April 9, 2018

AER Valens Credit Analysis – Consistent, material debt maturities, and neutral recovery rate imply ratings agencies and credit markets are understating risk

  • CDS markets are materially understating credit risk with a CDS of 94bps relative to an Intrinsic CDS of 253bps, while cash bond markets are understating credit risk with a cash bond YTW of 3.978% relative to an Intrinsic YTW of 5.148%. Additionally, S&P is materially understating AER’s fundamental credit risk, with their BBB- credit rating five notches higher than Valens’ HY2 (B) rating
  • Incentives Dictate Behavior™ analysis highlights management members are not material holders of the firm’s equity, implying they may not be well aligned for long-term value creation
  • Earnings Call Forensics™ of the Q4 2017 earnings call (2/14) highlights that management may lack confidence in the sustainability of strong earnings growth, and may have concerns about the new technology aircraft in their portfolio
  • AER is currently trading at a 1.3x UAFRS-based P/B, which is near the low end of valuations since 2008. At these levels, the market is pricing in expectations for Uniform ROA to remain at current 7%-8% levels, accompanied by 1% Uniform Asset growth going forward. Given that current expectations appear to be pricing in a continuation of recent trends, equity is likely fairly valued. However, should the markets realize the firm’s real credit risk, further multiple compression and equity downside may follow
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