividends and have built up a very large cash position allowing us to focus on growth,” he said, adding the company hopes to announce significant progress on its growth in the near future.
Analysts, however, seemed to be criticising executives for not communicating well with analysts, especially since the drop in revenues was entirely predictable given the special items booked in the first quarter of 2010. Mr Barrington also said that the sharply reduced earnings is not expected to be repeated.
Book value at the end of the first quarter was USD18.31 and the company declared its fourteenth quarterly dividend for the first quarter, representing 19% of available cash flow in the quarter. During the quarter, the company repurchased 1.1 million FLY shares at USD11.94 per share on average as part of a programme that has, to date, purchased eight million shares at an average price of USD7.89 per share. This accounts for 24% of its IPO shares. An additional USD30 million share repurchase programme was approved by the board on 3-May-2011.
“Of course we are disappointed in the share price relative to book value,” said Mr Barrington. “That is why we bought back shares because they were trading at a significant discount. I don’t know how to encourage shareholders to recognize the value, but with the new exposure resulting from a new entrant, hopefully analysts will start putting attractive values on our shares. We were disappointed when we bought 1.1 million shares and didn’t have an increase in share price which we should have seen. Our shares are a very good value and we still have share repurchase programme.”
He was alluding to the recent launch of Steven Udvar-Hazy’s Air Lease Corporation.
“The advent of a high profile, newly listed aircraft leasing company is likely to be positive for the existing participants as it will lead to greater interest in the sector and business generally, particularly from the analyst community,” he concluded.
Even so, analysts were quick to point out that the gap between the market price of FLY shares and book value is widening. One asked whether it made sense for the company to continue buying aircraft when they are automatically discounted by the market. He also wondered whether FLY was big enough to compete in the aircraft leasing market.
Mr Barrington indicated the size was not relevant owing to its relationship with BBAM, a point he made at the recent JP Morgan conference. He noted that BBAM managed 400 aircraft and FLY had the full resources of its market penetration. He also reported that FLY’s investment in BBAM continues to perform well, contributing USD1.1 million in equity earnings during the quarter.
“We don’t suffer from the dis-economies of scale,” he said. “Our financing is very competitive. Your point about whether to buy aircraft would be relevant if we were planning to issue shares which we are not. We do have a lot of free cash which can be used to continue to buy shares so effectively we are trading cash for aircraft but that is important to show growth in the company. We have got to deploy that cash to grow the company to show it has growth and earning potential and then maybe you’ll get a premium on share prices. That is where we’re heading right now.”
Outlook strong for leasing sector
While tempering his remarks because of fuel and Middle East unrest and the impact on customers, Mr Zissis reported a strengthening of demand for all aircraft types represented in the FLY Leasing portfolio as evidenced by an uptick for Airbus narrow bodies and the more common wide bodies such as the 777 and the A330. He noted the difference from the beginning of the recovery when demand centred on the 737-800.
“The lease rates for in-production aircraft types have rebounded sharply from immediately after the crisis,” he told analysts during yesterday’s earnings call. “Even after adjusting for the interest-rate environment today, compared to 2006 and 2007 when the industry was last firing on all cylinders, the net market for aircraft lessors are comparable or higher for the most in-demand aircraft.
He also reported large amount of capital flowing into aircraft leasing sector both from private equity but also the larger, existing lessors who were allocating capital to growth.
“This is creating a demand for aircraft subject to operating leases and prices are moving upward,” he said. “We have taken advantage of liquidity to rebalance our portfolio through selective sales of aircraft and in each case have achieved premiums to book value.”
The company had five returns during the quarter, four of which were extended with one release that is not expected to generate much down time and is expected to transition with minimum costs. Beyond that, FLY has no more re-marketing events this year.
Mr Barrington also discussed the USD5.9 million in investment made for a 57% interest in a joint venture that has acquired four 767s on lease to two North American carriers. The aircraft, on five year terms, are in their mid teens, he said, and the company expects to be able to release them when they come off lease, depending on the market at the time. While he did not disclose the expected returns on the JV, he did say analysts should watch earnings over the coming quarters.
“This was a very good deal that will provide significant returns over time,” he said.
Mr Zissis explained that fuel prices are driving up the price of aircraft. “Before even taking fuel into consideration, the demand for in-production narrow bodies is very strong,” he said in response to a question. “We are seeing lease rates creep up both for Airbus and Boeing as fuel prices increase. Airlines are looking for the most efficient aircraft which puts further pressure on demand. In addition, the production lines are sold out to beginning of 2015. If recovery stays intact we expect higher values and higher lease rates. There is true weakness in the mid-life stuff which has been lagging in value. But we are starting to see a bit of a recovery because airlines cannot find the new stuff. There is definitely a price differential between five-to-seven-year-old aircraft and we think that represents good value in the market. And the new stuff is being bid up by new capital coming in.”
Mr Barrington noted that all 60 aircraft in the portfolio were contracted for lease to 34 lessees in 23 countries.
"With all our aircraft currently leased and generating rentals, along with USD139.8 million of unrestricted cash, we remain well-positioned to grow our portfolio of aircraft," he said.
At the end of the quarter, the leases were generating annualized revenues of USD210 million with a 95% utilisation factor. On a quarterly basis that comes to about USD52.5 million per quarter. The average age of FLY's portfolio was 8.1 years weighted by the net book value of each aircraft. The average remaining lease term was 4.5 years, also weighted by net book value.
FLY Leasing finished the quarter with available cash flow of USD28.3 million compared to USD45 million for the same period in the previous year. Total assets were USD2.0 billion, including flight equipment with a net book value of USD1.6 billion. Restricted and unrestricted cash at the end of the quarter totaled USD306.5 million, of which USD139.8 million was unrestricted compared with. These amounts compare to total cash of USD329.0 million and unrestricted cash of USD164.1 million at the end of 2010.