Turbulence hits the aircraft leasing sector

Investors often overlook the small fleet of specialist funds that invest in plane leases. The last year has been tough for this subsector, but I think we are now approaching a point where adventurous fund investors might want to start taking a look again. The attraction of these funds is the long-term cash payments from big, reputable airlines that result in regular dividend payments. The steady lease payments flow through to generous dividend yields, some above 10%.

The downside? Many of these funds focus on the big A380 double-decker planes leased to the likes of Emirates. These face a finite future: Airbus will stop making them by the end of next year and airlines will slowly phase them out over the next few decades. As demand tails off we should expect resale values to drop sharply.

Selling planes on

Doubt surrounds the resale value of these huge planes. The issue is whether they really will be worth between 40% and 50% of the original purchase price (around $250m), which is the working assumption of most of the funds in this sector.

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Investors aren’t so sure and have marked prices down to levels where these planes might only fetch between 10% and 15%. Then total returns (income and capital) might be in the single-digit range, implying big capital losses. My guess is that over the next year or so we’ll see these planes either re-leased (at lower rates) or sold second-hand to a small group of buyers (who might even use them for parts).

I think we could see resale prices closer to a 20%-35% ($75m) range, at which point, assuming the debts built into the fund structures get paid off, we could see a full return of capital – plus those juicy dividend payouts. But that’s still a guess and there’s not a lot of hard data out there to base any hard predictions on. One of the few independent pieces of research comes from an outfit called Scope Analysis, which rightly points out the risks. It reckons that German investors have allocated around €1.6bn to a total of 21 Airbus A380s through their own local closed-end funds.

The lessees of these aircraft are Singapore Airlines, Air France and Emirates – and the first two of those airlines appear to be going cold on the A380, while Emirates has been reducing its orders for the plane.

But it’s not all bad news. According to Scope’s Frank Netscher, “the prices of funds whose A380s are already in a part-out – selling the aircraft for their parts – have risen slightly from previous lows: the process has provided investors with greater certainty over the expiry of the aircraft leases and return of the aircraft to their owners amid near-zero secondary-market demand for the planes”.

One aircraft leasing fund to research

The upshot? Top of my watchlist is a fund called Amadeo Air Four Plus (LSE: AA4), currently trading at 76p on a yield of just under 11%. Its A380s only represent a part of a diversified portfolio – currently eight A380s and six other planes. This vehicle’s leases only expire between September 2026 and January 2030. So there’s a lot of cash flow from leases still to come.

As Matthew Hose of Jefferies, an investment bank, puts it, “even at a 50% haircut, entailing receiving approximately 25% of purchase costs for the A380, there are still some nominally attractive returns on offer [especially] for AA4, given its [return] is supported by its A350 and 777 exposure, which hasn’t [had a] haircut”.

The market has probably priced these funds about right and AA4 looks the most diversified, least risky way in. But worries about industry leverage (especially at Norwegian) and concerns about aviation contributing to carbon emissions, could cause turbulence over the next few months.