Aircastle Limited (AYR), AerCap Holdings N.V. (AER) – This Industry Is Flying: Which Stocks to Buy?

Management teams’ sense of optimism about the aircraft leasing industry’s outlook, which emerged during last quarter’s earnings, was still noticeable during the 1Q13 reporting season. The market continues to witness improving aircraft leasing fundamentals that should help all aircraft leasing stocks.

However, the question is, which stocks in this industry will provide the best returns?

Investment thesis

Aircastle Limited (NYSE:AYR) was the first company to report its quarterly results on May 7. The company reported a crushing earnings beat. It reported 1Q earnings of $0.40 per share, topping the estimate of $0.26. The beat was a result of better than expected revenue (maintenance and other revenue) which covered for slightly higher than expected interest and other costs.

The guidance for 2013 asset acquisitions, that could meet or exceed last year’s $850 million in investments, is consistent with comments provided during Aircastle Limited (NYSE:AYR)’s investor day and reflects management’s optimism in aircraft demand trends. However, the revenue guidance for 2Q came in softer than anticipated, partially as a result of lower than expected lease rate factor (LRF) but also on higher amortization of lease discounts and incentives. (A lease rate factor is the lease payment as a percent of the total cost of the leased equipment or software. Stated another way, if you multiply the lease rate factor by the cost of the leased equipment or software, the result equals the periodic lease payment.)

As a result of weak guidance, the Street has reduced its 2Q estimates. Barclays reduced their 2Q EPS estimate to $0.33 from $0.41. However, with the 1Q beat, the FY13 EPS estimate was raised to $1.70 from $1.60. The FY14 EPS estimate has been reduced trivially to $1.95 from $2.00, leaving the price target of $19 unchanged (almost 20% upside).

Aircastle Limited (NYSE:AYR) is expected to expand its earnings. The company also has opportunities for value-creating capital deployment. Despite a favorable company and industry outlook, shares have suffered on a relative basis. An upside to the stock price is expected as the relative valuation gaps close. Also, the company’s dividend of 4.24% is under-appreciated.

The second in line was AerCap Holdings N.V. (NYSE:AER) that reported the earnings on May 7.The company reported 1Q earnings of $0.60 per share, topping the estimate of $0.47. The beat was a result of better than expected sales revenue combined with lower than anticipated costs.

Management sounded more optimistic and bullish than the previous quarter. However, the 2013 guidance remained unchanged (which was earlier considered to be conservative when it was first provided last quarter).