The Capital Cycle Podcast - Aircraft Leasing Lift-Off

Episode Date: March 31, 2026

A shortage of planes is a boon for leasing companies. Edward Chancellor talks to Tom Wharram, a North American Equities Analyst. For more information, or to access select articles from Marathon’s Global Investment Review publications which accompany this podcast series, please visit www.thecapitalcycle.co.uk Hosted on Acast. See acast.com/privacy for more information.

Hello, this is Edward Chancellor with another episode of Capital Cycle podcast. I've got with me again, Tom Waram, who's an analyst on the North American portfolios. Welcome. Hello, good to see you again. Tom, we're going to do something we've never done before on one of these Capital Cycle podcasts, which is to go backwards to a piece that you wrote actually in December 2024, which I liked at the time, but for some reason didn't really have space to include it in the podcast. Now, I'm also speaking this month to your colleague, Ben Slingsby,

who has written about the European aircraft engine manufacturers. And I wanted to talk about your old piece on aircraft leasing and the capital cycle in aircraft leasing to give us a sort of take on the aircraft and airline industry from a slightly different. different capital cycle perspective. So can we recap your piece and then later go in and discuss what has happened since then? So the peak of commercial aviation production was in 2018 when Boeing and Airbus delivered around 1,600 aircraft to customers. Unsurprisingly, as we all know, the trough in that came in 2020 when they produced fewer than half of that thanks to the pandemic. And when I wrote the piece at the end of 2024, I said that production remained 30% below

that peak. And then just updating that for today in 2025, production was about 15% below the 2018 peak. And we're still not expected to surpass that for another two years. So in a classic capital cycle, dramatic production cuts such as these would normally be the result of an excess of aircraft. Yes. That's what we'd normally see, those kind of production cut, you'd expect it to be because there were too many aircraft, but that's not the case here. The woes that have faced the aircraft OEMs over the past few years are extensive, but completely unrelated to the balance of supply and demand. The issues are very well known. They've been all over the papers, I suspect. In 2019, you had the 737 max grounding, and then obviously

you had the pandemic and all the associated supply chain disruptions. And then there'd be an extensive engine troubles. You had skilled labour shortages. You had labour strikes. and then the 737 Max 9 door plug issues that they had and other quality control items. So all of these things form a sort of connected web of challenges to scaling up production that can't be easily overcome. As I've said, the expectations are that we won't exceed that 2018 production number until 2027. And even these forecasts might turn out to be optimistic. the CEO of Air Cap made the point on their recent call that you just don't get surprises to the upside on aircraft production.

And on the other side of the equation, demand continues to grow robustly. Yes, the metric people use is revenue passenger kilometres, so that's total kilometres travelled by paying customers, and that's grown at an average rate of 5% since 1980. And 2024 was the year that it exceeded the pre-pandemic high. the middle class globally is expected to get to 57% of the population in 2030 and that compares to 47% in 2021. So that's a big increase and they will want to fly.

The other demand point to raise is that the new technology aircraft are about 20 or 25% more efficient or less fuel burn per seat than the previous generation. And so what this means is you have an aircraft shortage particularly for those more efficient new technology aircraft. And the challenges to scaling up production means there's little chance of that shortage being remedied before at least 2030. And you believe this is great news if, for instance, you own aircraft and delivery slots. In other words, you're an aircraft leasing company.

Yes, absolutely. And to take a little bit of a digression and a bit of history on aircraft leasing, the industry came about in the 1970s as new, small, small, airlines sprung up and they wanted a capital lightway to expand. And since then, the penetration of leasing has increased steadily. It's now about 50% of the global fleet. So while these leasing companies are not well known to people and they may seem pretty esoteric, they finance about half of the commercial airline industry. And that's expected to continue to rise. And you write particularly about one of the aircraft leasing industries pioneers. One of Marathons Holding is a company called

Air Lease. And that company was founded by Stephen Udvar Hasey. He co-founded one of the first aircraft leasing companies called International Lease Finance Corporation or ILFC. That was in the 1970s. And he sold it to AIG in 1990. And then he ran that business as part of AIG until about 2010 when he left there to found air lease. Which is another, or least has been another marathon holding. Yes, exactly. And you say that Mr. Udva has a long track record of success in the industry. He does. And my knowledge of the industry, or not all my knowledge, but some of my knowledge of the sort of history here

comes from a book called Crash Landing, which was written by an executive of the Irish Leasing Company GPA, which had to be rescued from bankruptcy in the early 1990s. I remember the GPA failure or near failure. Do you remember what actually caused GPA to go down? They had two issues. One was that they had ordered far. too many planes during the boom times. And then second of all, they had too many old planes.

And so they were getting all of these new planes being delivered, some of which were not the right models for the market at the time as well. So they were getting all of these new planes being delivered exactly into the downturn of the early 90s. And then they had a lot of older aircraft, all of which were on the ground. Anyway, ILFCR are mentioned as a contrast to what was going on at GPA and how much better they had done and they'd held back from ordering new aircraft in the boom times and they'd navigated that downturn much better. And do you say that Mr. Udfah, Hazi was doing well again in the early 20s? Yeah, so, you know, that history I've just given you is obviously a long time ago. But we saw that same countercyclical mindset on display during the

pandemic when Air Lease placed large orders of new aircraft, you know, at exactly the moment where future travel demand was uncertain. It's a very important. easy to forget now that people were talking about much less travel, especially business travel, which hasn't come to pass, and Boeing and Airbus were much more flexible on price. Since the market is recovered and aircraft prices have risen, they're not placing significant orders. They're simply waiting for the delivery of those aircraft that were bought at much more attractive prices. Conventional wisdom holds that you don't invest in airlines. One might expect that a fragmented aircraft leasing industry would have a bad, if not worse, capital cycle

and therefore investors would be wise to stay away. That was certainly what I expected when I first came across the industry, but maybe by way of example. So 2020, arguably the worst year in aviation history, and air leases revenues fell just 0.1% and profit before tax fell just 12%. So the business model is much more stable. than the airlines they supply. And there are a few aspects of this. Firstly, they focus on owning young aircraft and they sell them a third of the way through their economic life. And what you find is when there's a downturn, the demand for younger aircraft remains as they're more fuel efficient.

So you keep your young aircraft flying and the older ones are on the ground. And even where a customer goes bankrupt, the younger planes can then be remarketed to new customers. And Mr. Udvar has a 50-year track record of always being able to remarket aircraft when a customer goes bankrupt. And the company benefited from being a dominant player in the leasing business? This is also critical to the business model. They are one of only a handful of aircraft lessors large enough to go directly to the manufacturers, to Boeing and Airbus. And they can leverage their scale.

And as we've talked about, they can time their purchase of aircraft to get better terms than you would get if you were a small lessor or if you were a small airline. There are about 200 aircraft lessors. So at first you think this looks like quite a fragmented industry, but the vast majority lack the scale to go to Boeing or Airbus. And what most of the aircraft lessors do is they compete in a much more competitive sale and leaseback market, which is really about providing the lowest financing cost. The other scale advantage that Air Lease have, and again those sort of handful of large lessors,

is that they have investment-grade credit ratings, so they can fund themselves at a much lower cost than the long tail of, small lessors. So what interested me, Tom, about your piece was how it showed that in the aftermath of global financial crisis, low interest rates encouraged yield seeking in the aircraft leasing industry and attracted new entrance into the business. That's exactly right. So in 2010, 80% of the lease fleet was held by 21 lessors. And by the eve of the pandemic, this is nearly doubled to 38. So with interest rates having risen, we're now seeing this pattern start to reverse. And during the pandemic, what happened to air leases profitability? So during the pandemic,

one of the things that happened is lessors agreed low leasing rates on the aircraft being delivered, and they also restructured leases with their customers who were struggling. And so these deals acted as a drag on air lease's revenue. Since then, obviously, interest rates have come up and higher interest costs have pushed air leases funding costs up, pressuring net income. So the relevant metric here we talk about is a net lease rate. So this is effectively the spread between the leasing rate and then their funding cost. What you had in the aftermath of the pandemic was a squeeze where leasing rates were locked in at lower rates and funding costs were rising. and this meant that return on equity came down to about 7%

compared to the pre-pandemic average of about 13%. Unsurprisingly, this decline in return on equity meant air lease was at the time when I wrote the piece trading at a price to book for about 0.8 times compared to the pre-pandemic norm of about 1.2 times. You felt at the time that that depressed valuation was overdone? Yes. So if you think about the aircraft shortage, we could already see in 2014 that that was going to start pushing lease rates up. So, for example, an A321-Neo lease signed in 2023 was already around 20% higher than those signed in 2019.

But the portfolio is very slow moving. So there's a two-year lag between agreeing the lease terms with the airline and that aircraft actually being delivered. So the benefit of higher lease rates had yet to feed into air lease. revenues, but this was set to start happening sort of end of 2025 or during 2025 and continue for several years after that. You didn't believe that the aircraft leasing business had been structurally damaged by higher rates? No, in the long run, higher interest rates are passed through to the customer as high lease rates. But there is a duration mismatch. So as interest rates rose, you see air leases cost of debt squeezing the net lease rates before those high.

leasing rates come through on the top line. When we originally looked at this, it was hard to say when the balance of those two factors would start to drive return on equity up. But we expected return on equity to return to historic levels on something like a three to five year time horizon. And we thought the improvement in ROE would justify a price to book multiple, at least in line with history. And in the meantime, you were buying at a very low price to earnings multiple. and those earnings are all being retained in the book value to fund new aircraft deliveries, so you're getting continued book value per share growth as well. The other aspect of this thesis is that air lease normally sell aircraft around a third of the way through their useful life,

and the shortage of aircraft has obviously pushed aircraft values up, and that means they can make healthy gains on sale when they sell those aircraft. So they've been selling at around a gain on sale of around 15%. Now, it's quite hard to judge what the value of the total portfolio of aircraft they own is because they have these attached leases. And from the outside, it's quite difficult to judge how that impacts the value. But we felt that the improving gains on sales and the tightness in the supply of aircraft meant that it seemed likely that the book value was significantly underestimating the value of the aircraft.

And you also thought that the order book was another source of value. Yeah, so what we've just talked about is the book value, i.e. the physical assets that they currently own. But at the time that I wrote this piece, they had 112 unplaced orders. That is, orders that were going to be delivered from sort of 2025 to 2030. They have an estimated average cost of $63 million. And this was almost certainly below the market value of those aircraft, given the shortage of delivery slots and the fact that so many of those aircraft were ordered during the low prices during the pandemic. Now, the way Air Lease are going to monetize those deliveries is by placing the aircraft with airlines, not by selling the delivery slots. However, I think there is this

off-balance-y value, which is if they had sold the delivery slots, I think you could reasonably assume, I mean, I thought very conservatively a 10% premium to the price that they were going to buy them for, potentially more, and that again adds 10 to 20% to the book value. So Tom, when you wrote this piece back in December 24, you were saying that the exact timing of the improvement in air leases, profitability was uncertain, but the marathon was well placed with patience to benefit from what looked like a favourable capital cycle dynamics, but also a sort of key aspect of marathon's investment philosophy,

is looking at the capital allocation skills of the person running the business. Now, since you wrote that piece, the investment case has actually played out as expected. Yeah, so looking at the most recent quarterly results, net lease yields expanded, and that was the fourth quarter in a row of that expansion. Return on equity is going up. And that's really being driven by the things we've already talked about. So the lower yielding leases being extended at higher rates, the COVID-era leases rolling off and new aircraft coming on at higher lease rates.

And those positives are more than offsetting the higher financing cost. You know, as I've already said, they reported a 15% gain on sale on the aircraft they sold in the most recent quarter. And with aircraft production remaining tight, that's not expected to change any time soon. Now for the bad news? Yes, I don't know whether we necessarily want to frame it as bad news, but consolidation is continuing among the large less ores. I think in the original piece, I mentioned that Air Cap acquired GE-Cass and SMBC had acquired Goshawk. Now SMBC are acquiring air lease. So it's actually being bought by a consortium backed by Apollo and Brookfield.

So you've made a decent amount of money on the stock in the interim, but you're not quite happy with the takeout price? Yes, that's right. We have a huge amount of respect for Brookfield as investors. were actually shareholders of Brookfield, I suppose we would essentially agree with their conclusion that $65 per share just below the book value is still an attractive price for air lease. So you thought it might have been more? In 2025, the company achieved an adjusted return on equity of around 10%. That is still below the low teen level they can get to with a normalisation of net lease spreads.

And at those higher levels, a premium to book would be justified. and if you look at their competitor air cap, that's now trading it around 1.3 times book. And if you bear in mind, the buyers are buying the stock for about 10 times earnings. So you're getting a decent earnings yield today at today's depressed ROE, hence my view that a premium to book would be justified. The other thing is, as we've mentioned, that just looking at the book value gives no value to the order book of aircraft being delivered in the next five years, many of which were purchased at COVID-era prices, which are much lower than the current market value of the aircraft.

So thanks, Tom. And I think this conversation is interesting for two perspectives. One, just see another orthogonal take on the capital cycle in the aircraft manufacturing business and financing, but also more generally how interest rate cycle affects the capital cycle, because what you described is a period, in which when the interest rates were low, the aircraft leasing industry had an expansion of competition and now interest rates have risen, the industry is consolidating and turning into what we might call a benign capital cycle. And Marathon still retains some exposure to the aircraft leasing business. Yes, that's right. We have exposure through our ownership of BOC aviation in our EM portfolios. It's really a very similar thesis. The stock has been doing well.

and much for the reasons we've discussed. Very good, Tom. Thank you. Great. Thank you very much. Thank you for your time today. I hope you will listen to the next edition of the Capital Cycle. This communication is provided for information purposes only. Please refer to Marathon's website and the Global Investment Reviews for further information, including important disclosures.