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A low price-to-earnings (P/E) ratio doesn't always mean a stock is cheap. But I think value investors should take a closer look Aerocap Holdings (NYSE:AER) at a P/E multiple of 8.
The company makes money by buying and leasing airplanes. And it seems to me to be a potentially better choice than either. FTSE 100 airlines.
Overview
With a few exceptions, airlines typically don't like to own the aircraft they operate. And the reason is simple: they are expensive.
Buying and maintaining airplanes involves a lot of cash. By contrast, leasing involves a relatively small capital outlay up front and this gives airlines the chance to make quick profits when demand is strong.
The downside (and the reason I don't like airlines as an investment) is that making ongoing lease payments requires constant cash generation. And in a cyclical industry, that's very risky.
Aercap, however, takes the opposite approach. It used debt to buy planes directly and generates income by leasing them to airlines.
Valuation
With a P/E ratio of around 8, the stock looks cheap, but investors should be careful about jumping to conclusions about it. Aercap's profits not only decline in a cyclical downturn, but also turn negative.
Aircap EPS 2015-24
Created in TradingView
That means investors must earn enough when things go well to offset the effect of years of losses. This is why a low P/E ratio doesn't automatically make the stock a bargain.
A better way to evaluate stocks from a valuation perspective is the price to book (P/B) metric. Unlike a company's earnings, its book value is relatively stable over the business cycle.
Aercap P/B Ratio 2015-24
Created in TradingView
On a P/B basis, the stock is toward the upper end of its historical range. With this in mind, my instinct is to keep the stock on my watch list for the next downturn, rather than buying it now.
Aerocap Vs airlines
When a crisis hits (and the cyclical nature of air travel means I'm convinced it will) I'd rather buy Aercap shares than an airline. I think the risk of bankruptcy is much lower.
They can make big profits during strong periods and I could be wrong, but Airlines that have to make lease payments can find themselves in trouble during a recession. However, Aercap has a collection of assets that it can sell if necessary.
It's worth noting that the company has been selling its older planes for around double what it has them on its balance sheet. And this has allowed it to reduce its number of shares by almost 25% from 2022.
Neither easyJet neither International Group of Consolidated Airlines has managed to do this. And I see it as a clear reason to prefer Aercap over any of the FTSE 100 airlines.
When to buy?
I'm typically wary of cyclical stocks that trade at historically high multiples. But Aercap shares could be a good value right now, even with the threat of a slowdown.
The company achieved an average return of 10% on equity over the past decade. In addition, it sells airplanes at double their book value.
Given this, a P/B multiple of 1 for the stock doesn't seem high. So there are good reasons to consider the stock right now.
