AerCap Holdings, the aviation leasing giant, recently held their Q1 2024 earnings call. While the headlines focused on record earnings and a massive share buyback program, a subtle yet significant shift may have been revealed. During the Q&A, Aengus Kelly, AerCap’s CEO, made a statement that could change how we analyze leasing companies: "We aren't managing to net spread."

For years, "net spread" – the difference between the lease yield on aircraft and the cost of funding those aircraft – has been the primary metric for investors evaluating leasing companies. It's a straightforward metric that seemingly captures the core profitability of the business. But Kelly’s statement suggests that AerCap, arguably the most successful aircraft lessor globally, is looking beyond this simplistic view.

So, if not net spread, what *is* AerCap managing to?

The answer, according to Kelly, lies in “value creation, earnings per share, and the right risk profile of our fleet.” AerCap is prioritizing a holistic approach that emphasizes long-term shareholder value over optimizing a single metric like net spread.

This strategy is evident in AerCap's aggressive asset recycling program. They are selling older, higher-yielding aircraft, even if it temporarily impacts net spread. Why? Because the secondary market for aircraft is strong, allowing AerCap to book substantial gains on those sales. These gains are then used to buy back shares at a discount to book value, further enhancing returns for shareholders.

Kelly explained this approach, describing how AerCap turned $615 million of book equity against certain assets into $1.38 billion. This demonstrates how AerCap is leveraging market dynamics to extract maximum value from its portfolio.

"AerCap's Capital Recycling Strategy Step Action Result 1 Sell older aircraft in a strong secondary market Book substantial gains on sales 2 Use gains on sales to buy back shares at a discount to book value Amplify returns for shareholders 3 Acquire new technology aircraft Improve the risk profile of the fleet and generate stronger cash flows"

It's not just about gains on sale. AerCap is simultaneously improving its fleet's risk profile by shedding older aircraft and focusing on acquiring new technology aircraft. These newer aircraft command higher lease rates, generate stronger cash flows, and have a longer useful life, resulting in higher returns and lower risk.

AerCap's Share Buyback Spree

In 2023 alone, AerCap repurchased $2.6 billion of its stock, or 18% of the company, all while deleveraging its balance sheet. This buyback spree, fueled by robust cash flow and gains on sale, placed AerCap in the 99th percentile of S&P 500 companies for share repurchases.

This strategy is paying off for shareholders. AerCap's book value per share ended 2023 above $83, a 25% increase from the previous year. While their 2024 EPS guidance might appear conservative at first glance, it’s important to remember that they significantly outperformed their initial 2023 guidance.

What This Means for Investors

Perhaps it's time to reconsider our reliance on net spread. In a market marked by high demand for aircraft and limited supply, AerCap is demonstrating that a more dynamic approach to portfolio management and capital deployment can generate superior returns. They are actively shaping their fleet to capitalize on market opportunities, buying low (their stock) and selling high (older aircraft).

"KEY DATA POINTS TO CONSIDER * Gains on sale margins (AerCap's 2023 average was 22%) * Share buyback activity as a percentage of market cap * Portfolio composition by aircraft age and technology"

This earnings call may have subtly signaled the start of a new era in aircraft leasing, where maximizing shareholder value, not just net spread, takes center stage.

"FUN FACT The global commercial aircraft fleet is expected to double in the next 20 years, driven by rising air travel demand, particularly in emerging markets. Boeing Commercial Market Outlook [https://www.boeing.com/commercial/market/]"