Economic conditions remain uneven as AI reshapes investment opportunities

Economic conditions remain uneven

Economic conditions remain ‘mixed’. Overall consumer sentiment is low. More affluent consumers continue to benefit from rising stock markets, robust home prices as well as interest income. Less affluent consumers are under pressure from higher living costs including fuel prices, as well as less Government fiscal support. Wealth distribution is highly unequal (Figure 1).

We continue to see this divide reflected in company performance. We have actively positioned the portfolio to limit exposure to businesses exposed to less affluent consumers.

Inflation remains above central bank targets in many regions, in part due to the Middle East conflict. This limits the scope for interest rate cuts despite uneven economic growth. Globally, interest rates have been drifting upwards. In response to inflation concerns, the Reserve Bank of Australia has increased interest rates three times (by 25 basis points each time) during 2026, placing additional pressure on consumers with floating rate mortgages.

We have recently returned from the U.S. during which we met with management of more than 50 companies across diverse industries. Outside areas benefiting from artificial intelligence capital expenditure (which is booming), business conditions in many segments of the economy are challenging.

Current investment environment – Artificial Intelligence (AI) is creating opportunities and distortions

We are increasingly positive about AI. The capabilities of AI models and rate of improvement continue to exceed our expectations. Capital expenditure on compute to deliver these capabilities also continues to exceed our expectations. We have investments in Nvidia and Taiwan Semiconductor Manufacturing Company (TSMC) which are AI capex beneficiaries. However, investor enthusiasm and momentum trading are stretching the valuation of some AI capex centric companies.

Many high-quality, resilient businesses outside the AI ecosystem are now trading at attractive valuations. Current examples held in the L1 Capital International Fund include:
• AerCap – the world’s leading aircraft leasing company (detailed below)
• CRH – one of the largest building materials companies in the world operating predominantly in North America, as well as Europe and Australia
• Danaher – a leading provider of equipment and services to the Biotechnology, Life Sciences and Diagnostics industries with around 80% of revenue generated from recurring sources such as consumables
• Intercontinental Exchange – operates leading regulated derivatives exchanges, the New York Stock Exchange, provides proprietary fixed income pricing and other data services, and owns a comprehensive U.S. mortgage technology platform
• Mastercard and Visa – ubiquitous global payments companies

AerCap – Investment Overview

Every time you catch a flight, you probably don’t spend a huge amount of time thinking about whether the plane you are sitting in was bought or leased by the airline. Yet this is an important decision for the airline management team. Aircraft leasing is a well-established, but highly specialised niche of the secured asset lending industry, but there are limited ways to invest through stock markets.

AerCap is the world’s leading aircraft leasing company. It benefits from a global shortage of aircraft and engines, highly shareholder aligned management, strong financial performance and an attractive valuation, yet continues to fly below the radar of most investors.

Role of aircraft lessors

More than half the world’s commercial aircraft are leased rather than owned, reflecting the structural advantages aircraft lessors provide to airlines:

• Stronger financial position and lower cost of capital than most airlines
• Able to optimise the use of aircraft over their entire 25-to-30-year economic life
• Able to purchase larger volumes of aircraft from Airbus and Boeing and secure volume discounts.

Aircraft and aircraft engines remain in short supply

During the Covid pandemic the airline industry effectively shut down and airlines went to ground, literally. Orders for aircraft were restructured, Airbus and Boeing reduced production, and many experienced employees left the industry. Air travel has recovered strongly since the pandemic. However, Airbus and Boeing have struggled to increase production, while engine supply issues have further reduced operational aircraft availability. As a result, lease rates and asset values have increased.

Highly aligned management, focused on shareholder value

CEO Aengus Kelly has a personal investment in AerCap approaching $1 billion (including restricted stock), creating exceptionally strong alignment with shareholders. He leads a highly experienced management team which has proven visionary in capital allocation. In 2021, despite the uncertainties caused by Covid, AerCap acquired GE’s aircraft leasing business (GECAS) for around $30 billion. These aircraft were acquired at a discount to market value which has subsequently recovered strongly to the benefit of AerCap shareholders.

However, when we invest, it is not just about growth. Kelly and team have demonstrated the oldest adage in investing, ‘Buy low, Sell high’. Over the 5 years since acquiring GECAS, management has progressively sold aircraft at a significant premium to book value, reducing the size of the fleet.

Attractive valuation

Despite reducing fleet size, AerCap’s earnings per share have increased through disciplined capital allocation. Management has used buybacks to reduce shares outstanding and, more importantly, bought them back below our assessment of fair value.

We estimate AerCap is currently trading on around 8x price earnings ratio and under 1.2x understated tangible book value.