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Monday, December 2, 2013 - 10:00

Get Income and 30% Upside From This International High-Yielder

Monday, December 2, 2013 - 10:00am

One of my favorite scenes from the classic movie "Wall Street" is the boardroom scene when Bud Fox realizes that Gordon Gekko is going to dismantle Blue Star Airlines piece by piece. A portly, bespectacled investment banker glibly says: "No sweat. We sell the gates and pawn the planes off on the Mexicans. Do we have a deal or what?"

Sure, there are more action-packed parts of the flick. But to me, that particular scene helps explain what investing is all about: buying an asset and watching as the value is realized or unlocked.

I've found a stock that fits that scenario that, coincidentally, is also in the airplane business: Fly Leasing (NYSE: FLY).

Based in Dublin, Fly Leasing is in the commercial aircraft leasing business. Airlines are increasingly turning to operating leases to supply their fleets. In fact, over one third of the world's airline fleet is leased.

Basically, the companies are renting the planes to avoid having a gigantic, swiftly depreciating asset sitting on its balance sheet. Firms like Fly assume the risk. Why? As that portly investment banker implied, you can always find someone who needs a plane.

Fly Leasing does business with 55 airlines in 32 different countries, with the majority in Europe, India, Asia and the South Pacific. The company has a well-diversified customer base: No lessee represents more than 8% of total revenues. Too much dependence on a couple of key, large customers can spell disaster for any business.

The equipment portfolio consists of 109 aircraft, mostly narrow-body planes such as the Boeing 737 and the Airbus A320. These are the most widely used jets by commercial carriers -- but what makes Fly Leasing successful is how it acquires those aircraft.

Most of the planes are purchased in the secondary market rather than from the manufacturer. Remember, the reason airlines are gravitating toward leasing is to avoid holding a swiftly depreciating asset. Naturally, Fly Leasing has the same challenge -- thus its purchases of used planes. This adds immediate value to the balance sheet (no instant depreciation) and maintains a higher margin on the lease income the company takes in. And the numbers are impressive.

Fly's recently reported third-quarter results showed net income for the quarter rose more than 130% from the same period last year, to $39.1 million. Diluted earnings per share (EPS) also nearly doubled to $1.20, from $0.63 cents a year ago. The company also announced a dividend increase. The quarterly dividend was raised almost 14%, to $0.25 a share, putting the annual yield at 6.4%, based on FLY's current price near $15.

Fly Leasing has also been doing an outstanding job of managing its balance sheet. In July, the company raised over $170 million in equity by issuing 13.1 million common shares in the form of American depositary shares (ADS) and has renegotiated a credit facility secured by seven aircraft. Prior to amending the loan, the balance stood at $209 million. Following a sale of one aircraft and some debt extinguishment, the new balance will shrink by nearly 40% to $127 million with an interest rate of just slightly above 3%.

Although the specter of higher interest rates haunts the business community, lenders are still eager to offer Fly attractive terms thanks to two key factors: Fly's high-quality, high-value collateral and the fact that the company is based in Ireland, one of the most business-friendly environments in the European Union.

However, one of the most compelling reasons to own shares of Fly Leasing is that the stock currently trades at a nearly 30% discount to its book value. That gives the stock room to move.

This year's EPS is projected to come in at $1.47, and EPS is projected to drop slightly to $1.38 next year. However, revenue is expected to increase from $370 million this year to $383 million for 2014. For 2015, EPS should hit $1.96 with revenues of $408 million annual revenue. That would translate into 21% annual earnings growth over the next two years. I'd gladly pay 70 cents on the dollar for that.

Risks to Consider: The greatest risk Fly Leasing faces is interest rate risk. Specialty finance companies rely on debt to finance their business, and rising rates can squeeze profitability quickly. Fly can play defense thanks to favorable terms locked in for the next few years and a portfolio of high-quality, tangible assets. The company is also involved in the airline sector, which historically is extremely sensitive to changing economic conditions.

Action to Take --> Based on the unique niche Fly occupies and its exposure to international air travel growth, FLY presents an excellent opportunity for investors seeking growth, income and international exposure. Shares trade at around $15 and yield around 5.7% (soon to increase to 6.5%). A 12-month price target of $20 combined with the dividend would provide a total return of nearly 36%.

P.S. The StreetAuthority research staff recently identified more of the market's most dominant companies in our latest report, "The Top 10 Stocks Of 2014." These 10 stocks have nearly tripled the market's return, delivering an average 129.5% gain over the past five years. To get more information -- including names and ticker symbols -- click here.

Adam Fischbaum does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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