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Goodbye Exelis. Hello Air Lease. Reshaping My Portfolio - Part 2

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February 24, 2013 – Comments (8) | RELATED TICKERS: XLS , AL

Last week I started a post on how I am transforming my personal, real-money investment portfolio by selling larger cap names that don't seem to have any catalysts that will cause them to rise in the near future and looking to add more smaller cap names.  Part one of the post (http://caps.fool.com/Blogs/reshaping-my-portfolio-two/799408) ended up being so long that I decided to break it up into two posts.  Here's part two.

The other larger cap name that I decided to sell is:

Exelis Inc. (NYSE:XLS)

This is the defense contractor that was spun-off of ITT when the company broke up into three parts, Xylem (XYL) the water-focused segment of the company, ITT (ITT) a smaller industrial conglomerate and Exelis (XLS).

For now I have decided to hold onto ITT and XLS.  I think that the future prospects for both look pretty good, though the growth that people were baking into XYL's price probably won't materialize, it's still a good business. So why not hang onto XLS?  After all, it's a spin-off (which tend to outperform over time), it's cheap and pays a solid 3.9% dividend?   Hmmmm, I had better be careful or I'm going to talk myself into buying XLS back :).  

To begin with, I think that XLS is cheap for a good reason...its sector faces tremendous headwinds.  Many will argue that this is already priced into the stock, but I'm just not so sure.  Our country is facing some serious budget issues.  Now I don't know whether this will happen or not and I generally don't like to make macro bets, but one can't bury their heads in the sand either.  Defense just seems like such a logical sector for cutbacks for a country that is looking to cut spending.

I like spin-offs in general, but I just think that there's better places for me to put my money right now in terms of smaller companies with larger potential gains and real potential catalysts in the near future.

How did my investment in XLS turn out, well not that great.  Since I went long the stock here in CAPS in November 2011, my position in XLS returned -0.71% versus a 22.10% gain in the S&P 500 for total underperformance of 22.81%.  The good news is that I didn't really lose money, which is very important.  to be honest with you, I was very excited about the whole ITT split-up when I first heard about it and subsequently invested in it, but they whole thing has been pretty much a dud.

So where did I put the money that I raised by selling Kraft and Exelis?  Well most of it went to cash that I'm looking to deploy in the near future.

A portion of it went into a new investment in a company called:

Air Lease (NYSE:AL):

Here's what I had to say about the company when I did a quick write-up on it on 2/11/13...

The type of special situation that I am going to use for this pick is called a jockey play. That means that you find an entrepreneur who has successfully started a business in the past and sold it for a large profit who is starting a new venture that you can get in on on the ground floor.

Air Lease is an airplane financing company that went public in April of last year at a higher price than it is trading at today. It was started by Steven Udvar-Hazy, who previously started a similar company called International Lease Finance and sold it to AIG.

I am personally somewhat familiar with the airplane leasing industry from my previous foray into International Lease Finance distressed bonds that I purchased during the credit crisis. I can tell you that massive recessions are not kind to airline leasing companies :). I was sweating my investment in the bonds at the time, but things eventually turned OK.

Flash-forward to today and Udvar-Hazy is attempting to recreate the magic with a new airplane leasing venture. The new company seems to have a decent tailwind so to speak in that the terrible airline industry is doing about as well as it is ever going to. Add to that the need for air carriers to purchase more efficient planes in today's relatively high cost fuel environment and there should be plenty of business for AL. 

In fact, Air Lease has significant orders on the books already for new planes over next three years. These orders alone should cause the company's earnings to rise from $1.20 in 2012 to $2 in 2013 and $3 in 2014. That's some pretty solid visibility into excellent earnings growth. At a multiple of only 15 times that 2014 earnings estimate, down from the 21 times that AL trades at today, the stock would be a double from its current level.

So what could go wrong? Well, the main thing would be another recession that would cause airlines to cancel these orders before they take delivery of the planes. If you're optimistic about the economy, as I am, then this shouldn't be an issue.

This isn't my typical value-type of stock pick, but a jockey play is a special situation that I will venture outside the value world for.

This idea comes courtesy of John Osterweis of Osterweis Capital via an interview that he recently did with the excellent publication Value Investing Insight.

Anyone who is interested in more information on Air Lease should check out Maxx Chatsko's aka TMFBlacknGold's interesting article on the company:

Is Boeing's Battery Good News for Air Lease?

http://www.fool.com/investing/general/2013/01/21/is-boeings-battery-good-news-for-air-lease.aspx

Now I know that I'm a value investor at heart, but my portfolio definitely has a place in it for a smaller position in a jockey play like this one that relies on growth to generate returns.  Steven Udvar-Hazy has proven in the past that he can generate outstanding returns for investors.  Furthermore, perhaps it's a function of the bull market that we've been in, but whatever the reason growth stocks have actually outperformed value stocks over the past five years.  So I'm not opposed to having a jockey, growth play in my stable of investments.

I am deploying another piece of my recently freed up cash into an experiment that I am working on, creating a basket of demutualized smaller banks, but that discussion is for another day.

Thanks for reading everyone.  Please share your comments if you have any thoughts about any of the companies that I've mentioned, both bullish and bearish.  I welcome all opinions.

Deej 

8 Comments – Post Your Own

#1) On February 25, 2013 at 9:32 AM, awallejr (81.59) wrote:

Well if you are interested in the air lease space you may want to take a look at AYR.  The best chance was during the great crash when you could have bought it for $2.5 but it is a tribute to management to having kept the company profitable all during that time.  The danger with these types of investments is the debt load.  But it does pay a respectable dividend.

You might want to wait until after AL's earnings release Feb 28.  AL's PE seems a little too high for me.

As for smaller bank plays I prefer BDCs more because I think Dodd-Frank will be more disruptive than people think.

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#2) On February 25, 2013 at 3:57 PM, TMFDeej (99.41) wrote:

Hey awallejr.  The best chance to buy everything was during the great crash ;).  AL is a tad on the expensive side, but that will look a lot better voer the next two years with the huge number of commitments that it already has from major airlines to lease from it.

No BDCs for me.  That's some scary stuff.  Did you read "Fooling Some of the People All The Time?"  I absolutely love the concept of BDCs, but there has been so many shenanigans in the sector.

Thought that you might find my latest pitch interesting: 

"PVR was absolutely hammered by after its recent earnings release, perhaps rightfully so its results were fairly weak.  Having said that, I don't think that the market fully appreciates the company's ongoing transition from heavy dependence on royalties from coal towards a more fee-dependent mid-stream pipeline and processing company.  As its coal business continues to wind down and its new mid-stream projects come on-line PVR will have much more steady cash flow.  That's not to say thatthe company will be completely insulated from weakness in the natural gas market, ultimately low gas prices put the brakes on drilling and impact PVR's volumes negatively.  It's still a whole heck of a lot better than coal and the company's stock price will likely reflect the change at some point in the future.

With a 10% distribution after its recent hike, it looks as though PVR will be able to cover for now.  However, if nat gas prices take a turn for the worse I wouldn't be surprised if the distribution needed to be cut.

I like companies with stories like PVR's change in business model.  Kudos to awallejr for initially bringing this one to my attention."

Deej

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#3) On February 25, 2013 at 4:36 PM, awallejr (81.59) wrote:

Regarding PVR I wanted to buy a couple hundred more shares today but when I entered the amount I put in 2200 and mindlessly hit enter.  My heart dropped when I realized the mistake but fortunately the stock was in rising mode and I sold out the 2000 extra at a .13 profit at least.

As for the article you mentioned, no I have not but was that about REITs or BDCs?  Personally I like BX, ARCC and PSEC.  I owned them since 2009 and have been happy with them ever since.

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#4) On February 25, 2013 at 5:34 PM, Mega (99.96) wrote:

No BDCs for me.  That's some scary stuff.  Did you read "Fooling Some of the People All The Time?" 

I read FSOTP and thought it was a great book.

In my opinion air leasing companies are not that different from BDCs. They are leveraged financing companies in a cyclical industry. Of course, their credit risk appears more favorable than BDCs, which allows them to use more leverage than BDCs are legally allowed to.

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#5) On February 25, 2013 at 8:04 PM, TMFDeej (99.41) wrote:

HA, I think that we've all made a trade like that before.  

Here's the link to David Einhorn's book about BDCs.  It's a great read: 

http://www.amazon.com/Fooling-People-Complete-Updated-Epilogue/dp/0470481544

Deej 

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#6) On February 25, 2013 at 9:21 PM, awallejr (81.59) wrote:

Oh that was pre-crash stuff.  You had overlevearge, sloppy due diligence and reckless lending.  The thing with Dodd-Frank is it now limits what many banks can do. I guarantee you GS is seething over that act.

BDCs are basically replacing them as the place to get corporate loans.  Since the crash many have delevered dramatically. Of the 3 I mentioned I suspect ARCC is the most conservative, PSEC more aggressive and pays monthly, and BX probably has the best capital gains potential.  They have a ton of cash and are buying low.

Mreits are more dangerous.  While Alex and I have had many an argument over them he is right to the extent that you really do need to monitor them closely.

I've followed many of your blogs Deej and your investment strategy seems similar to mine.  You like yield. You made some great picks in 2009 especially.   Keep accumulating that wealth it will help you tons when your kids become college bound ;)

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#7) On February 26, 2013 at 12:44 PM, Sturmudgeon (< 20) wrote:

TMFDeej:  I hope you are right about "the recovery", but you may wish to check out 'shadowstats.com', as the "real" stats are very much pointing to severe recession!

good luck!

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#8) On March 01, 2013 at 8:58 PM, awallejr (81.59) wrote:

Nice earnings report by AL.  I also like that they started a dividend even if only small.  But small can always grow big heheh.

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