Saturday 18 November 2017

'Airlines are now able to fly routes that were unprofitable when oil was at $100 a barrel'

As a youngster, Aengus Kelly once watched spellbound as aviator Tony Ryan was interviewed on the Late Late Show. Now Kelly heads the world's largest aircraft leasing company and insists that the current fear over China's future, and oil prices, won't hurt the sector, writes John Mulligan

AerCap Holdings boss Aengus Kelly, at this week’s Airline Economics Dublin 2016 event, brushes off fears that lessors might be feeling the pinch. Photo: Aidan Crawley/Bloomberg
AerCap Holdings boss Aengus Kelly, at this week’s Airline Economics Dublin 2016 event, brushes off fears that lessors might be feeling the pinch. Photo: Aidan Crawley/Bloomberg

Aengus Kelly laughs as he briefly reminisces about driving up and down the old N7 road between Dublin and Limerick in his Nissan Micra when he was getting his first taste of the aviation industry.

Fresh from UCD and working with KPMG, he'd been despatched to Guinness Peat Aviation (GPA) in Shannon to work on its audit there. He ended up doing eight-hour shifts photocopying aircraft leases. And then the kerosene seeped into his veins. GPA later poached him from the accountancy firm.

As head of the world's largest aircraft leasing company, AerCap, Kelly (42) has risen to the top of the heap in his sector. He's also been running it in what might well be remembered as a golden age for the leasing industry.

"I remember as a kid growing up watching 'The Late Late Show' and Tony Ryan came on," says Kelly, who's part of a large network of international executives that has been attending two high profile aviation conferences in Dublin this week.

Tony Ryan had established aircraft leasing firm GPA (and Ryanair) and the business had been hugely successful but would fall victim to the fallout of the first Gulf War.

"Now, this was Ireland in the '80s. This was so exotic and so exciting. To me, the concept of buying and selling aircraft all over the world was off the charts back then," says Kelly at a suite in the Shelbourne Hotel in Dublin. Both Kelly's father and his grandfather were accountants (there was a family firm), so the writing appeared to be on the wall.

"When you start in KPMG, you see all types of things - mushroom factories, Pretty Polly tights (made at one stage in Killarney) - and then you go down to those fellas in Shannon and you're part of something big and intrinsically interesting," he adds.

He says a lot of his fellow graduates were going to London and that's where he was also heading.

"I was talking to some of the investment banks about going to London. But I told one of them that I was taking a job. They asked was it in another bank and I said no, it was with a company in Shannon in the west of Ireland. It took the boys in London a while to figure out why I'd go there."

With GPA having failed to carry off a stock market flotation in 1992, GE came to its rescue in 1993 by buying its aircraft. That formed the basis for GECAS, with both it and AerCap now dominating the global aircraft leasing sector.

And "those fellas" in Shannon at GPA included a who's who of today's Irish contingent in the international leasing business - Kelly, as well as players such as Peter Barrett, who's chief executive of SMBC Aviation, and Domhnal Slattery, who has just sold the Avolon business he co-founded to China's Bohai Leasing. Ireland, meanwhile, has become the centre for the world's aircraft leasing business.

"Ironically, I think the implosion (of GPA) did a lot more for Ireland than the actual business," Kelly explains. "What happened was that all these people had a very niche skill set but were very talented. They went out and set up all these companies and that's why we're here today. It's why Dublin and Ireland is what it is today for the leasing sector."

With about 1,700 aircraft on its books and total assets of $43bn (€39bn), AerCap buys, sells or signs a lease agreement for just over one aircraft every single day. Its planes are deployed in over 100 countries and used by airlines everywhere and Kelly has been running it since 2011.

AerCap has a market capitalisation of $6.8bn (€6.2bn), but its shares have plunged about 20pc since the end of December as concerns about China's growth weigh on sentiment.

Some shareholders have taken that as an opportunity to increase holdings. Last week, Waha Capital, the Abu Dhabi investment company increased its stake in AerCap from 13.6pc to 14.6pc. In 2014 (its full-year 2015 results aren't out until next month), AerCap generated turnover of $3.6bn and net income of $808m. At the end of 2014, between restricted and ordinary stock, Kelly owned 1.7pc of AerCap, a stake currently worth $115m (€105m).

In its most recent reported quarter, to the end of last September, AerCap delivered revenue of $1.3bn and net income of $294m.

In 2014, AerCap also completed its $7.6bn acquisition of AIG-owned International Lease Finance Corporation (ILFC) - a game-changer that not only gave AerCap a significantly bigger market share, but also prized production slots for Boeing's Dreamliner and the Airbus A350.

And Kelly brushes off speculation that leasing companies might already be feeling the pinch as those growth concerns about China filter through to airlines' outlooks and their confidence to enlarge fleets.

Sharply lower oil prices also colour the perceived prognosis for leasing companies, because there's one argument that cheaper fuel can enable airlines to postpone replacing older, less efficient aircraft, of which leasing companies have thousands ordered.

"Airlines are now able to fly routes that were unprofitable at $100 a barrel, but are extremely profitable at sub-$50, so that results in an uptick in the demand for aircraft," says Kelly.

"What we have observed is that all the gas guzzlers that we thought would be scrapped for beer cans are still flying but there's a limit to how far they'll go. There's a hard stop point for airlines and that's driven by maintenance costs. To overhaul the two engines and the airframe on a 767 will cost about $20m. So airlines won't put $20m into it and neither will we. They'll go for the new aircraft type."

"What's happened to oil over the past 12 months is irrelevant," he insists, pointing out that airlines can't hedge oil way out into the future because it would be just way too expensive. "The only way they can protect against it in the long run is having fuel efficient assets. Unequivocally, lower fuel prices are a very good thing for our business."

Kelly also says that AerCap will be looking to Iran for business as the country emerges from sanctions.

"Once the sanctions are formally lifted and we've got a licences, yes we will. Iran will be a big source of demand as we go forward. It's a big country and has the oldest fleet in the world."

This week, IAG boss Willie Walsh said that British Airways is eyeing a return to Tehran.

But will the slowdown in China really be impact neutral for AerCap and other lessors?

"You have to disaggregate the Chinese markets between the financial markets and domestic demand," he insists.

"Last year, air traffic grew by 12pc in China, so that's a lot of growth. We've seen that the air traffic demand has outstripped GDP growth and why is that? There are so many people who have never got on an airplane, and once you do it's quite sticky. Rather than get the bus for 20 hours, you're going to save up to buy a plane ticket."

And with China trying to muscle in on the aircraft leasing business, does Kelly think the dominance of AerCap and GECAS can ever be challenged? The main barrier to entry is the huge financial resources required.

"To challenge us or GECAS - what's that, six or seven Avolons - it's very tough," Kelly reckons. "Maybe someone will get there, but I don't know. You have these two giants, but actually the business does very well for a lot of people.

"The margins are very robust and very stable. The airlines (by and large) are non-investment grade so they're always going to need someone to give them the airplanes.

"And underpinning the whole thing is growth. You know that more people are going to travel next year than last year."

And Kelly is among those who's done very nicely out of it. Although, he won't say what kind of car gets him from A to B on terra firma these days.

"It's not a Nissan Micra."

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