Spinoffs offer a solution for aviation lessors

DAVID FICKLING AND BROOKE SUTHERLAND

Sometimes the most surprising thing in financial markets isn’t what happens, but what doesn’t.

Take aircraft leasing. Two of the three largest aircraft fleets are stuck inside giant conglomerates, in the form of General Electric’s Gecas and HNA Group’s Avolon.

By rights, that situation should be ripe for reversal. The global airline industry, for years a notorious money pit, is forecast to post a record $38.4 billion in net profit this year, according to the International Air Transport Association (Iata).

Ten years ago, passenger load factors – a measure of the percentage of seats on planes filled by paying passengers, which relates closely to profitability – only broke north of 80 per cent at the best-performing airlines.

Nowadays, that is the median level for the industry as a whole, and five carriers are above 90 per cent. Planes, in other words, are full – and when that happens, demand for more wings should be positive news for lessors.

Even recent bankruptcies have barely caused more than a bump. The fleets of Europe’s Alitalia, Air Berlin and Monarch Airlines have been quickly snapped up by rivals, according to KPMG. Such events are traditionally one of the few ways that lessors can be driven into loss-making territory, as a flood of disused aircraft hits the market and pushes down valuations.

Shares in AerCap, the only one of the big three leasing fleets that is quoted on public markets, reached a record high in January before last week’s market rout. Price-to-book valuations of BOC Aviation and Air Lease both recently touched multi-year records.

Such riches could do a world of good for GE and HNA, which are suffering sudden cash crunches after years of abundance. As Bloomberg wrote last month, an at least partial sale of Gecas would be a great way to kick some capital back to headquarters – and the same goes for Avolon and HNA.

A deal like that would be a winwin for both conglomerate and leasing subsidiary. For all the glamour of an industry that controls the world’s largest non-military fleets of aircraft, lessors are much like any other finance business: the only real way they can compete is on cost of capital.

That normally makes a conglomerate a very good place to shelter. Vying for capital against other group companies rather than in the wider market, a lessor has a chance to invest counter-cyclically. By spending heavily when others are tightening their belts, lessors owned by conglomerates and banks have traditionally been able to get better deals from aircraft manufacturers.

The situation at present is reversed, though. GE is facing a $15bn shortfall at a legacy insurance business. HNA is planning to sell about the same value of assets by the end of June to escape a looming liquidity crunch. As a result, Gecas and Avolon are more likely to be starved than fed.

Giving them a chance to tap public capital markets wouldn’t just drive cash back to head office – it would boost their ability to hold their own against bank-controlled lessors such as Bank of China’s BOC Aviation, Sumitomo Mitsui Banking-affiliated SMBC Aviation Capital, and Macquarie Group’s AirFinance unit.

At present, it doesn’t look like that is going to happen. For one, they remain good businesses for their conglomerates, particularly given the way their parents are embedded in the aviation industry through jet engines (in the case of GE) and airlines, services and hotels (in the case of HNA). More to the point, the scale of their parents’ problems potentially exceeds the cash that could be raised from any partial spinoff.

Gecas had about $40b in assets as of the fourth quarter, with JP Morgan analyst Steve Tusa estimating it will earn $1.05bn in 2018. Avolon, with about $43bn in assets last April, is of similar scale. Apply an AerCap-like valuation around or slightly above book value, and each is probably worth $10bn or so – a substantial sum, but not enough to solve their parent companies’ problems.

Don’t count out the odds of a reversal if GE and HNA’s travails deepen, though. Nestling in the down of a doting parent has allowed Gecas and Avolon to do well of late. At some point, though, every bird must learn to fly on its own.