Exciting Growth Stock Flying Under the Radar

The quote below explains better than I ever could why FTAI Aviation is such an exciting investment.

It isn’t every day that a new business model promises to change the century-old commercial-aviation industry. FTAI Aviation might be doing so at just the right time.

The stock of this jet-engine leasing and repair company is up more than 800pc over the past five years, and the sky does seem to be the limit. During the same period, the U.S. Global Jets ETF, which includes carriers, manufacturers, travel agencies and airports, is down about 40pc.

In the depths of the pandemic, it looked as if there were more planes and engines around than carriers would ever know what to do with. The opposite has turned out to be true: Fliers came back in force, while supply-chain shortages and Boeing’s quality-control snafus slowed production of new models.

To boot, the two big manufacturers of engines for state-of-the-art narrow-body planes, RTX-owned Pratt & Whitney and CFM — a joint venture between GE Aerospace and Safran — have reported durability issues. Pratt’s have led to hundreds of Airbus A320neo jets being grounded. This has pushed up demand for old aircraft and engines, shrinking the pool of available spare parts and further lengthening repair-shop visits. Low-cost carriers, including Spirit Airlines and Wizz Air, have been particularly affected.

The industry’s economic incentives are now in question, because manufacturers sell turbofans at a loss and make the real money through maintenance, repairs and overhauls, or MRO, performed either in-house or through partners. Usually, they lock in revenue for years through maintenance agreements with airlines. Once engines get too old to be within the scope of such programs, their manufacturers still benefit by selling replacement parts for them, which tend to become more expensive over time.

“Everyone conspires against the airlines and wants them to spend more money,” said FTAI Chief Executive Joe Adams. “We are trying to change the industry’s behavior.”

Three years ago, FTAI started vertically integrating its leasing business with maintenance and repair capabilities. FTAI still sells and leases to airlines, but these days a lot of its business involves taking in battered engines, swapping them for shipshape units and letting customers go on their merry way. It then fixes the engines, leveraging the use of parts that are second hand or built by companies other than the original manufacturer, and the process starts again.

Its new “aerospace products” division has expanded to make up 43pc of the company’s earnings before interest, tax, depreciation and amortization — which has grown threefold during this period. On top of its two existing MRO plants, FTAI recently announced the purchase of Lockheed Martin’s 526,000-square-foot repair facility in Quebec.

Whereas other MRO operations don’t have the mandate or the capital to build a portfolio of engines in need of overhaul, FTAI’s roots as an investment firm frame them as highly fungible and durable assets. The company was founded in 2013 under the umbrella of Fortress Investment Group, the alternative-asset giant co-created by Wes Edens that was acquired by Japan’s SoftBank in 2017. After Fortress changed hands to Abu Dhabi’s state-owned investment company Mubadala last May, however, FTAI severed all remaining management ties with its former parent company.

Unlike a traditional repair shop, it doesn’t have an incentive to find as many issues to fix as possible. Indeed, FTAI has set up an online site where the three modules or individual pieces of the CFM56 — the most-used turbofan in the world, powering older generations of the A320 and the Boeing 737 — can be bought separately. An entire engine no longer needs to be sent to the shop whenever the module with the shortest life cycle needs maintenance.

The New York-based company recently expanded into other legacy engines that are now in high demand, namely International Aero Engines’ V2500. Eventually, it plans to move into newer models too.

For investors, the main risk is that FTAI’s big altitude gain could already be behind it, particularly if the industry’s supply problems start easing: Its enterprise value is currently 16.4 times prospective Ebitda, compared with less than 10 a year ago.

But Airbus’s recent downgrade of delivery targets underscores that the timeline for normalization is likely to keep being pushed back. Crucially, FTAI’s proposition is game-changing regardless, and has huge scope to reduce costs further as it gains economies of scale. It estimates that its costs for repairing a CFM56 engine will eventually be 50pc lower than what other MRO shops charge.

There is a great stock with “AI” in its name, and it has nothing to do with ChatGPT.

Dow Jones Newswires, 22 August 2024

What the modules look like.

Attractions of the Outsourcing Business Model

Back in the day, a UK-quoted company called Capita provided services to the public sector. It took over services peripheral to what the bureaucracy was doing. It did them more cheaply often by laying off employees, something the politicians were reluctant to be seen doing.

It grew fast because the public sector transferred big slabs of business to Capita which did them more efficiently and profitably. The shares were fabulous performers until they weren’t. The shares rose 100-fold in the late 1990s but have collapsed since 2016.

This mode of business is called outsourcing where companies and organisations outsource non-core activities to outsourcing specialists in the the private sector.

I see echoes of this in what FTAI is doing, for example, the group’s recent purchase of Lockheed Martin’s repair facility in Quebec. Even before this purchase, the Products division was growing gangbusters.

Aerospace Products had yet another excellent quarter with $91.2m of EBITDA at an overall EBITDA margin of 37pc. We’re seeing tremendous growth in the aerospace products business in general and feel good about raising our estimates for 2024 EBITDA in Aerospace Products from our prior estimate of $250m, up to $325m to $350m. We also are experiencing expansion in Aerospace Products margins as demand for refurbished modules and engines remains very high, while increasing efficiencies at our two CFM56 maintenance facilities in Montreal and Miami is controlling or, in some cases, lowering our costs.

Overall, looking ahead, we now expect annual aviation EBITDA for 2024 to be between $825m to $850m, not counting corporate and other versus our original estimate of $675m to $725m. And finally, about two years ago, we first outlined our corporate financial goal of generating in 2026, $1bn of EBITDA, comprised of $500m from Leasing and $500m from Aerospace Products. So now that we’re halfway through this time period and ahead of plan, we’re resetting the target. Our new goal is $1.25bn of EBITDA in 2026 comprised of $550m of Leasing EBITDA and $700m of Aerospace Products EBITDA.

Joe Adams, FTAI Aviation, Q2 2024, 23 July 2024

Nowhere Near the End of Our List of Opportunities

The company said this in relation to the Lockheed deal.

I think that we’ve indicated we expect about $30m of savings per annum once we close initially on just the CFM56 overhaul operations, so that should add 3 percentage points to 4 percentage points to the margins just from that closing. Then, I think the efficiency, we haven’t really baked that in yet, but we did see quite an improvement when we took control of the Miami facility. We’ve seen a pretty significant increase in throughput per person. So we expect a similar trend in that facility, although, we don’t yet have our hands on it. So it’s something we think we’ll be able to accomplish and we don’t see any reason why not because we’ve done it before.

And then lastly, incremental to that is the piece part repair business, which we’ve talked about for quite some time, and there’s a lot of capability in the Lockheed Martin facility that was not fully developed. So we are going to accelerate the development of the piece part business, we do more repairs for our own engines, repairs for third-parties and then, we’ll develop new repairs. We expect to generate an incremental $10m to $15m of EBITDA from that, but not starting until 2025 and then growing from there. we’ll update you on that. But we see this — every time we look at the engine and we look at something new, we find millions of dollars lying on the floor.

There’s so many opportunities that we can pursue that are big dollars. So we’re very optimistic that we’re going to — we’ll keep going. This is continuous improvement as we’ve said over the last five, six years. And we’re nowhere near the end of our list of opportunities.

Joe Adams, FTAI Aviation, Q2 2024, 23 July 2024

I was also impressed with the following exchange between CEO, Joe Adams, and an analyst.

So the typical industry turn time what we’re seeing is anything from 120 days to 180 days. Our turn time on modules is about 30 to 60 days to do module — to actually build a module, right? And then to actually execute that module depends on the module is anywhere from 5 to 25 days. So from a customer’s perspective, they’re doing the module swap in 5 to 25 days versus 120 to 180 days. And again, we’re seeing industry turn times that are long and getting longer. And I think we’re in a much better position predominantly for four reasons, right?

Number one is we have capacity up in Montreal and in Miami. So we have the capacity and the workforce. Number two is we have access to use service material via our AAR [airport arrival rate?] program. Number three is what Joe mentioned is we have access to repairs at Lockheed, where we can repair parts. And number four, we have the flexibility since it’s our fleet of mixing, matching modules as well as planning. So as we see turn times go down industry wide, I think it is accelerating more and more demand for modules because one of the key attributes of modules is a faster product than a traditional MRO.

Joshua Sullivan

Got it. And then just as a follow-up on the piece part repair business expansion. Is that an organic effort or do you see opportunities to bolt-on inorganically at Montreal?

Joseph Adams

Both. I think that our base case is organic, but we have a lot of conversations that we’ve been engaging with different parties in that business for the last two years looking at different alternatives. And there might be some combination of the two, which is organic plus working with another player in the industry. So we are always open-minded and flexible and over whatever the math and the operations would support, we’ll take a look at it. There’s not enough capacity in the piece part repair business globally.

And we realized that last year, I think we spent $50m on — with third parties where we’re a big buyer of care services and no one had ever called on us and marketed as a product to us. It’s amazing. It’s — the industry is — it’s all order takers. So there’s a lot of things that we think we can do to grow and increase that business that are – we’re just at the very, very beginning of that.

Joe Adams, FTAI Aviation, Q2 2024, 23 July 2024

I found a bit more on the Lockheed deal and how FTAI operates.

FTAI Aviation has announced its agreement to acquire Lockheed Martin Commercial Engine Solutions (LMCES) from Lockheed Martin Canada for $170m. This transaction is pending customary regulatory approvals and is expected to be finalised in the latter half of 2024.

LMCES operates a 526,000 ft² aircraft engine maintenance and repair facility in Montréal, Quebec, with extensive capabilities in engine and piece-part repairs for CFM56 engines. FTAI, as LMCES’s largest customer, partnered with LMCES in 2020 to establish The Module Factory™ at this site to distribute CFM56 modules globally. The facility can handle up to 900 CFM56 modules annually and features three on-site test cells.

This acquisition will significantly strengthen FTAI’s maintenance, repair and exchange (MRE) business, creating permanent engine and module manufacturing capabilities in Canada. FTAI aims to expand its module customer base, which currently includes over 50 airlines and lessors worldwide. Moreover, FTAI plans to establish a centre of excellence in Montréal for piece-part repairs, serving both its own operations, including the used serviceable material business and third-party clients.

“Acquiring Lockheed Martin Commercial Engine Solutions represents a significant milestone for FTAI as we expand our MRE offerings,” stated Joe Adams, CEO of FTAI. “We know the facility well and greatly value the team’s technical expertise and commitment to quality. We are excited to grow the shop’s piece-part repair capabilities and continue delivering modules and engines to the aftermarket from a world-class facility in Montréal.”

FTAI focuses on the ownership and maintenance of commercial jet engines, primarily specialising in CFM56 and V2500 engines. FTAI’s unique portfolio of products, which includes The Module Factory and a joint venture for manufacturing engine PMA [engine parts manufacturer approval], offers cost savings and flexibility to its airline, lessor, and maintenance, repair, and operations customers. Additionally, FTAI owns and leases jet aircraft, often facilitating engine acquisitions at favourable prices. FTAI invests in aviation assets and aerospace products that provide strong and stable cash flows with potential for earnings growth and asset appreciation.

AviTrader, 4 June 2024

Joe Adams summed up FTAI’s business model as follows.

When we talk about our business model we are in the engine maintenance business. Most lessors are in the maintenance avoidance business, and they force it on to the airline, and we’re the opposite. So we want to do the maintenance, and we want the airlines to get out of the maintenance business because we’re better at it. So we’re providing an outsourced opportunity for airlines to not have to manage shop visits, which for the most part, most airlines are not particularly good at.

Joe Adams, FTAI Aviation, Q2 2024, 23 July 2024

Demand took off when people began flying again after lockdowns ended and has remained strong ever since. A big question is when things will return back to normal with supply and demand for engine maintenance services in balance. This is what Joe Adams said in response to a question.

So we’ve always thought to run our business assuming normalisation. This is just an unexpected gift that we got. So we think we have a great business even in an environment where everything is smooth and running and functionally well. Having said that, the — it is difficult to project, but I also would point out that it’s not going to be a cliff.

You’re not going to wake up in 2027 and all of a sudden, everything is good. So it will be a gradual return to normalisation over some extended period of time because as you see, fixing supply chains, hiring people back is a very lengthy process, and it only takes one part of that supply chain to negatively affect the entire supply chain.

So I think it will be probably what everybody — generally, the extremes are not right. It’s somewhere in the middle. Somebody says 2030, something said 2026, it’s probably in the middle, but it’s — it’s a gradual return to normal, not all of a sudden a bright line event.

Joe Adams, FTAI Aviation, Q2 2024, 23 July 2024

The company also believes it has a huge opportunity.

We indicated that we have now 50 customers in our module factory. And if you think back in 2022, when we rolled out our maths for getting to $1bn, we were forecasting $500m by 2026. So we’re now at 50pc in 2024. So things are moving quickly. And part of what happens in a crisis is when people need something, then they’re more receptive to changing their business model.

And so we see that the current environment is accelerating people’s transitioning to outsourcing maintenance, engine maintenance, which is what we’re offering the customer. Those 50 represent what we would say, 300 total potential. So maybe we’re 1/6 of the operator base, and we’re not getting — with a couple of exceptions, we’re not getting 100pc of people’s business yet.

But we’re aspiring to because we don’t see any reason why we shouldn’t once people realize they save money, they save time and they eliminate negative surprises. It’s like how hard — what else do you need to tell you. So I think it’s still growing. It’s a huge market. The total universe, if you think about 3,000 shop visits a year and you can argue whether it’s 4,000 or 2,500 or something, but roughly 3,000, that’s 9,000 modules moving through a maintenance facility somewhere in the world per year. And we’re talking about doing 400, 500, it’s still less than 10pc.

It’s half of 10pc. So we’re not anywhere near where we think the penetration could get to. And we have our own maintenance capacity, we can do 300 shop visits in Montreal a year, which is 900 modules. And 150 in Miami, which is 450 modules. So we have 1,350 module rebuild capacity that we own now. So if you think about 400, 500 is what we’re shooting for that’s 5pc market penetration, we can handle 15pc today based on what we own and we’re in a pretty good position to keep growing that. We haven’t had anybody that use the product that didn’t want to do it again.

So that, to me, is one of the main litmus (ph) test is that people like it and they have a good experience, and that’s what we’re trying to foster so the word-of-mouth spreads, people put testimonials up in their Instagram accounts and they talk about how great this is we have photos of people and maintenance facilities, like I say, I just did an LPT swap in two weeks, and that engine would have been in the shop for 6 months if I hadn’t done that. So those are the kind of things where the viral marketing that we’re using to accelerate even more. So I might have missed — there are a lot of elements to your question, but I don’t know if I got all of them, but…

Joe Adams, FTAI Aviation, Q2 2024, 23 July 2024

Below is what Lufthansa Teknik said when I looked up LPT.

For starters, the goal of Mobile Engine Services is to optimise flight cycles and the engine’s utilisation. Low-pressure compressors (LPC), high-pressure turbines (HPT) and low-pressure turbines (LPT) have different limits on the life-limited parts. Our approach is that when only an LPC or only an LPT has to be overhauled and the core is still good, we isolate the part and service only that, which maximize the life of the part and saves cash. We do that work at Mobile Engine Services shops in Tulsa (Oklahoma), Montreal, Frankfurt and Shenzen, China. We basically swap the module, which saves the engine having to be sent to Hamburg for an overhaul.

If operators have a spare module, such as an LPT–which larger airlines usually have–we would initially swap the modules and then overhaul the module that we took off. Then we just perform an on-wing test: there is no legal requirement to do it in the test cell. If the operator doesn’t have a spare module, we remove the module and overhaul it. However, Mobile Engine Service is more than just swapping modules: Lufthansa Technik also performs complex workscopes such as HPT blade replacement, VSV bushing replacement, high-pressure compressor top case repairs, and many more to avoid having to send the engine for a major overhaul. 

What are the cost savings from this approach?

You can easily save millions of dollars from not having to transport the whole engine, and if you only overhaul the LPT, for instance, and you’re not looking at the rest of engine, you can save a few more million because you don’t repair what you don’t see.

Ziegler Aerospace

Strategy – Buy FTAI Shares

There are many quotes and much to read but this is a new company for me and my subscribers. I had never heard of it three days ago and I think it is exciting.

If you look at the chart there is both a ‘rubbish theory of value’ and a ‘something new’ going on. The rubbish theory of value bit is the share price collapse in 2020 when lockdown hammered demand for aircraft engine maintenance and parts. The ‘something new’ is the outsourcing and modular approach to aircraft engine maintenance which is faster and cheaper.

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FTAI Aviation Inc. FTAI (22 August 2024)