S A I B U S R E S E A R C H June 8, 2017
AeroCentury is Ready for Takeoff Strong Buy
Our firm has a long position in AeroCentury (ACY), a microcap aircraft leasing company. AeroCentury enjoyed strong revenue and profit growth from 2003 to 2009 but its financial results stagnated since then. AeroCentury’s share price is trading at a 59% discount to its book value. We believe the cause of this significant share price discount to its book value is a result of the lackluster management of the company’s management team and its board of directors’ willingness to serve as lapdogs for company management instead of serving as watchdogs that put shareholder interests first. Despite its turbulent past, we believe these four catalysts will help AeroCentury realize value for its shareholders: AeroCentury’s return to profitability since Q4 2014, After AeroCentury declined one of its largest shareholders proposal to buy out the company at $12.50/share, it bought him out via an indirect inkind exchange valuing the former shareholder’s shares at $19.53, New members of the Board of Directors (Karen Rogge and former GE Capital Aviation Services CEO David Wilson) represent 40% of the board and AeroCentury hired former Saab Aircraft Leasing CEO Michael Magnusson last year to succeed the late Neal Crispin as AeroCentury’s CEO.
AeroCentury’s Valuation Target
Our target price for AeroCentury is $28.66, which is its book value per share. Although AeroCentury’s book value per share only grew at a mediocre rate of 6.5% since its founding, we believe that it could generate stronger and more consistent returns on invested capital if a larger peer acquired it. Alternatively, AeroCentury’s performance may benefit from the leadership of its new CEO Michael Magnusson, who had previously served as Saab Aircraft Leasing’s CEO and President from 1998 to 2015. Saab Aircraft Leasing and its successor Saab Regional Aircraft focused on foreign regional carriers just like AeroCentury. AeroCentury’s peers excluding AeroCentury are trading at a 6% discount to book value, versus a 59% discount for AeroCentury. Finally, what validates our $28.66/share target price for AeroCentury is that a colleague of ours hired an independent expert to appraise the company’s assets and liabilities and the appraisal value was 1% greater than that of its book value. This gives us confidence that the company would not be incurring any significant asset impairment charges as it did in 2014 and confirms our target price for AeroCentury.
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Source: Morningstar Direct
Corporate Overview
AeroCentury is an independent aircraft leasing company that focuses on foreign regional carriers. AeroCentury generally targets used regional aircraft and engines with purchase prices between $5 million and $20 million, and lease terms less than five years. JetFleet Management, an integrated aircraft management, marketing and financing company, manages the assets under an agreement with AeroCentury. As of April 2017, AeroCentury’s held for lease portfolio consisted of 5 aircraft engines and 25 aircraft and its assets for sale consisted of 1 aircraft and 3 turboprop airframes. Certain officers of AeroCentury are also officers of JetFleet and hold significant ownership positions in both JetFleet Management and AeroCentury.
Based on AeroCentury’s mediocre and inconsistent performance over the last six years, we believe that the Board of Directors should not have given JetFleet a new 10year management contract in 2015, even after taking into account that AeroCentury had achieved record earnings that year. AeroCentury’s longsuffering shareholders are relieved AeroCentury earned an all time high of $4.17/share in 2015 after losing $7.32/share in 2014. At the same time, we were aware that AeroCentury would have incurred a $2 Million pretax loss if it had not realized $12 million in discrete gains associated with salestype leases and the disposal of aircraft.
Like many smallcap companies, AeroCentury has not paid a dividend and plowed back all of its retained earnings into growing the business. The good news for AeroCentury is that its book value per share increased from $8.56 in January 1998 to $28.66 in Q1 2017. The bad news is that its compounded annual growth rate in book value per share since it went public was a mediocre 6.5%. To put this in perspective, a regulated utility in Massachusetts is authorized a 10.35% return on equity. We understand that AeroCentury is in a different industry than a regulated utility. However, we cannot overlook the fact that although AeroCentury is in a much riskier industry than a regulated utility, its longterm performance has been weaker than a regulated utility. Normally, we expect companies in riskier industries to be able to achieve stronger ROEs than companies that are in lessrisky industries.
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Source: Morningstar Direct
AeroCentury hired Michael Magnusson as CEO to succeed its late Founder and CEO Neal Crispin last August. Magnusson had worked from 1982 to 2015 at Saab Aircraft Leasing, which included serving as its CEO from 1998 to 2015. As Chief Executive Officer, Magnusson oversaw an aircraft portfolio of over $500 million and a 40 person staff. AeroCentury also added David Wilson to its board of directors in 2015. Wilson had retired from General Electric Capital Aviation Services in 2014 after a 21year career in which he most recently served as a Senior Vice President, concentrating on asset sales and aircraft securitizations to a worldwide investor base.
Large Shareholders of AeroCentury:
Toni Perazzo (Senior Vice President of Finance and widow of company founder Neal Crispin) (367K shares, 23.4% of AeroCentury)
Dimensional Fund Advisors (76K shares, 5.3% of AeroCentury)
Leisure Capital Management (53K shares, 3.75% of AeroCentury)
Perritt Capital Management (50K shares, 3.5% of AeroCentury)
In additional Lee Beaumont previously held 150.95K shares, representing 9.8% of AeroCentury before selling them back to the company in exchange for a GE jet engine previously held by the company
Risks to AeroCentury include the following:
Increased competition from other aircraft leasing companies or financial institutions in its regional aircraft leasing market segment.
Slowdowns in the worldwide economy reducing the demand for aircraft and air travel.
Unanticipated future crises dampening travel demand such as war, terrorist events or a flu epidemic.
Although oil and jet fuel prices have declined over the last couple of years, if this
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reverses, this will provide another headwind for aircraft and air travel demand.
Its three largest customers account for 55% of its lease revenue as of FY 2016 and loss of any of these customers will have a negative impact on its revenues and profits.
Four of its customers have declared bankruptcy over the past three years and the company could see additional potential bankruptcies in future years.
Illiquidity in the capital markets resulting in the company to make timely acquisitions or disposals of aircraft
Increased interest rates resulting in increased finance expenses
Although its share price is 59% below its book value, AeroCentury’s stock is not for the faint of heart. AeroCentury went public in 1998 at $8.75 per share and it steadily sagged to a low of $2.05 in August 2004. It then reached a high of $26.67 in January 2008, sunk to $3.15 in March 2009, climbed to $25 in May 2010, dropped to a low of $5.30 in November 2011, recovered to $22.30 in August 2013 and shed 50% since then to trade at $11.35 on November 23, 2016.
Source: Morningstar Direct
Industry Overview:
The good news for AeroCentury is that there are not many aircraft leasing companies worldwide, maybe a dozen or two dozen. AeroCentury occupies a narrow niche in that it focuses on regional airlines and is one of the few companies worldwide that specialize in this segment. At least AerCap reduced competition in this segment by acquiring ILFC from AIG for $7B. AeroCentury has a poison pill, which will not help the odds of a takeover. Speculators may consider buying AeroCentury because its most senior executive may want to cash out and retire from the company. Although AeroCentury turned down a $12.50/share offer from Lee Beaumont nearly three years ago when its shares were trading at $8, AeroCentury did pay him $19.53/share via an inkind exchange earlier this year when its shares traded at $10. However, given that AerCap paid 0.62X book value for Genesis Lease in 2009 and paid 0.95X book value for ILFC, there can be no guarantee that a buyer will acquire AeroCentury at our fair target value of 1X book value.
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Recent Performance
Operating Lease revenue increased by 21% yearoveryear in Q1 2017 versus Q1 2016 due to revenue from assets that AeroCentury purchased during Q3 2016. Partially offsetting this was the loss of revenue from assets that were on lease during Q1 2016 but off lease in 2017. During Q1 2017, the Company acquired three aircraft and entered into direct financing leases for such aircraft. AeroCentury also enjoyed $637K in revenue from finance leases and gains. This helped pretaxincome increase 52% ($358K) yearoveryear.
The one analyst firm that covers AeroCentury expects that it will earn $1.61/share in 2017. Although this is a significant improvement from the $7.32/share loss incurred in 2014, its projected ROE for 2017 is still only 6%. Average portfolio utilization was 96% in Q1 2017, 93% in 2016 and 92% in 2015. This increased by 10% in 2015 after increasing by 6% in 2014.
Source: 2013-16 Annual Reports and Q1 2017 Report
Conclusion
In conclusion, we believe AeroCentury is a Strong Buy. We like that it is trading at a discount to its book value and it enjoys significant insider ownership. Although its asset impairment charges during the first nine months of 2014 were a concern, at least it generated a profit in its last 10 quarters and analysts covering AeroCentury expect it to earn $1.61/share in 2017. The four catalysts we believe will help AeroCentury realize value for its shareholders are as follows: AeroCentury’s return to profitability since Q4 2014, After AeroCentury declined one of its largest shareholders proposal to buy out the company at $12.50/share, it bought him out via an indirect inkind exchange valuing the former shareholder’s shares at $19.53, New members of the Board of Directors (Karen Rogge and former GE Capital Aviation Services CEO David Wilson) represent 40% of the board and AeroCentury hired former Saab Aircraft Leasing CEO Michael Magnusson last year to succeed the late Neal Crispin as AeroCentury’s CEO.
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DISCLAIMER
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Disclosure: Analyst covering ACY is long ACY
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