By David Sterman
NEW YORK (
) -- "Debt" has become a four-letter word, thanks to the financial crisis. But as the economy rebounds, debt can be a benefit.
That's because equity comprises a small part of a company's enterprise value (market value plus debt minus cash) and profits can become quite large relative to that small equity base. But investors remain wary of debt-laden companies, recalling that those were among the stocks that appeared to be headed toward bankruptcy when the economy started to contract almost three years ago.
As a result, shares of companies that buy and then lease airplanes to major airlines, all of which carry lots of debt, are among the cheapest in the stock market. Yet if the global economy stays aloft and grows sustainably, those companies could see impressive profit and dividend growth.
The stars are aligning for this industry. Airline traffic is up 10% from a year ago, banks have become supportive by providing very low interest rates for asset-backed loans for airplanes, and the key players are generating strong cash flow that is helping to reduce debt levels. Most importantly, a glut of unused airplanes that have sat idle are returning to service, and with fewer airplanes available, lease rates are rising.
The industry is dominated by the finance arms of
(GE - Get Report)
(AIG - Get Report)
. But investors can play the sector through smaller players such as
(AER - Get Report)
(AYR - Get Report)
(FLY - Get Report)
Willis Lease Finance
(WLFC - Get Report)
. And as this table shows, all of these stocks appear quite cheap on a price-to-earnings basis:
But those stocks are also inexpensive relative to their assets. For example, the value of Aircastle's fleet of planes, even after subtracting the company's debt, is around $1.02 billion, more than 50% above the company's $661 million market value, according to analysts at
. They think the shares should reflect that value and trade up to about $13 from a current $8.40. In a recent note to clients, they wrote that, "with its share price trading at almost half of book value, and given more demonstrable evidence of a rise in aircraft market values, it is possible that Aircastle could spend surplus cash on buying back shares or raising the dividend."
As long as these stocks remain below book value, share buybacks make plenty of sense. And that's what FLY Leasing is doing. The company's fleet of planes (minus its debt) is worth more than $17 a share, well above the recent $12.50 share price. Any weakening in the economy would change that equation. (In 2008, when the economy was sliding, airline lease rates fell sharply, dragging down the value of planes, so FLY Leasing's book value then was just $12 a share.)