Aircastle Limited (NYSE:AYR) Q3 2022 Earnings Conference Call January 12, 2023 9:00 AM ET
Company Participants
James Connelly – SVP, Corporate Communications
Mike Inglese – CEO
Roy Chandran – CFO
Conference Call Participants
Mark Streeter – JPMorgan
Doug Runte – Deutsche Bank
Operator
Good day, and welcome to the Aircastle Limited Third Quarter 2022 Financial Update Call. Today’s conference is being recorded.
And at this time, I would like to turn the conference over to James Connelly, Senior Vice President of Corporate Communications. Please go ahead, Mr. Connelly.
James Connelly
Thank you. Good morning, everyone, and welcome to Aircastle Limited’s third quarter 2022 financial update call. With me today are Mike Inglese, Chief Executive Officer; and Roy Chandran, Chief Financial Officer. Other members of the management team are on the line and they’ll be available during Q&A.
We’ll begin the presentation shortly, but I’d like to remind everyone that this call is being recorded and a replay will be available through our website at www.aircastle.com. There you can also find the press release and PowerPoint presentation that accompany this call.
I would like to point out that statements today, which are not historical facts, may be deemed forward-looking statements. Actual results may differ materially from the estimates or expectations expressed in those statements. Certain facts that could cause actual results to differ materially from Aircastle Limited’s expectations are detailed in our SEC filings, which can also be found on our website. I’ll direct you to Aircastle Limited’s press release for the full forward-looking statement legend.
With that, I’ll now turn the call over to Mike.
Mike Inglese
Thanks, Jim. Good morning, everyone. Thank you for joining us. I’d like to start off by wishing everyone a happy and healthy 2023.
As per our usual agenda, I’ll kick off this call by sharing a few brief observations on the global aviation marketplace along with some highlights from our third quarter. Roy will then provide more detailed color on our financial results, after which we’re happy to take some questions.
Last month, IATA shared its global outlook for air transport, which forecasted airlines returning to profitability this year. I believe this optimism is rooted in the continued demand for travel and by the resiliency airlines have shown as they manage through significant economic headwinds.
Earlier this week, IATA released their latest air passenger market analysis reporting that industry wide RPKs are at 75% pre pandemic levels with a 41% increase from 2021. Despite headwinds due to inflation, fuel prices, interest rates and foreign exchange rates, airlines continue to find ways to meet growing demand for travel while managing their costs. Strong demand for travel is seen in North America, Latin America, Europe, India and many parts of Asia, regions where Aircastle serves a significant number of customers.
While the situation in China remains volatile with local easing of restrictions being somewhat offset by new restrictions on Chinese travelers, the broader Asia Pacific region experienced a 426% increase in international RPKs during our fiscal third quarter versus the same period in 2021. The creativity and resilience we’re seeing from our customers is similar to what we observed during the 2008 financial crisis. The airlines weather challenging times because their skilled operators who adapt to meet the continued demand for travel allowing to the overall aviation sector to grow.
We’ve seen more key evidence of this growth in the past few weeks. Major airlines and lessors have placed large orders for new narrow-body aircraft and wide-body aircraft with Boeing and Airbus providing a strong indication of Aviation’s long term growth trajectory.
Although manufacturers are happy to take new orders, they continue to be impacted by supply chain issues for which there has been little measurable improvement. This means that airlines continue to look to leasing existing aircraft for lift further proving the unique relevance of Aircastle’s position in the market.
Because demand exceeds supply for new narrow-body passenger aircraft, we’re seeing steady requests for lease extensions on our planes. That said, it’s still a challenging landscape for lessors and customers alike.
Relatively strong U. S. dollar and high fuel prices prevent formidable headwinds. 2023 also presents the risk of recession as inflation and interest rates remain elevated. Yet favorable travel volumes continue despite these headwinds and I’m pleased to report that Aircastle achieved a very profitable quarter in our fiscal third quarter.
We finished the third quarter with $50 million in net income, $258 million in total revenue and adjusted EBITDA of $240 million. Roy will provide more details on these results in a minute. But I believe the deciding factor in this quarter’s success was effective transaction execution by our team.
As to be expected in an environment of interest rate spikes, increased debt costs have somewhat slowed the overall pace of aircraft trading. Despite this, we continue to see our momentum from the second quarter, acquiring another 7 narrow-body aircraft including E2s, two A321neos and A320neo and a 737-MAX 8. Clearly, our portfolio growth strategy is focused on new technology aircraft.
Two-thirds of the acquisitions Aircastle has made over the last 12 months have been new tech. We’ve achieved a 55% net book value increase in the best new fuel efficient emissions narrow-body aircraft sought by our customers.
While the industry’s net 0 goals are ambitious and heavily focused on the use of sustainable aviation fuel, the limited availability of staff has forced airlines to add new tech aircraft to help reach sustainability goals. Acquiring new aircraft technology remains extremely competitive. Narrow-body aircraft attracts a good credits, attract many investors. I believe our ability to execute in such a challenging landscape is testament to our experienced team and the strong relationships we’ve built among the sectors airlines and trading partners.
Not having a large forward order book also gives us flexibility to deploy capital and pursue the most attractive assets in the market. Our competitors strengths are ability to execute quickly and our reputation among counterparties for reliability and professionalism.
On the portfolio management side, we sold 8 aircraft and other flight equipment for a gain of $53 million. Among these were the sales of two 747 freighters, and a 777. After these sales, our narrow-body passenger aircraft make up 91% of our portfolio.
Shifting from aircraft trading to finance, we announced a new $450 million secured financing facility in November, which bolsters our conservative debt profile during a challenging interest rate landscape. After many years of success in unsecured borrowings, our deep capital markets team has cultivated strong banking relationships. Lenders appreciate our track record, our investment grade ratings and the opportunities afforded to us by our unique ownership structure with Marubeni Corporation and Mizuho Leasing.
It’s understood that there are near term headwinds for aviation but Aircastle’s deep team possessing multi cycle experience is well suited for whatever 2023 brings our way. We’re confident we can creatively build aviation solutions for our customers while maintaining a risk focused objectivity and broader aviation marketplace to ensure that we’re always protecting our asset values.
Our growing fleet of new technology aircraft keeps us addressed of the technology transition taking place across our customer base. We’re strengthening the value of our portfolio, while also helping customers achieve their sustainability goals. Because of our conservative balance sheet, our investment grade rating and the strong support of our shareholders, we continue to be well positioned for the future.
Now I’ll pass the call over to Roy to go through our third quarter results.
Roy Chandran
Thanks, Mike. Good morning, everyone.
For the third quarter, we reported net income of $50 million and adjusted EBITDA of $240 million. Total revenues were $258 million including gains on sale of flight equipment of $53 million. We also successfully collected $24 million of outstanding letters of credits related to former Russian leases basically everything that was still outstanding.
Year-to-date operating cash flow was $344 million, a 27% improvement from prior year reflect stabilized customer performance as does our 39% decrease in AR over the same period. We invested $298 million this quarter for 7 narrow-body aircraft, 6 of which was new technology. The 8 aircraft sales Mike mentioned brought in proceeds of $163 million. The average age of aircraft sold was 18 years.
Transactional impairments were largely offset by related maintenance and other revenues, as well as a $24 million received from Russia-related letters of credit. Excluding the effective impairments, expenses are down 3% compared to third quarter of 2021, primarily due to lower maintenance costs resulting from fewer assets on the ground.
As Mike mentioned, we successfully closed a $450 million secured aircraft financing facility. This facility has a 7-year term and we expect it to be funded over the next three months. Continuing with our capital structure, our net debt to equity stood at 2.7x, down slightly from last quarter. We finished the quarter with total debt of $4.5 billion of which 85% was unsecured. The average — weighted average rate on our debt was 4.24% a slight uptick from last quarter.
Continuing on liquidity as of January 6, we had total liquidity of $2.3 billion. This includes $1.7 billion of undrawn facilities, unrestricted cash were $100 million — $100 million in contracted sales and projected 12 months adjusted operating cash flows of $400 million. Our next major debt repayment is in April, but we expect to repay sometime between now and maturity.
Looking ahead to 2023, new technology narrow-body aircraft will be a high priority for our portfolio. As we constantly trade in the market, we expect to adhere to allow the usual conservative leverage while maintaining forward commitments. With our long term focused investment grade rated shareholders, we are optimistic about 2023.
And with that, operator, we’re happy to open the call up to questions.
Question-and-Answer Session
Operator
[Operator Instructions] And we’ll take our first question from Mark Streeter from JPMorgan. Please go ahead.
Mark Streeter
Great. Thanks. Good morning. Roy, you mentioned the recent secured facility. I saw — I think you gave an interview in Air Finance Journal. You talked about the decision to add recourse to that. So I’m sort of wondering if you can talk through of your secured debt, how much has recourse? How much is non-recourse secured? Just very curious for an investment grade company to borrow secure with recourse. We don’t see that a lot. So I’m wondering if you can talk maybe about what that saved you by offering that recourse. Maybe you can just walk us through that.
Roy Chandran
Sure. I think the — maybe that report was slightly off. I mean, all our secured financings are recourse. We’ve traditionally traded non-recourse for recourse and used effectively the benefit of recourse in our investment grade status, some operational flexibility. So, I wouldn’t say it’s pricing obviously matters, but at the end of the day for us the flexibility around moving assets around trading assets, not having to go back to our lenders for consents I think was important. And so we have a very wide range of operating flexibility within our terms. So if you go back to all our financings effectively have been recourse, and we haven’t done anything, which is really purely non-recourse.
Mark Streeter
So when you think about for this most recent transaction, a secured recourse facility versus issuing similar duration unsecured bonds, how much do you think you saved going the secured route?
Roy Chandran
I’d say given where when we did the transaction, my guess is somewhere between 100 to 150 basis points. That’s a bit of a moving target obviously, right? When we decided to enter the markets, the markets were much more volatile subsequent to that, a couple of peers have been to the market to settle down. But I’d say on average, we’ve always looked at the delta between unsecured bonds versus secured bank transactions, usually in that range, 100 to 150 basis points.
Mark Streeter
And I know your spreads were obviously, they were way too wide. They’ve come in a bunch. They’re still probably too wide, certainly in your opinion. And I think I shared that view. So when you think about the market now going forward for 2023, how much more flexibility do you think you have to issue secured if you were to do a deal tomorrow, do you think it would be secured or do you think are you getting more comfortable where unsecured yields are? And how should we think about what’s that next deal look like? Is it going to be secured or unsecured?
Roy Chandran
I think we’re never comfortable where rates are, right, as an issue, we always wanted to be lower. There are some natural constraints on secured transactions. We’ve always adhere to trying to keep secured within sort of a boundary of less than 20%. Right now we are 15, so theoretically we have some capacity.
The flipside is we do want to be a frequent issuer in the unsecured market. The unsecured market have got the deepest form of capital. So I think all things being equal, we have enough capacity to deal with our near term maturity. We’ll look at the markets and plan sort of to be in the market at some point in the next six months. When and exactly when I don’t know. But really, we, as reasonably frequently sure, we are prepared to kind of go at short notice and I think we’ll wait for the market to sell down a little bit more. But I’d say that will be our first quarter call. We’re also looking at some alternative financing in other markets, but I think first priority is always to maintain some liquidity in the unsecured markets.
Mark Streeter
Great. Thanks. And then the last questions for me. Mike, you sort of mentioned average age of the portfolio right continues to come down long term trend at least, right? So when it came down this quarter, how important is it that you continue to drive down the average age because you know, you still have your mid-life strategy, but obviously more of what you’re buying is newer generation technology and so forth almost all of what you’re buying. So I’m just sort wondering how you’re thinking about the average age of the portfolio and where that may evolve to?
Mike Inglese
Yes. I think practically speaking, as we’ve begin investing in new tech over the last year or so and as the technology in the marketplace will grow, simplistically thinking if we add new-tech and some old tech and you roll forward reasonable investment levels for four or five, that may change your mix because if you think about three or four years from now, there’ll be mid aged new tech aircraft, which will probably become the focus of our investment target.
So the age of what we’re buying will probably increase as market penetration of new tech increases. So realistically going from somewhere between 10 and 11 down to somewhere around nine to 10 is sort of how I think will most likely wind up. So it won’t be — we’re not going from 10 to two and we’re probably not going from 10 to five.
Mark Streeter
Okay. That’s helpful. Thanks very much, and hope to run into you in Dublin next week. Safe travels.
Operator
Our next question comes from Doug Runte from Deutsche Bank. Please go ahead.
Doug Runte
Yes. Good morning. A question on the very impressive gain on sale? I believe you said it was two 747s and a 777?
Mike Inglese
That’s correct.
Doug Runte
And so was that a net gain on sale? And is there some triggering that created the $30 million, looks like a $30 million impairment in the quarter?
Mike Inglese
So yes, the gain on sale of the 747, and one of the 747 and the 777 were assets that came out of Russia and more previously impaired. So just to be clear, it’s different accounting period realities for those assets.
Doug Runte
Okay, that’s helpful. And it looks like in the quarter, there was a pretty sharp uptick in maintenance revenue relative to overall lease rental. Is that simply a function of utilization improving? Are you seeing a higher percentage of your assets being maintenance payers, maybe a little bit more color on maintenance revenue?
Mike Inglese
Yes. I think typically for us, Doug, the maintenance revenue that gets recognized is more driven by transactional activity in one lease pending and another lease beginning for the sale of an asset. So it wasn’t reflective of a change necessarily in the quarter of maintenance collections from all of our customers who are maintenance payers.
Doug Runte
Okay. And then a quick last question on operations, very impressive utilization number. At this point in the COVID cycle, I guess, and to what extent do you still have airlines that have significant deferrals or most of them back to where they should be? What do you expect going forward particularly with Asia Pacific reopening?
Mike Inglese
So when I think about deferrals in the context of our customer base, two of our significant customers in Southeast Asia, we did in essence, lease restructurings, that will defer a collection of revenue over a long period of time. And so with what’s happening in that part of the world most recently, which has been the part of the world that has lagged from a recovery, we’re seeing good positive momentum in the context of those airlines getting back on track.
Doug Runte
Great. And maybe a last question linked to Mark’s question earlier. Your average debt tenure 2.4 years, your lease term now average lease term extended nicely to 5.1. Conceptually, should those two numbers be a little bit closer or are you somehow, I guess, getting comfort with your shareholders that works?
Mike Inglese
No, Doug, I mean, I think, I’d say that those two numbers should be closer and end of the day think we’ve always tried to push out debt maturities as far as we can. But in terms of financings end of the day, how steep is the curve going from sort of 3% to 5%, 5% to 7% percent and ultimately 7% to 10s, right? So our long term game plan is to try to continue to push that out and bring those two things more in sync. In a perfect world, you want them to be close, but that’s tough to do.
Doug Runte
Right, understood. Well, I’ll save the rest of my questions for Dublin. Thanks very much for the presentation and the granular information.
Mike Inglese
Thanks Doug.
Roy Chandran
Thanks Doug.
Operator
[Operator Instructions] And it appears that there are no additional questions at this time. I’ll turn the conference back to James Connelly for any additional remarks.
James Connelly
I just want to thank everyone for joining today. Please reach out if you have any questions and hope you have a great day.
Operator
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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