Aercap (NYSE: AER)


How would one make money from the boom in air travel?  Is the answer to invest in airlines?  It sure looks like it in recent times as Warren Buffett, the Oracle of Omaha, has invested in multiple US airlines.  However, one would do well to remember the timeless quote from Richard Branson – “If you want to be a millionaire, start with a billion dollars and launch a new airline”.  Airline is notorious for its low returns per capex dollar spent.  When an airline invests in new aircrafts, competitors would have to do the same in order to keep up.  However, because competition is fierce, there is very little pricing power for airlines.  All this results in a boon for consumers but very little benefit to the airlines.

A better avenue, I believe, is to look at an auxiliary business for airlines — aircraft leasing.  The aircraft leasing business has high barriers of entry due to the significant financial muscle required and this has resulted in few global players.  One of these global players is Aercap (NYSE:AER) which was listed in 2006.  Since listing, it has grown book value impressively from $USD 8.83 to $USD 50 as of 2016. In 2013, it acquired AIG’s ILFC to become the largest independent aircraft lessor globally.

On a high level, aircraft lessors such as AER, borrow money from the financial markets to purchase planes from manufacturers and lease out these planes to airlines in return for monthly lease payments.  Put it simply, AER is profitable when net interest margin is over and above all outgoings. AER currently trades at less than $USD 46 per share with FY 2016 EPS at $USD 5.52.  Management has guided FY2017 EPS to be $USD 5.7 which gives AER a forward P/E ratio of around 8.  From a valuation perspective, AER looks like a no-brainer.

One aspect of the business that may trip up investors is the amount of debt that AER carries — $USD 28B as of FY 2016.  Should one be concerned by this?  On face value, the debt to equity ratio of 2.7x may look distressing but the ratio that we should be looking at for a finance company should be the equity/asset ratio.   AER’s equity/asset ratio is at 20% which shows that it is conservatively geared.  Therefore, I do not concern myself with AER’s debt for my evaluation of the company.  Before you get your panties in a knot, think of it this way — the interest expense on debt for AER is a cost of sales and with a 20% operating margin, AER will make a profit of 20 cents for every dollar it borrows to purchase an aircraft and lease it out.  If this isn’t making money hand over fist, I don’t know what is.

A few other plus points from the earnings call – AER has obtained an investment grade credit rating from Moody’s which should bring down its borrowing costs.  Also, AER board has authorised a $USD 350M share buyback which will run till 30 June 2017.  Bearing in mind with a current market cap of $USD 9B, that is about 4% of the shares that could potentially be bought back.

My next post will be on Select Harvest (ASX: SHV) after it has reported earnings for HY2017.

General Motors (NYSE: GM) and Michael Kors (NYSE: KORS)

Bought a sizeable position for GM at $35.1 USD

Initiated a small position in KORS at $34.93 USD

A truly value investor should always sniff out value stocks regardless of the form.  Essentially, this means looking for underpriced stocks in different sectors, different countries, yield vs growth etc.  You get the drift — basically under every rock.  This would particularly ring true for any Australian investors.  Any trade in Australian equities would most probably be a crowded trade.  If you don’t believe me, just check out your default option in your superannuation and it will be heavily weighted to Australian shares.  The slush of cash flowing into superannuation which subsequent gets pumped into Australian equities results in immense bidding for a small pool of quality Australian companies.  Therefore, I see great benefits in investing in international shares.

For any potential converts, there are several ways to invest internationally.  One avenue is to use Australian brokers but the commission costs are unnecessarily high and will eat into your profits (especially if your investment amount is small).  Another way is to use an international broker such as Interactive Brokers which has more reasonable pricing.  The last avenue that I can think of is to invest international via contracts for difference (CFDs).  Full disclosure, I have investment interests in two CFD providers i.e. IG Markets and CMC Markets but I don’t imagine having enough sway via viewership numbers to make a difference.  The payoff profile when investing in a CFD of a certain company is largely similar to investing in its shares except for franking credits.  Also, CFD allows one to apply leverage but this can be a double-edged sword i.e. both gains and losses are amplified.

All of this babbling brings me to the main focus of this post.  General Motors (NYSE: GM) and Michael Kors (NYSE: KORS) had just received their latest earnings on the 7 February 2017 and both suffered significant drop in their share price.

GM is the largest automobile manufacturer in the USA.  Brands under its umbrella include Buick, Cadillac, Chevrolet & GMC brands in the USA and the Buick, Cadillac, Chevrolet, GMC, Holden, Opel & Vauxhall brands outside of the USA.  Analysing GM is simply a numbers game.  GM is extremely cheap with a share price of $35 USD and management guided earnings of $6-6.5 USD which gives it a P/E ratio of less than 6X.  GM pays out $0.38 USD of dividend per quarter which gives it a dividend yield of 4.5%.  It has also $10B USD worth of share buyback remaining and with a market capitalisation of $54B USD, that would equate to a buyback of approximately 20% of its shares.  Critics have been ranting on about ‘peak auto’ for some time and has so far been incorrect with 2016 numbers coming in at 17.6M cars sold (2015: 17.5M) .

Source: CNN Money

With a dividend payout ratio of just 25%, GM would still be able to sustain its dividend if America’s new car sales crash and GM’s profits were to collapse by 50%.  Its latest earnings results prompted a 5% decrease in share price even when it topped estimates.  Sometimes, similar to God, Wall Street works in mysterious ways.  I can only assume that the decline in price is due to profit taking because of the YTD run up in share price.

KORS is a semi-premium brand best known for its women handbags.  It has seen its share price decline from a high of $98 USD to a current $38 USD which is near to its 52 week low. It is a serial buyer of its own shares with management (and I) believing that its share price is severely undervalued compared to its competitors.  Since the inception of the share buyback program in 2014, it has since bought back $2.5B USD worth of shares.  Compared to its market capitalisation of $5.5B USD, this is significant.

KORS Share Price
KORS Share Price (Source: Google Finance)

Like most retailers everywhere else, KORS is facing some headwinds and its share price has crashed by 11% since the latest earnings result.  It has seen less mall traffic and its wholesale channel is aggressively discounting its products.  To counter this, KORS is pulling its products from the wholesale channel and embarking on growth initiatives like selling smartwatches and increasing its presence into menswear.  According to the latest earnings call, management is currently looking at M&A opportunities and other capital initiatives.   Its main competitors are Coach (NYSE: COH) and Kate Spade (NYSE: KATE) and both companies has higher valuation than KORS despite lower earnings.  With the P/E ratios of COH and KATE at 21x and 19x respectively, KORS looks extremely undervalued at 9x.  It should be noted that, unlike COH with a dividend yield of 3.6%, KORS does not pay a dividend but instead focuses on share buybacks.  I reckon KORS would be trading at a higher multiple if it introduces a decent dividend in the future.