Earnings Call Transcript - AL Q2 2022

Jason Arnold, Head of Investor Relations

Good afternoon, everyone, and welcome to Air Lease Corporation's Second Quarter 2022 Earnings Call. This is Jason Arnold, and I'm joined this afternoon by Steve Hazy, our Executive Chairman; John Plueger, our Chief Executive Officer and President; and Greg Willis, our Executive Vice President and Chief Financial Officer. Earlier today, we published our second quarter 2022 results. A copy of our earnings release is available on the Investors section of our website at www.airleasecorp.com. This conference call is being webcast and recorded today, Thursday, August 4, 2022, and the webcast will be available for replay on our website. Before we begin, please note that certain statements in this conference call, including certain answers to your questions, are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. This includes, without limitation, statements regarding the state of the airline industry, including the impact of sanctions imposed on Russia, and aircraft delivery delays, our future operations and performance, revenues, operating expenses, stock-based compensation, and other income and expense items. These statements and any projections as to our future performance represent management's estimates for future results and speak only as of today, August 4, 2022. These estimates involve risks and uncertainties that could cause actual results to differ materially from expectations. Please refer to our filings with the Securities and Exchange Commission for a more detailed description of risk factors that may impact our results. Air Lease Corporation assumes no obligation to update any forward-looking statements or information in light of new information or future events. In addition, we may discuss certain financial measures such as adjusted net income before taxes, adjusted diluted earnings per share before income taxes, and adjusted pretax return on equity, which are non-GAAP measures. A description of our reasons for utilizing these non-GAAP measures, as well as our definition of them and the reconciliation to corresponding GAAP measures can be found in our earnings release and 10-Q we issued today. This release can be found in both the Investors and Press section of our website at www.airleasecorp.com. As a reminder, an unauthorized recording of the conference call is not permitted. I would now like to turn the call over to our Chief Executive Officer and President, John Plueger.

John Plueger, CEO

Well, thanks, Jason. Good afternoon, everyone, and thank you for joining us today. I'm pleased to report that ALC generated $558 million in total revenue during the quarter, up 13% relative to the same period last year, while our diluted EPS of $0.95 per share rose 27% year-over-year. Second quarter performance benefited primarily from the growth of our fleet, recognition of cash basis revenue, and the reduced impact of restructuring stemming from the pandemic. We purchased 22 new aircraft, adding approximately 1.4 billion deployed equipment. Our operating cash flow is up roughly 18% relative to the second quarter of last year, benefiting from improved cash collections relative to the prior year. We ended the second quarter with a lease utilization rate of 99.6%. Commercial aircraft demand, meanwhile, continues to strengthen. And with the uptick in international traffic volume, we're seeing that extend into the wide-body demand in addition to the narrowed market, which has been strong for some time now. In fact, we are now more than 80% placed on our widebody order book, which includes the A330neo, the A350 passenger and freighter, and the 787. Our overall order book placements reflect the strong demand environment with lease placement of 99% of our deliveries through 2023, with 60% of our deliveries in 2024 placed and with 25% placements in 2025 well ahead of our expectations. Some of our narrow bodies, such as the A321neo, including the LR and XLR versions, now have forward placements out 5 years through 2027, farther out than we had pre-COVID. As such, at the recent Farnborough Air Show, we placed a large order of Pratt & Whitney for additional engines to allocate to our A320 and 321neo order book. At Farnborough, we also announced an added replacement with a new online customer for 6 new A320s. We're also seeing a higher pace of lease extensions well in advance of lease expirations on both single- and twin-aisle aircraft, which is lending added support to used market lease rates and aircraft values. Reasons for this include a desire to secure current lift to face escalating new aircraft prices and higher interest rates, concerns over supply chain constraints leading to future delivery delays of aircraft on order, and as a hedge against aircraft shortages. We were pleased that our aircraft deliveries for this quarter exceeded our guidance. Our Boeing MAX deliveries this quarter happened to exceed our Airbus A320 and A321neo deliveries, 11 to 7. Now by saying this, I'm not making a forward prediction on the ratio of MAX and neo deliveries for the future, rather just that the MAX is enjoying good recovery with escalating deliveries and lease placements. Having said that, as you're aware, Airbus and Boeing are experiencing continuing supply chain and labor issues, resulting in delivery delays. So despite our deliveries exceeding guidance this quarter, we continue to experience delays of several months on our Airbus narrow-body deliveries, and 737 MAXs continue to be delayed as well. Supply chain challenges will likely extend for the next couple of years and we will likely further exacerbate what was already shaping up to be a shortage of commercial aircraft as post-pandemic demand continues to accelerate. On the widebody side, the Boeing 787 has been the primary challenge. But it is our understanding that the FAA has approved Boeing's delivery resumption plan. Now much like the time it's taking for Boeing to clear accumulated MAX inventory, it will take time to deliver the 787s and therefore, we retain our estimate of taking delivery of only one 787 by the end of this year. We're very pleased that there seems to be finally an end in sight to the 787 delivery freeze, and our airline customers are very eager to add the 787 aircraft to their fleets, particularly given the acceleration in international traffic. Given all these factors, we continue to expect about $3.5 billion to $4.5 billion of deliveries in total for 2022, consistent with our prior guidance. We expect $1.2 billion of aircraft investments in the third quarter, subject, of course, to manufacturer delays. On the sales front, we are targeting up to $750 million of aircraft dispositions in the second half of this year, somewhat subject to any further significant delivery delays we might experience during the second half of this year as we consistently prioritize fleet growth and core lease earnings. Lastly, I do want to provide a brief update on our efforts on insurance claims from our Russian fleet. We submitted our claims to our insurers in June to recover losses on these aircraft and continue to vigorously pursue our claims. Similar to last quarter, I want to point out that this is a complicated matter, and we're not able to provide much additional color beyond that, but we will update you on meaningful progress over time. To summarize the big picture, while there are many cross currents in the global macro environment, continued sizable traffic recovery tailwinds remain a source of strength offsetting these factors with further recovery momentum building in Asia, as Steve will now share with you.

Steven Udvar-Hazy, Executive Chairman

Thank you very much, John, and thanks to all of you for joining this call for our second quarter results. We are very pleased to see a significant increase in global air traffic volumes. I included the June traffic numbers released today to illustrate the ongoing substantial improvement, with total traffic up 76% year-over-year. This year, international markets have experienced the largest percentage increases, rising an impressive 230% year-over-year. The Asia Pacific international traffic has been one of the slower regions to recover from the pandemic, and although it started from a very low level, it recently posted a 492% traffic improvement compared to June of last year, marking the largest gain among major international market segments. Domestic traffic is also on the rise in most regions, with China lagging for most of 2022. However, recent easing of travel restrictions has helped stabilize domestic travel, particularly on major routes between key cities. While travel limitations still affect traffic in many countries, these are quickly becoming exceptions rather than the rule. Additionally, certain domestic markets and some international routes have now surpassed 2019 traffic volumes, with domestic traffic in Australia, Brazil, the U.S., Canada, and India being very close to or matching those levels. Forward bookings remain high compared to earlier this year. Despite traffic improvement facing challenges like rising interest rates, inflation, signs of a slowing global economy, and the unfortunate ongoing war in Ukraine, the underlying pre-pandemic demand returning to the market provides a strong counterbalance to these headwinds. I want to spend some time on the implications of the strong demand recovery on the global air traffic control system and airport constraints. Recent news has highlighted labor shortages and disputes affecting airlines during the busy summer season in the Northern Hemisphere, especially in Western Europe, resulting in numerous flight cancellations and delays. Many of these issues stemmed from airlines not adequately planning for increased traffic volumes, but delays and cancellations have also been exacerbated by airports and air traffic control systems, which were not prepared for the significant return of traffic. Airlines have been waiting for departure clearances, and planes have been held in inefficient routing, resulting in tens of millions of dollars in added fuel and labor costs at a time when prices for both are soaring. While politicians are focused on reducing carbon emissions, it’s essential to consider the emissions produced by aircraft sitting on the ramp with engines running or in holding patterns due to insufficient airport capacity. Rectifying this issue could enhance airline operations, profitability, passenger experience, and global emissions. The summer delays we've experienced this year remind us of the consequences of neglecting airport and air traffic control modernization. At Air Lease, we are actively placing new aircraft orders with both first-time and existing airline customers during this recovery period when demand for both new and efficient used aircraft is rapidly increasing. In addition to announcing the lease placement of our six new A220s with TAAG Angola Airlines at the Farnborough Airshow, we also shared news in late June of leasing three new A321neo Aircraft to LATAM, South America's largest airline. Just this week, we announced the placement of two new A321neo aircraft to Uzbekistan's largest private airline. More significant lease placement announcements are on the way as we capitalize on the strong demand for aircraft in our forward order book from Boeing and Airbus, as well as lease placements extending into the future. Consequently, lease rates are increasing due to diminishing aircraft supply, rising interest rates, and higher aircraft values. As John mentioned, our deliveries this quarter exceeded expectations. In total, we delivered 22 aircraft to customers, including Aerolineas Argentinas, Air Astana, Alaska Airlines, Caribbean Airlines, China Airlines, Corendon Airlines, a Norwegian low-cost carrier, IndiGo—which took delivery of three aircraft in the second quarter—and Vistara, which received three A320 deliveries. Lastly, Virgin Atlantic and Starlux each took delivery of a new wide-body aircraft. In conclusion, the ongoing strengthening of global air traffic after the pandemic clearly demonstrates that the need to travel is irreplaceable. This demand is not only regional but global, spanning both developed and developing markets. With our substantial $28 billion backlog of orders with Boeing and Airbus and a current fleet valued at $23.5 billion composed of advanced technology, environmentally-friendly aircraft, Air Lease Corporation is well-positioned to benefit from a robust airline demand environment and an increasing shortage of aircraft. Now, I will turn the call over to our CFO, Greg Willis, to provide more details on our financial results for the second quarter.

Gregory Willis, CFO

Thank you, Steve, and good afternoon, everyone. In the second quarter, ALC generated revenues of $558 million, up 13% as compared to the prior period. This was comprised of $545 million in rental revenues and $12 million of aircraft sales, trading, and other revenue. The increase in our rental revenues was primarily driven by the growth of our fleet, the recognition of $8.7 million in cash basis revenue, along with significantly reduced impact from lease restructurings. These benefits were partially offset by a reduction in rental revenue from the termination of our leasing activities in Russia in the first quarter. It's also worth noting that in the second quarter of last year, we were unable to recognize $42 million of rental revenue due to cash basis accounting. It's clearly a significant improvement here as the impact of the pandemic abates. Additionally, in the prior year, you will recall that we recorded a $34 million windfall from the sale of our Aeromexico bankruptcy claim. Overall, our airline customers are continuing to benefit from improving passenger traffic trends, which ultimately has benefited our operating cash flows. As we have said before, we have a very limited appetite for providing additional accommodations to our customers as the environment continues to improve, especially as our customers continue to look to lease new aircraft from our order book. Moving on to expenses, the interest expense line rose 5% year-over-year, driven by an increase in average debt balances, offset by a decline in our composite cost of funds. Our composite rate decreased to 2.81% as of the end of the second quarter, down from 2.91% in the prior year. As John mentioned, our composite rate is only slightly higher than it was in the first quarter in spite of a meaningful increase in market interest rates. Depreciation continues to track the growth of the fleet, while SG&A rose as our business activities have increased following the pandemic, along with an uptick in some of our operating expense. In particular, at the end of the quarter, we completed the renewal of our aviation insurance program, which as a result of current market conditions, we will incur a $15 million increase on an annualized basis. We do expect these higher operating costs and higher expenses to persist given inflation, the market for insurance, and recent geopolitical events. Beyond those factors, though, SG&A was also impacted by expenses related to aircraft transitions, primarily related to the aircraft we recovered from Russia in the first quarter. On the financing side of the equation, you will recall in January, we raised $1.5 billion in senior unsecured notes at a blended rate of approximately 2.5%, taking care of our refinancing needs for 2022. Earlier this year, we also increased our revolving credit facility to $7.1 billion with the final maturity of May of 2026, which provides us with a substantial amount of liquidity to fund our commitments. We ended the quarter with 92% of our debt at a fixed rate, leaving us relatively well insulated from movements in interest rates over the intermediate term. That, combined with interest rate escalators built into most of our lease placements, provides us with a one-time upward adjustment in the lease rate at the time of delivery. This all works together to help insulate us from the negative effect of a rising rate environment. Furthermore, our strong credit profile provides us with a significant funding advantage over our customer base, which ultimately supports our margins over the long term. As such, we remain firmly dedicated to maintaining an investment-grade balance sheet, utilizing unsecured debt as a primary form of financing, maintaining a high ratio of fixed-rate funding, and targeting a debt-to-equity ratio of 2.5x. We ended the second quarter with a debt-to-equity ratio of 2.85x on a GAAP basis, which net of cash on the balance sheet is approximately 2.69x. While leverage now is somewhat above our target due to the rush write-off last quarter, we expect it to trend back towards target as we resume our aircraft sales activities. As of quarter end, our unsecured funding exceeded 99% of our total debt financing, resulting in an unencumbered asset base of over $26 billion, contributing to the strength of our balance sheet. Our liquidity position remains very strong at $7.6 billion as of the end of the quarter. Our financial position and balance sheet remain strong, and we are very excited about the future of our business. As illustrated by our results this quarter, we are seeing performance continue to expand as we move beyond the pandemic. We expect new deliveries from our $28 billion forward order book to further bolster our performance, along with economies inherent in our operating expense base over time and a positive contribution from aircraft sales as our sales efforts pursue. With that, I'll turn the call back over to Jason for the question-and-answer session of the call.

Jason Arnold, Head of Investor Relations

Thank you, Greg. This concludes management's commentary and remarks. Now I'd like to hand the call over to the operator to open the line for the Q&A session. Daniel?

Helane Becker, Analyst

I have two questions. The first is regarding China. Are there any concerns that China might close its airspace, and how would that impact your operations, if at all? The second question is about the SAS restructuring; do you have any exposure to them?

Steven Udvar-Hazy, Executive Chairman

Yes, there's no plans for China. We have had close communications with the CAAC, the Civil Air Administration of China. There are no plans that we're aware of to close airspace. There could be some minor restrictions from time to time when they conduct military exercises in the state of Taiwan; generally, those are below 25,000 feet above sea level. And so we're not really seeing that as an issue. I mean, there are literally hundreds of planes that overfly China a day that do not go to and from China. So we're not aware of any restrictions in that area whatsoever. It's also a great source of revenue for China because they charge exorbitant overflight navigation charges. So it's a profitable business for the Chinese if an aircraft is flying from, say, Europe to Korea or somewhere in Southeast Asia and has to overfly China.

John Plueger, CEO

On your second part of the question, Helane, yes, we have 5 very young A320neo and 21neo LRs leased with SAS. It's the most desirable youngest part of their fleet. We have strong indications that they very much target those aircraft as their highest priority to keep. So we don't really have too many concerns about that bankruptcy.

Steven Udvar-Hazy, Executive Chairman

Yes. The main problem, Helane, at SAS is that about half of their wide-body operations from Denmark, Norway, and Sweden were across Asia, to Japan, Korea, Hong Kong, China, Bangkok, and Singapore. So because of the fact that they are forbidden from flying over Russia, going eastbound from Scandinavia and coming westbound from Asia, basically, half of their wide-body fleet is nonoperational or they're not able to utilize them. So unlike a lot of other European airlines that have a much stronger transatlantic operation as a percentage of their total wide-body fleet, SAS and Finnair are the two airlines that have a very high proportion of their wide-bodies dedicated to Trans-Asia traffic that has to go through Russia. So that is one of the major focuses of SAS is to reduce their A330 and A350 fleet. And the second comment I have on that, the only A321 LRs they have, which operate across the Atlantic on some of their thinner routes, are all leased from ALC. They have no other A321 long-range aircraft, except the 3 that they have from Air Lease.

Moshe Orenbuch, Analyst

John, considering your remarks about the ongoing delivery delays and the supply chain issues that have resulted in reduced deliveries over several years, can you provide any insight into when we might start to see some progress in catching up? In other words, will there be a point when deliveries might exceed the levels we previously contracted for? How long do you anticipate this process might take?

John Plueger, CEO

Thanks, Moshe. Look, it's a very complex equation. But the biggest factor that leads to single-aisle delays really is engine deliveries. And I think that's really well known. How far forward we have to look in terms of delays or limitations on engine deliveries is hard to say. But I think the broad answer is that recovery is more dependent on engine delivery than anything else. I think in Boeing's last earnings call, David Calhoun said he would go to 38 a month today if he had the engines. And so the things we look at is as there are engine shortfalls in the operating fleet, which takes a priority. Back 1.5 years, a couple of years ago, there were engines that were actually taken that were ready to deliver on new airplanes, and they were taken to put out to support the fleet. So we don't know the extent, if any, of that is happening yet. That's what happened in the past. But I think that is the single biggest driver. That is what we're watching. At Farnborough, we met with the CEOs of all of the engine manufacturers, and they're working their hardest to meet the delivery requests. At the same time, they have their own limitations. So I don't have an answer except to say, look primarily at the engine supply side.

Moshe Orenbuch, Analyst

Greg, maybe just as my follow-up question, you've got some tremendous execution on the fixed income side. And obviously, the markets are turbulent. Are there going to be opportunities, do you think, in the next 6 to 12 months where you can do things that others couldn't and kind of put that debt capital to work? Are there things you're thinking about that you could share with us?

Gregory Willis, CFO

Well, I think I'll start with the fact that that's one of the reasons why we maintain such a high level of liquidity, right? We want to be able to take advantage of windows to access the market at a time. So I think right now, we're watching the market carefully. We'll also look at other alternatives to figure out ways to raise inexpensive debt to fund our growth, and I can't give you any specific examples of what we're going to do, but that's one of the reasons why we maintain a lot of liquidity to let us take advantage of those market windows when they present themselves.

Hillary Cacanando, Analyst

You mentioned the debt market and expressed some optimism. I noticed that you utilized your revolving credit facility slightly during the quarter instead of issuing unsecured bonds. However, I assume you will need to access the market at some point this year due to your capital expenditure requirements. While you've briefly discussed your capital market strategy, could you elaborate on whether you plan to enter the market this year and what you anticipate regarding the cost of funds, considering the rising interest rates?

Steven Udvar-Hazy, Executive Chairman

Yes. We're looking at a collage of opportunities in the bond market. I recently had a trip to Southeast Asia, met with a whole number of Asian banks that have a surplus of dollars. We're looking at the possibility of a direct bank facility on a term loan basis separate from our revolver. And we're looking at optimizing our payment programs with the OEMs, particularly with regard to these delays. Because, as you know, we pay progress payments based on the contracted delivery of aircraft. And now that we're experiencing these sustained delays from both Boeing and Airbus, we're going to look at that very carefully. And see if we can rejig some of the progress payments to those manufacturers, which will give us additional cash liquidity. And then lastly, don't forget that between now and the end of the year, we will bring in well over $1 billion more of cash from the airlines through lease payments, deposits, reserves, etc. So cash flow is strong. And we're going to access anything that makes sense for us and keeps us having the lowest average cost of financing among all the lessors.

Gregory Willis, CFO

Steve, just to add to that. On the revolver side, it shouldn't surprise anybody that we would drop on our revolver. We typically target between 1/3 and 50% utilization. During the pandemic, we maintained very little drawn under that revolver, increasing our liquidity even higher. But that is designed to be a used facility.

Steven Udvar-Hazy, Executive Chairman

And also as we ramp up our aircraft sales in the second half, and we traditionally try to focus the business on taking a lot of aircraft in the first half and then selling aircraft at the tail end of the year, because we can enjoy the rental revenue on those aircraft until they're sold. So as we ramp up sales in the second half, that's also going to give us additional liquidity that will minimize the amount of external financing that we require.

Hillary Cacanando, Analyst

Understood. That's helpful. I have a question regarding the escalator and the OEM. I know there’s an escalator to account for the higher interest rate environment. However, I also understand that OEMs have their own escalators to address rising supply costs. Does your escalator incorporate the OEM escalators for increased aircraft costs, or is it solely related to the higher interest rates experienced by the OEMs?

Steven Udvar-Hazy, Executive Chairman

We have both.

John Plueger, CEO

We have both. The manufacturers escalation formula is a well-known provision lease rate adjustments as well as interest rate adjustments as well.

Unidentified Analyst, Analyst

This is James on for Jamie. Just one for me. You mentioned in the prepared remarks, first-time customers. Any color you can share on the demographics of those, whether it be region, credit profile or scale of them?

Steven Udvar-Hazy, Executive Chairman

No, I think they're geographically spread through Latin America, Western Europe, Central Asia, and Southeast Asia. There's no particular concentration in any particular geographic zone. It's quite diversified.

Jason Arnold, Head of Investor Relations

Thank you, everyone, for your time participating in our second quarter call today. We look forward to speaking with you again when we report third quarter results. Operator, thank you, and please disconnect the line.

Steven Udvar-Hazy, Executive Chairman

Now you complete Tog Gun.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.