Fly Leasing Limited
Q4 2018 Earnings Call Transcript

Published: 7 Mar 2019

[Operator:]

Good day, ladies and gentlemen, and welcome to the FLY Leasing Fourth Quarter Earnings Call.At this time all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions]It is now my pleasure to hand the call over to your host, Matt Dallas with Investor Relations. Please go ahead, sir.

[Matt Dallas:]

Thank you and good afternoon everyone. I'm Matt Dallas, the Investor Relations Manager of FLY Leasing, and I'd like to welcome everyone to our fourth quarter 2018 earnings call. FLY Leasing, which we will refer to as FLY or the company issued it's fourth quarter earnings results press release which is posted on the company's website at flyleasing.com. We have a slide presentation that accompanies today's call which is available to participants on the webcast. If you are not accessing the webcast, you can find a copy of today's presentation in the Investor Relations section of our website on the Events & Presentations page. If you are listening to both the live call and the webcast, you may want to mute your computer as there will be a slight delay in the webcast audio. Representing the company today on this call will be Colm Barrington, our Chief Executive Officer; Julie Ruehl, our Chief Financial Officer; and Steve Zissis, the President and CEO of BBAM, the company that manages and services FLY's fleet. This conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements include but are not limited to statements regarding the outlook for the company's future business and financial performance. Forward-looking statements are based on the current expectation and assumption of FLY's management, which are subject to uncertainties, risks and changes in circumstances that are difficult to predict. Actual outcomes and results may differ materially due to factors that are summarized in the earnings press release and are described more fully in the company's filings with the SEC, please refer to these sources for additional information. An archived webcast of this call will be available for one year on the company's website. And with that, I would now like to hand the call over to Steve Zissis, the President and CEO of BBAM. Steve?

[Steve Zissis:]

Thanks, Matt and welcome everyone. The fourth quarter results are out and I can assure you it's very difficult to not spend the next 20 minutes talking about the progress FLY has made and the tremendous results we are delivering for our shareholders. Well, I'm going to resist that urge and let Colm and Julie walk you through FLY's fourth quarter results in greater detail later on this call. Instead, I'd like to spend a few minutes discussing industry fundamentals and our competitive landscape. During our third quarter earnings call we discussed some of the industry conditions that we were watching carefully. This included rising fuel prices, growing trade tensions, higher interest rates, and a strengthening U.S. dollar against many emerging market currencies. I'm pleased to report that during the fourth quarter of last year and into the first quarter of this year, those conditions have improved significantly and our concerns have moderated. Of course, we will continue to pay very close attention as conditions change quickly. Given these favorable industry conditions, it's no surprise that IATA is forecasting worldwide airline profits of over $32 billion for last year and over $35 billion in 2019. Notably, they forecast many key markets like North America, Asia Pacific, and the Middle East to have higher net profits and/or earnings before interest and tax margins in 2019 as compared to 2018. In addition, passenger traffic growth remains robust with three largest markets; North America, Europe and Asia Pacific reporting 5%, 6.4% and 8.5% growth respectively in 2018. And more importantly, airlines in these markets were able to improve their load factors to record levels by controlling capacity growth.With a consistent forecast for traffic growth in 2019, I think it's fair to say that the industry outlook for 2019 remains very positive. At the lessor level, we're seeing strong demand for our new and used aircraft,a growing secondary trading market for used aircraft and ample available debt capital being offered at very attractive rates.The one downside is that these favorable conditions have attracted a significant amount of new capital which correctly sees the aircraft leasing as an attractive investible asset class. Much of that capital has been earmarked for new aircraft on lease to top tier credits pursuant to sell leaseback transactions which have resulted in lease rates on those deals falling to historic levels. FLY has avoided participating in these type of sale leaseback campaigns because we didn't believe they offered us an appropriate investment return. Instead, FLY has used BBAM's global platform to originate privately negotiated deals. We will continue our successful strategy of growing prudently and positioning FLY's fleet to improve it's profitability, cash flow and return-on-equity. As I've stated many times on previous FLY earnings calls, we simply refuse to grow for growth's sake and we will continue to be highly selective in capital allocation decisions. In fact, while Colm and Julie will address FLY's results in greater detail during their prepared comments, I will simply note that despite general compression and lease rate yields over the past several years, FLY has over the same period been able to improve it's net leasing margins. We have done this by calling our fleet of weaker performing assets, finding attractive acquisitions, and lowering our financing and operating cost. Moving to the FLY remarketing front; there is actually very little to share at this point. FLY has six aircraft to remarket during 2019, none of which were scheduled to come off-lease before the fourth quarter. However, given the current health of the airline industry and the strong demand for aircraft, I see no issues placing these aircraft for lease or selling them profitably. Before handing the call over to Colm, I want to remind everybody that BBAM shareholders represent by significant margin the largest shareholder in FLY. Collectively, we own 17% of FLY stock which ensures that BBAM and FLY shareholders are highly aligned with FLY's success. We continue to believe that BBAM is a strong partner for FLY, and I continue to believe that FLY is on the right track. I'm very proud of what we've accomplished at FLY and how well we've positioned FLY for the future. Thank you again for your support. And I'd like now to turn the call over to Colm Barrington, FLY's CEO.

[Colm Barrington:]

Thank you, Steve and thank you everyone for joining us this morning. Well, in a few short words, FLY had another excellent quarter and our best year ever. Initiatives that we've taken at FLY over the last few years which includes disposing of older and the underperforming aircraft, optimizing our capital structure, repurchasing shares at significant discounts to book value, and perhaps most importantly, growing up fleet prudently have all combined to produce now a very positive quarterly financial result and a significant increase in FLY's book value per share. For the quarter we are at $0.94 adjusted earnings per share and produced a 17.8% adjusted return-on-equity, both very positive numbers that were based on our 26% growth and operation lease rental revenue combined with the lower growth in expenses. The growth in operating lease rental revenues in the quarter was based on our larger fleet along with 100% fleet utilization. In the quarter we were pleased to complete the acquisition of 33 aircraft in the portfolio deal that we contracted earlier in the year. These aircraft along with 7 CFM56 engines that we acquired as part of that portfolio deal will have a positive impact on FLY's ongoing earnings. We also sold 3older aircraft in the fourth quarter generating a total sales gain of $7.9 million. FLY has consistently sold aircraft from it's portfolio, and mainly older aircraft, at gains to book value. We expect to continue to do this in the future demonstrating the hidden value in our portfolio. FLY's Q4 results showed a significant uplift from the same quarter of the previous year with a 26% growth in operating lease rental revenue to $112.2 million, a $24 million growth in adjusted net income to $30.8 million, and a 68% growth in adjusted earnings per share to $0.94 per share; all very positive figures and very positive trends. For the 12 months to December 31, FLY produced adjusted net earnings per share of $3.06, and an adjusted return-on-equity of 14.8%. Our net spread after depreciation was 3.3% of average net book value, which has improved from 2.9% in 2017 and 2.5% in 2016. These positive earnings also added significantly to FLY's net book value per share, which at the end of the year stood at $21.50. This net book value represents a 95% premium to our current share price. As mentioned earlier, we believe that our fleet will continue to trade as premium to it's net book value,a premium that we expect will be reflected in the steadily growing net book value per share. Our excellent results in 2018 was based on a solid growth in operating lease rental revenue, based partly on the 34 aircraft we acquired in the year, a high fleet utilization and significant gains from the sale of 6 older aircrafts. These fullyear results mirrored quarter four with significant increases in operating lease rental revenue to $389.4 million, adjusted net income growing to $91.2 million, and adjusted earnings per share up $3.06.With our per share book value, we are also seeing a disconnect between FLY's share price and our earnings. Our shares currently trade at less than 4x 2018 net income. At year-end, FLY had a fleet of 113 aircraft plus 7 CFM56 engines. Our fleet comprises almost entirely in production types from Airbus and Boeing, with only 2% by value comprising other [ph] production aircraft. We expect to dispose of these other production aircraft at a profit during 2019 and to nearly 2020. At year-end, the average fleet age was 7.2 years and our average lease term was 5.8 years,figures that compare favorably with our industry peers. We'll continue to execute on our active sales program continuing to delever to reduce lessee concentration, and to contain a young and active fleet.FLY has a well-diversified customer base with 46 airline lessees in 26 countries. It should be noted that our major exposure in the Indian market, which represents 10% of our portfolio value, is to the national airline of India and is fully guaranteed by the Government of India. In 2018, FLY's aircraft sales program produced very positive results. In the year, we sold 6 aircraft for total economic gain of $29 million, which represented the premiums netbook value of these aircraft. This premium comprised both of book value gain and end of lease income that FLY retained, and that was mainly with respect to 2 older aircraft that we sold for [indiscernible]. In December we announced that we had agreed to sell a portfolio of 12 aircraft. We had been transferring these aircrafts to the neworder [ph] since then. To-date we have transferred 11 aircraft and expect to complete all 12 transfers by the end of the first quarter. These sales along with 9 others, one of which has already been completed are expected to contribute handsomely to our results in the first half of 2019, and for which our CFO, Julie Ruehl, will be giving positive guidance later in the call. When we announced our portfolio acquisition last year, we pointed out this would result in bringing our financial leverage to over 4x, and that we were targeting to bring it to a range of around 3.5x within two years. We're already well ahead of this target and expect by the end of this year we will have beaten our target, mainly due to positive aircraft sales program which we announced last year and which we're continuing to execute ahead of schedule. In recognition of this deleveraging success in January, Moody's confirmed FLY's BA3 rating and took FLY off credit watch. FLY continues to provide investors with a real value proposition. We have grown our fleet substantially with attractive aircraft and have produced strong financial results. We expect these results to continue. Our valuable portfolio of modern and in-demand aircraft and long-term leases to a diverse group of airlines globally, provides FLY with a secure stream of income. FLY has demonstrated that it can grow it's portfolio without having to place and pre-delivery payments on speculative orders from Airbus and Boeing. We've also demonstrated that we can execute an active sales program allowing us to recognize substantial gains and reduced lessee exposures. We have a disciplined financing strategy which is substantially based on long-term and amortizing secure debt. Our current average financing terms of 5.3 years broadly matches our average lease terms. In particular, this financing structure isolates FLY from the vagaries [ph] of the capital markets and the need to refinance large trenches of debt at times when the capital markets maybe dry. FLY has no significant refinancing requirements until 2021 when 325 million of our unsecured notes falldue [ph]. These notes represent only 9% of our total capitalization, so FLY's financing is indeed robust.Based on rewards and risks, we believe that FLY is currently a very good value stock, a value that our insiders have recognized when last year they purchased more than 1 million shares for $15 per share. As stated earlier, our shares are currently trading as a significant discount to net book value and a very low multiple of reported 2018 and prospective 2019 earnings. And with that I will hand you over to our CFO, Julie Ruehl, to take you through our financial overview.

[Julie Ruehl:]

Thank you, Colm. FLY is reporting net income of $31 million for the fourth quarter of 2018, a $24 million increase from the year ago quarter. Earnings per share increased from $0.25 a year ago to $0.95 in the current quarter, nearly a four-fold increase. Overall, we are very pleased with our improved financial results. FLY achieved ROE of 17.9%, the third consecutive quarter of double-digit ROE. For the full year, FLY is reporting net income of $85.7 million, an increase of $83 million from fiscal 2017.Earnings per share increased from $0.09 in 2017 to $2.88 in 2018. ROE for 2018 was 14%, a tremendous improvement from 0.5% in 2017. These strong results for 2018 reflect the growth of the fleet and the higher level of gains for aircraft sales, as well as no aircraft impairment in the year. FLY's operating lease rental revenue in Q4 2018 increased $23.2 million or 26% to $112.2 million due to the growth of the fleet and higher lease rate factors. Double-digit growth occurred in every quarter of 2018 and annual operating lease rental revenue grew by 16% to $389.4 million. Total revenue increased 13.3% to $122.3 million in Q4 2018 from $107.9 million in Q4 2017. In Q4 2018 FLY recognized $4.3 million of end-of-lease income related to the expiration of two leases and release of those aircraft to other airlines. In addition, FLY recorded a $7.9 million gain on the sale of 3 aircrafts. These 3 aircrafts are part of a 12 aircraft portfolio sale that we announced in December and the aggregate gain on the sale of the entire portfolio is being prorated across the 12 aircraft and is being recognized as individual aircraft sales close. These 3 aircrafts were sold at a 12% premium to net book value. For the full year FLY's total revenue increased $65 million or 18% to $418.3 million. In comparing expenses to the prior year quarter depreciation, interest expense and SG&A are all up due to the growth of FLY's aircraft portfolio, although on a combined basis these expenses grew by 22%, a lower growth rate than the operating lease rental revenue growth rate of 26%. There were no impairment charges recorded in the quarter. Also in Q4 2018 FLY incurred $1 million of debt extinguishment costs consistent almost entirely of non-cash write-off of debt costs related to the 12 aircraft portfolio sale that I mentioned a moment ago. For the full year depreciation, interest expense and SG&A on a combined basis grew by 10%, a lower growth rate than the operating lease rental revenue growth rate of 16%. There were no impairment charges recorded in the year. Now I'd like to cover our guidance for Q1 2019. For the first quarter of 2019 we are expecting operating lease rental revenue of $102million to $104 million. We expect amortization of lease incentives of $1 million to $2 million. Gain on sale of aircraft will be approximately $30 million. We expect no end of lease income. Depreciation expense will be approximately $37 million to $38 million. We expect interest expense of $38 million to $39 million. Debt extinguishment costs are expected to be $2 million to $3 million. Maintenance and other costs are expected to be less than $1 million. We expect SG&A expense of $8 million to $9 million without consideration of any foreign exchange gains or losses that may occur. I'll turn it back to Colm now for his closing remarks.

[Colm Barrington:]

Thank you, Julie. And before we move to your questions let's have a quick recap of 2018. During the year we grew our fleet by 34 aircraft or 33%. We achieved a 16% growth in operating lease rental revenue to nearly $319 million. We sold 6 aircraft for totally economic gain of $29 million, 17% above our netbook value. We produced $3.06 of adjusted EPS and a 14.8% adjusted ROE. At year-end, our net book value was $21.50 per share. And finally, we've given pre-tax income guidance of over $45 million for the current quarter. These outcomes as you'll see are all highly positive and have established a trend that we expect to continue in 2019. And with that, we're ready to take your questions.

[Operator:]

[Operator Instructions]Our first question comes from Jamie Baker of JP Morgan. Your line is open.

[Jamie Baker:]

Hey, good morning everybody and thanks for a very thorough set of prepared remarks; a couple of high-level questions. So a number of your competitors, both public and private -- I've been on the road this week meeting with investors and one subject that came up is whether depressed lease rate factors and you called this out in your remarks. Whether the depressed lease rate factors are a permanent phenomenon on a secular development and perhaps that investor hopes for firmer future rates in the future -- firmer future rates should be abandoned;and I think this chatter was a contributing factor behind the weakness that you saw in the space yesterday, just curious about your thoughts on this topic.

[Colm Barrington:]

I think in our industry there is sometimes confusion about lease rates, right. If you're talking Jamie about lease rates with respect to sell lease back of new aircraft, then I would tend to agree that directionally they reached a new level and are most likely to stay within that band for a very long time. And the reason I say that is I think aircraft leasing has become now an accepted asset class, you have very diversified capital sources around the world whether it's pension programs, credit funds, infrastructure funds, Japanese capital, Chinese capital, Middle East capital, public sector capital -- you have all different types of sectors of capital that want to play. So the way that we look at it is we think the asset class has reached a different level and that out lease rates may come off the bottom, but they're not going to return to the levels that they were 10 years ago.

[Jamie Baker:]

That is very helpful, thank you for that. And second, I think that the pace of -- everybody is debating the depressed multiples, significantly depressed in your case, still depressed elsewhere. And I think one issue is the pace of recent bankruptcies is -- it's tough to discern whether airline bankruptcies are in fact elevated relative to this point in prior cycles. I think that is weighing on your valuation or maybe just in the day of -- I don't know, social media, media press coverage,there is the impression that bankruptcies are running higher than average. What are your thoughts on this?

[Colm Barrington:]

Well, look, I think in Europe there has to be some consolidation, right. The market is still too fragmented and therefore you are seeing probably a higher level of bankruptcies in Europe than in the past. And I think that will continue for a while until the market reaches a firmer level, like in the U.S. But I would just say, Jamie, in general, that the aircraft leasing market is broader, more dense, and more resilient than the way we thought about the market, again 10 years ago. So these bankruptcies as you've seen over the years have been absorbed quite easily across the industry. Now, if there is a major bankruptcy with an airline that has a massive order book that could change things temporarily. And so those will...

[Jamie Baker:]

All right. Trust me, you're preaching to the choir, I wholeheartedly agree. It's shocking to me how much time in regards to the leasing names; I'm confronted with this question from investors. So it would be nice to push it aside and get people to focus on fundamentals. I'll turn it over to somebody else. Thank you very much everybody.

[Operator:]

Thank you. Our next question comes from Helane Becker of Cowen and Company. Your line is now open.

[Unidentified Analyst:]

Hey, guys, this is actually Tyler [ph] on Helane. So, I'm just curious;clearly there is [indiscernible] in the secondary market is strong for the mid-life narrow bodies. So I'm curious if you think that given how active most of your peers are in that market and so are you guys, if you think that there could potentially be oversaturation in the secondary market as the year progresses and that could potentially lead to lower lease yields in the secondary market as the year progresses?

[Steve Zissis:]

Look, there is a lot of capital in that secondary market and what we've seen is as people enter the aviation space they want to deploy capital, Tyler. That they see what's going on in kind of the front-end of the market, so the Tier 1 new-ish sale leasebacks, and we realize that the only place they really can get returns is in the mid-life market. And so you're seeing a lot of that capital kind of revert to the higher yield, if you will, mid-life market. So I think we see that as being a market that continues to be very liquid and for people to probably bid up assets, and I think it continues for quite a long time. Now I think for the public lessors,keep in mind that all of us are long aircraft in a massive way; so anytime you're starting to bid up prices along the spectrum of the industry, it's just increasing the book values of all these public lessorsand that's one of the things that we're frustrated with. It's like we're selling a lot of aircraft way above our book values and we get no credit in the market for it.

[Unidentified Analyst:]

Got you. And then my follow-up question is just regarding Jet Airways. I think you guys have 3 aircraft on lease with them. Do you intend to take back those assets or do you -- are you waiting for more color regarding their restructuring and what the State Bank of India does?And, if Etihad decides to increase their investment in that company?

[Steve Zissis:]

So, we have 3 fairly young 800sthere that represent about 3% of our revenue at FLY. We've been a long-time lessor to Jet and to Etihad,and we're a big believer in the Indian aviation market. I mean you look at the metrics of that market, it's phenomenal, so any major lessor has to play in that marketplace,it's -- long-term it's the place to be. So we have grounded our aircraft, we have control over our aircraft but we have not terminated the leases, and we were waiting for the airline to approve all it's restructuring with the State Bank of India. And if that goes through at the end of the month, obviously, we will stay with Jet. If they can't get that done then we'll take our aircraft back and redeploy them.

[Unidentified Analyst:]

Awesome. Thank you. Congrats on a good quarter.

[Operator:]

Thank you. Our next question comes from Scott Valentin of Compass Point. Your line is now open.

[Scott Valentin:]

Good morning, thanks for taking my questions. Just with regard to the fleet size, I think you guys pointed out in your sale, probably, I think it's 18 aircraft in '19. And just wondering, I think again, recalling from the schedule, you have 4 aircraft coming in from the AirAsia of transaction, I know there are some options. Just wondering how we should think about the fleet size going forward? And then, kind of following up on that question to fleet sizes, you pointed out leverages coming down quicker than you milled [ph], and you'd start to be I think just over 3x at year-end. One is, is that level of leverage at year-end --does that enable your buyback stock or do you think it has to go lower than that?And I guess three, if it has to go lower than that can you accelerate sales of aircraft in order to deliver faster and maybe buyback stock sooner?

[Steve Zissis:]

Well, Scott first of all, you're quite right, we are very comfortable with the way our leverage has gone, we are way ahead of our targets in deleveraging following the portfolio acquisition we did last year and we expect to be down very close if all else being equal [ph] -- be very close to 3x by the end of the year. So we do now have capacity ahead of what we thought we have -- we're going to have to acquire the aircraft and to buyback shares. We have a program to acquire over $500 million worth of aircraft this year, including those 4 new that you mentioned. And we have a $50 million share repurchase program which we now hope we can begin to use again,now that we have our leverage into a more comfortable area.

[Scott Valentin:]

Okay, thank you for that. And then, in terms of the tax rate, this was a year-end true up, the tax rate came a lot lower than we thought. How should we think about tax rates for 2019?

[Julie Ruehl:]

We're modeling about 15% going forward.

[Scott Valentin:]

Okay. And just one final question, on the remarketing; I guess you mentioned there is some aircraft left to remarket by the end of '19. I'm just wondering what those aircraft types are and ages?

[Steve Zissis:]

Yes. So we've got 6 aircraft, they are all in the fourth quarter, Scott.And 2 of them are A340-600s which will go for part out,2 of them are A319s and 2 of them are 737-700.

[Operator:]

[Operator Instructions] Our next question comes from Kush Patel of Deutsche Bank. Your line is now open.

[Kush Patel:]

Good morning. I just had one question here. Just keeping in mind Steve's commentary on growing for growth's sake through the sale and leaseback market;how should we think about the AirAsia transaction you guys executed last year? Just kind of -- I was hoping you could give us a kind of a one-year look back at the transaction, your thoughts around kind of taking on an order book and whether this is a strategy you would consider employing for future growth?

[Steve Zissis:]

Look, we're still happy about the transaction. We thought it was very beneficial to FLY in our ability to grow. If we found another opportunity like that, we'd like to do it. We do see a couple kind of opportunities in the market that have similar characteristics or we're exploring those but there is nothing about it that we didn't like about it except the concentration. But look, given the size of FLY is, we have to fly hot on a few parameters compared to our competitors; and those areas of concern are always a concentration and leverage. And as Colm mentioned, we're bringing our leverage down sooner than we thought, and we'll reduce our exposure to AirAsia overtime. We're definitely on target for '19 and we'll see what 2020 brings.

[Operator:]

Thank you. Ladies and gentlemen, this concludes today's question-and-answer session. I would like to turn the call back over to Matt for any closing remarks.

[Matt Dallas:]

We'd like to thank everyone for joining us for our fourth quarter earnings call. We look forward to updating you again next quarter. You may now disconnect.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program, and you may now disconnect. Everyone, have a great day.