Aircastle (AYR) yields 5%, trades below book value & management is conservative, shrewd, and truly shareholder oriented. With a payout ratio of 53%, there is more than enough room to keep growing the dividend at a rate above 4-5% per annum for the foreseeable future.
At the current price of $22, I strongly recommend buying shares.
For those of you who aren’t acquainted with Aircastle, they lease and sell commercial aircraft to airlines. At the end of the first quarter, they owned 224 aircrafts, with an occupation rate of 99.4%.
1st quarter earnings increased by 35% compared to Q1 2017, on revenues which were 0.78% weaker. Since then, the company’s stock price has traded between $19 and $25, averaging $22, the current price. Aircastle increased their dividend by 7% last year giving the company a 5% dividend yield, thus making it really close to introducing into my screener.
The S.A.F.E dividend stock screener is designed to find stocks which have attractive yields , a history of dividend increases, room to grow the dividend, and whose financial condition ensure dividend stability.
It screens on 5 criteria:
- Dividend yield greater than 3%.
- Payout ratio less than 70%
- Current ratio greater than 1x
- At least 5 years of consecutive dividend payments
- And a positive PE Ratio.
The two first elements are the most important ratios in the screener. They ensure that I’m getting a yield which I am content with, without horrifying payout ratios. The dividend streak shows some commitment from management to return cash to investors. Positive PE means the company generated positive net income in the last year, so I know we are not looking at companies that are losing money. The current ratio is a sanity check to only include companies which can cover their short-term liabilities.
This method only gives you a handful of results at any point in time. I like this because I can focus my efforts on a handful of stocks. The obvious shortfall is that some very good dividend growers will be excluded. You can still apply the rest of the framework to any dividend paying stock, this screener gives you a starting point.
Aircastle fits the bill in every single respect bar the current ratio, as the table below suggests.
The S.A.F.E Dividend Method is a framework developed by my son Sam and myself to uncover undervalued dividend growth stocks.
Within our framework, I analyze in detail any stock which makes it into our screener. I monitor the screener weekly for new entrants as well as exits.
REVENUES AND NET INCOME
Aircastle ‘s revenues have grown at a compound annual growth rate ((OTCPK:CAGR)) of 3%, the same as the S&P 500’s average; however Aircastle TTM earnings grew faster at a 35% CAGR vs 5.6% for the S&P 500.
While revenue growth has been somewhat inconsistent throughout the past few years, management has been great at managing its cost structure to increase profits. This will be covered extensively throughout the article.
When you look at the overall trend in net income, the current levels of profitability can be explained mainly by depreciation and interest costs being lower relative to revenues than they were between 2012 and 2014.
These costs have continued to represent a smaller percentage of revenues throughout the subsequent years, which is encouraging.
HISTORICAL PAYOUT RATIO & OUTLOOK
I look at the company’s payout ratio relative to its historical value., as well as look at the evolution of the two underlying line items: net income and dividends.
Aircastle has maintained a payout ratio between 50% and 140% throughout the latest 7 years. It now sits at 53% for the trailing twelve months. This is a positive with a slight caveat. When going through tough years the payout ratio has risen abruptly above 100%. However, the company sits on enough cash to pay more than twice the yearly dividend, which should provide some cushion through periods of stress. The company is expected to remain within the 50% – 60% range for 2018.
HISTORICAL DIVIDEND YIELD
I then look at the company’s dividend yield compared to its historical value.
Aircastle has historically yielded between 3.5% and 6.4%. At 5.09%, Aircastle is trading slightly above its median yield for the last 7 years. While a 6% yield would be even more desirable, I am more than content with a 5% yearly yield.
An even more impressive point, Aircastle’s dividend yield has remained high despite outperforming the S&P 500 throughout the last 9 years.
Since 2016, the company’s stock price has been trading within a tight range. If you bought the stock in 2015, you probably even lost money.
Nonetheless Aircastle’s price will at some point move in line with fundamentals.
SAFETY OF THE DIVIDEND
Next, I need to assess the safety of the dividend, since the stock has a high yield, I want to make sure that the company isn’t exposed to excessive amounts of debt.
The company’s balance sheet has expanded with an increase in unsecured debt. Since 2011, the company has increased liabilities by $1.7bn while shareholders equity only increased $0.5bn.
Now more leverage isn’t fundamentally bad if the company can generate returns in excess of debt payments. This seems to be the case given that the interest coverage ratio is the same in 2017 as it was in 2011, about 1.6x.
This has been made possible through consistent reduction in the average interest paid on unsecured debt.
At the end of the first quarter of 2014, the average interest rate of the company’s unsecured debt was 6.6% whereas it was only 5.3% at the end of this year’s first quarter.
This is a positive. What remains to be seen is at what rate debt expiring in upcoming years will be rolled over.
As you can see, about 1/3 rd of Aircastle’s debt is expiring in the upcoming 3 years. The silver lining is that the 2019 and 2020 notes carry the highest interest rates (6.25% and 7.625% respectively) of all the company’s outstanding debt.
Therefore, I expect the average interest rate to either go down or remain stable, even in an increasing rate environment.
After interest and debt payments, the second most important component of Aircastle’s cost structure is depreciation.
Recently the company has been selling new aircraft and focusing on buying aircraft which is 8-10 years old.
This is an extremely clever move. Why? When you buy a new car, you know most of the depreciation is going to happen in the first few years. The same applies to aircraft.
By buying aircraft which is 10 years old, the price is 10 years closer to its residual value than if you buy it new. This means yearly depreciation is less, on average.
Depreciation went down from 40% of revenues in 2011 to 37% in 2018. This means all else held equal, savings of $23mn per annum, at the current revenue levels.
I also want to know that the company has shown dedication to increase its dividend over time. Aircastle has been increasing its dividend every year for the last 7 years by different amounts. This is encouraging because it shows commitment to increasing the dividend and returning capital to shareholders. However, it is important to note that the company slashed their dividend dramatically in 2008.
As you can see hikes have been quite consistent. the dividend has grown at a compound rate of 15% since 2011. These increases have been fantastic, but like I just said, they only show part of the story.
Aircastle’s dividend took 10 years to get back to its pre-crisis levels. While I don’t expect a major setback in upcoming years, it is important to note that demand for aircraft remains cyclical and is impacted by economic conditions.
Overall, I believe that Aircastle’s management’s efforts to de-risk the business and lighten the cost structure make the company ready to withhold minor setbacks in the future.
The company has sufficient cash to weather one-off bad years and enough room to increase dividends generously.
VALUE OF THE DIVIDEND STREAM
Next up is figuring out what I want to pay for a stock which pays 1.12$ in dividends per year, which I will assume grows at 4% per year.
I run a simple DDM Model three times adjusting the dividend growth rate by +/- 1%. I then divide these values by the price to see what portion of the stock price can be attributed to the dividend stream, and what premium I must pay for exposure to potential stock appreciation.
I assume a constant 10% discount rate for every equity I analyse which allows me to compare the stocks within my screener’s theoretical value to their stock price.
For Aircastle this gives us a value between $16.64 and $23.39, or between 74% and 104% of the current share price. This is extremely encouraging, since Aircastle’s dividends represent only 53% of net income. This means that the market is attributing close to zero value to the remaining part of earnings.
These are situations I love, because it bakes in a certain margin of security.
I then look at Peter Lynch PE lines over the last 5 years. A Peter Lynch PE line gives you the theoretical price at a point in time if the stock traded at a certain multiple of earnings. I look at the PE line for the average 5 year PE as well as the minimum and maximum PE over the same period.
As you can see Aircastle is trading below its average PE multiple for the last 5 years. It is trading close to its minimum PE multiple, indicating that the stock might be undervalued. While short term there is little correlation between earnings and price, in the long run, the correlation is close to perfect.
I expect to see mean reversion during the next decade, which once again gives me a sense of security that the stock is cheaply priced today.
Given that demand for aircraft is function of economic conditions and oil prices, it is always difficult to predict bumps on the road ahead.
Nonetheless I believe that Aircastle’s price is a bargain. With a 5% yield and considerable dividend growth, you are well compensated if you purchase at these prices.
I will be analyzing other stocks which are in my S.A.F.E stock screener during the next few weeks, so if you enjoyed this article please follow me and don’t hesitate to ask any questions you might have.
Disclosure: I am/we are long AYR.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: These views represent the opinion of the author and not those of his company, uuptick LTD.