Headwinds Threaten Aircastle's Dividend

Aircastle's(AYR Quote) lofty 20% dividend yield looks enticing on first glance. But with global aviation demand weakening and the aircraft financing markets under pressure, the aircraft-leasing company may be forced to cut its dividend this year or next.

Aircastle makes its money by buying planes and leasing them to passenger and freight carriers such as US Airways(LCC Quote) and Sterling Airlines, its two largest customers.

The company's rapid growth in recent years was fueled by an acquisition binge that was financed through cheap long-term debt secured in the asset-backed securities market, which is now virtually shut down.

Aircastle's management said in its February earnings call that it is having trouble finding new planes to purchase since debt costs remain high but sellers are not yet cutting prices on planes.

The difficult plane purchasing market is hurting Aircastle's growth prospects. As well, the company is facing near-term cash flow pressures from a perfect storm of weakening airplane lease rates, ballooning oil prices that may force airlines to ground their planes and margin calls on the firm's interest rate swaps.

Amid these headwinds, Aircastle has been paying out more dividends than it receives in net income. The extraordinary 20% dividend yield today means investors are either betting on a possible dividend cut or substantial hits to book value, because stocks rarely trade at such high yields.

Aircastle's stock has already plunged about 60% in the past six months to around $14, a discount to its recent stated book value of $16.50. The stock's dismal performance is a black eye for alternative asset manager Fortress Investment Group(FIG Quote), which owns a substantial stake in Aircastle and took it public in 2006.

The company sits as yet another dog in Fortress' "castle" line of businesses, which also include real estate investment firms Newcastle Investment(NCT Quote) and Eurocastle Investment, a public company traded on the Amsterdam exchange. All four companies are trading at 52-week lows.

Aircastle and Fortress did not respond to requests for comment.

Somewhat surprisingly, not one Wall Street analyst rates Aircastle a sell. Skeptics say that is because no one wants to upset Fortress, which pays hefty trading and investment banking fees to the major banks.

FBR analyst John Stilmar, who rates the stock "market perform," says Aircastle's shares have been hit too hard by the broader credit crunch.

"Any company that has to re-access the capital markets as part of near-term business strategy is continuing to be penalized," says Stilmar, who thinks Aircastle shares are worth $23 and will trade higher once credit risk premiums lower across the financial industry. (He says the stock has shown a strong correlation to corporate credit default swaps for large global banks.)

One major issue looming at Aircastle is that $900 million related to recent plane purchases still sits as debt outstanding on its credit facilities, which need to be paid off by year's end.

Last year, Aircastle would have tapped the asset-backed securities market to fund this debt on a cheap long-term basis. But today, the ABS market is shut down amid the fallout from existing asset-backed securities paper tied to soured residential and commercial mortgage loans.