Global airlines should consider themselves extremely lucky right now, as their feelings of general good health and optimism, do not span all industries, particularly those in the emerging markets.
Instead, the emerging markets are a tale of two cities at present.
On the one hand, embattled mining giant Glencore is on a selling spree to shore up cash to pay down some $50 billion in debt due to heightened worries over its exposure to a slowing Chinese economy and a sharp fall in commodity prices.
Meanwhile, China’s Bohai Leasing, which is also facing the similar concerns of a worsening Chinese outlook, and an emerging markets rout, is on a buying extravaganza with fresh talks under way to add yet another lessor to its enormous and growing aerospace platform.
So, how is this duality, in the same market, possible?
Glencore exists in the global real economy and has been adversely hit by the commodity downturn. Though it has been funded with cheap debt. This funding carries steep amortisation that will be a challenge to service in the face of plummeting commodity prices.
Bohai Leasing, however, operates predominately in the airline industry, which also is able to access cheap debt, but instead of facing a slump, is having a record year.
Sure, Brazilian airlines in particular are under pressure from a weak real, economic downturn in Brazil, and currency devaluations in most South American countries. Brazil’s economy is expected to contract this year and next with inflation estimates inching upwards in both periods.
However, the sector, as a whole, remains in good shape. Airline capacity, as measured by ASKs, increased by 5.9% in August, while the sector’s load factor climbed to 84.7% - a 17 percentage point increase over the industry’s performance a decade ago, according to IATA.
And, for the first time on record, IATA anticipates airline sector returns will cover the cost of capital this year.
Strong industry profits are often a good indicator of solid demand for future aircraft orders and this positive sentiment, no doubt, is helping to fuel Bohai’s expansion into the aircraft leasing sector.
The Chinese lessor, which is majority owned by HNA Group, is rumoured to be in talks to add Dublin-based AWAS to its aerospace stronghold.
Bohai recently disclosed its acquisition of Avolon, also Dublin-based, in a $7.6 billion deal. It appears likely that Avolon will be merged with its existing leasing entity, Hong Kong Aviation Capital.
These lessor purchases are also being fuelled by China’s devaluation of the yuan – a move that is pushing Chinese companies into US dollar cash streams.
The acquisition of Avolon and AWAS could enhance Bohai's influence in the global aviation industry, particularly with the manufacturers, as it would bring together airlines, leasing and ground handling within one group.
Such a mega lessor could alter the way the market buys aircraft. No doubt, it would benefit from attractive pricing from the OEMs, a saving that could likely be passed onto the lessees.
Are we seeing the first signs of a sort of low-cost lessor, brought about by access to cheap funds, scale and therefore enhanced bargaining power with the manufacturers? Is leasing aircraft about to get a lot cheaper for airlines?
AerCap and GECAS currently dominate aviation leasing, with committed balance sheets in excess of $45 billion each – but a large majority of delegates at the recent ISTAT Europe conference in Prague expected additional mega-lessors to emerge.
In a poll, 37% of voters predicted that the number of aviation leasing players of the size of AerCap and GECAS would increase to four by 2025, while a quarter envisage five or more. Only 15% believe the market will stay the same with two superpowers.
But while low interest rates and low fuel prices are helping to make airlines feel confident, now is not the time to lose perspective. This is a boom and bust industry, so airlines should brace for tough times, as their share of headaches will come about too.
One key difference, compared with Glencore, is that airlines and lessors can reduce capacity quickly if the operating environment starts to look more challenging.
The sector’s ability to manage excess capacity properly will determine its ability to raise capital efficiently during the next downturn.
Already there are some signs of concern in the widebody market, as more Boeing 777s and Airbus A330s are becoming available from the likes of Singapore Airlines, Emirates and Malaysian Airlines.
However, for now there is no reason to panic, the bullish forecast remains, and the flow of attractive capital looks set to continue for airlines and their lessors.
Source: Airline Business
