After the financial crisis, numerous financial related stocks traded at prices below book values due to the fears in the accuracy of their reported balance sheets. In the years since the crisis, most of those fears have disappeared yet many financial stocks haven’t regained the valuations suggested by the improving asset bases.
A prime example exists in the airplane leasing sector where the majority of the stocks trade below book value. While not typically considered as part of the financial sector, AerCap Holdings , Aircastle LTD and FLY Leasing trade similar to financials. The stocks currently trade at roughly 70% of asset values. As with the insurance companies written about last week, the stocks have surged towards 52-week highs yet significant value still exists.
Sure all airplane leasing stocks aren’t equal, but the leader, Air Lease , trades right near book value. In general, the companies operate in the same concept of buying planes and leasing them to commercial airlines around the world. The companies though can diverge significantly based on type and age of planes. Not to mention the diversity of customers and lease terms.
Book valuations aren’t perfect
As with any financial measurement, book value can be an imperfect calculation. The valuation can include intangible assets, risky investments, or any number of assets or liabilities that might be calculated according to flawed estimates or accounting methods. Regardless, book value provides a solid basis for starting research on an investment. Any stock trading substantially above or below such a valuation should be questioned as to whether the market has become too bullish or conversely bearish. Prior to the financial crisis, these airplane leasing stocks traded at multiples of book value.
As with the insurance sector of the financials, the fears of rising rates hurt the stocks. The lower-for-longer interest rate environment helps the interest expense paid to borrow money to purchase planes. Conversely it hurts the lease income as customers demand lower prices due to the interest rate environment. The investor concern is that the company is locked into lease terms for over 10 years on new planes, but interest rates could soar in that time period. Obviously these companies would prefer a stable rate environment.
Another issue is that the companies are required to depreciate the airplanes though most new planes hold their value. In many cases, the values listed on the balance sheet are below the real value providing a potential boost to book value.
The below table highlights the listed price to book values of the airplane leasing stocks:
Solid earnings growing book value
The extremely perplexing part about this selection of stocks is that earnings have been solid and consistent throughout the financial crisis. Outside of some minor bankruptcies in the airline industry, the companies maintained high utilization rates on the leased planes. In fact, airplanes returned by bankrupt airlines were typically leased at comparable or even higher rates.
As an example, the book value of AerCap has grown from $13.25 at the low of the financial crisis at the start of 2009 to over $18 now. Not only does that question the logic of investors remaining fearful, but also why is the stock trading significantly below book value with the crisis long over.
In general, the favorite stocks are the ones trading at the lowest price to book value. In the aircraft leasing business, a key distinction can be the fleet age and the average term of leases. A company with a younger fleet and longer locked-in leases should easily garner higher valuations.
The below table highlights the comparable fleet ages and lease terms:
While AerCap trades at a slightly higher book value ratio than the other two, it has a much younger fleet and longer lease terms. If another financial crisis occurs, the firm has fewer worries about lease contracts rolling over at lower rates or not at all.
Another reason to pick AerCap is that the company has made significant buybacks in the last year at significantly below book values. Dividend investors can enjoy the 6.6% yield of FLY Leasing, but investors should focus more on the management teams doing what’s best for investors instead of what is popular at the moment.