Aircraft values are starting to firm up as the industry looks beyond the downturn to better times ahead
Few are as sensitive to the peaks and troughs of the air transport business cycle than those leasing and financing aircraft. So, the optimism now spreading from the leasing sector could indeed be an early pointer to better news ahead. Aircraft values appear steady and demand is trickling back. Some lessors go so far as to suggest that this year could even see a return to the former times when carriers would actually compete with each other for an aircraft lease.
An upturn was not before time. Values, even for the most modern airliners, plummeted in the wake of 11 September 2001 and have stayed down. DVB, a German bank specialising in transport, estimates that the world fleet shed 18.8% of its value during 2002. Last year the decline averaged a more modest 8.2% across all types, although that is still nearly double the 4.6% that would be considered the "normal" annual decline for an ageing fleet.
A similar pattern shows through in the Airline Business Top 40 Leasing Survey, compiled by the Airclaims consultancy. Having plummeted by over 17%after the 11 September attacks, the average value of aircraft in the survey have stayed more or less level, edging down less than 2% this time.
Within the average, some types have clearly fared worse than others. Discontinued aircraft have led the plunge. Over the past three years DVB estimates that the Boeing 737-300 lost around 58% of its value and the Boeing MD-82 shed even more at 65%. Other types with dwindling order books have suffered too, with the Airbus A300-600R, Boeing 747-400, 757-200 and 767-300 all halving in value since the start of 2001. "Apart from the temporary aircraft surplus, the drop in used equipment prices may have been caused by increased scepticism about new aircraft prices," says DVB.
The well-publicised easyJet order for 120 Airbus A319s, with an option for 120 more, has been a talking point among appraisers in 2003. The carrier started to place many of these aircraft with lessors on a leaseback arrangement in 2003.
Appraisers caution that rumours over the generous discounts won by easyJet could harm future values. Doug Kelly, vice-president for asset valuation at AVITAS, estimates that the airline achieved a discount of around 40% off the going rate of $36 million per aircraft. "The likes of ILFC and GECAS, which are also strategic customers for Airbus, are going to want the same," he warns. "They will remind Airbus that they were launch customers for the A330, A340 and A380."
Production issues
Airbus has also cut back less hard on narrowbody production rates than Boeing. Airbus delivered 233 A320 family aircraft last year, only 24 below the peak rate that it hit in 2001 (see table over page). By contrast, output of the next generation Boeing 737 came in at 172 last year, down from nearly 300 at the peak.
"In a few years time, we may well see more A320-family types available because of this. As a result, the values may be softer than for 737NG aircraft," says Colin Sach of aircraft financial arrangers Sach & Co. However, Airbus dismisses such concerns, arguing that it is just a matter of timing.
Phil Seymour, managing director at aviation consulting group IBA, agrees that there will be little to choose between the two types in the longer term. However, he warns that the tendency for the large low-cost orders to include very tailored specifications poses a potential worry when it comes to remarketing aircraft. For instance, he notes that the fact that the easyJet A319s will have the front galley area taken out to add extra seats will add significant costs should a leasing company later try to place these aircraft with mainline carriers.
Kelly at AVITAS sees parallels with the situation at SAS Scandinavian Airlines a few years ago when it placed its 767s on the market configured for 180 seats rather than the usual 240-280.
However, Singapore Aircraft Leasing Enterprise (SALE) points out that around half of narrowbody sales over the last year two years have been to low-cost players. So their layout is, argues the lessor, fast becoming one of the standard specifications for short-haul aircraft. SALE, which has struck a number of deals with low-cost carriers, argues that it may be the charter layout, combining high density seating with premium galleys, that will prove to be most difficult to remarket.
Narrowbody
The A320-types appear to have suffered a little more than the 737NGs in terms of value. For example, DVB suggests that the core A320-200 has lost 30% of its value over this period compared with 25% for the 737-700. However, most concede that this is as much to do with bad luck than any fundamental imbalance in the market. Most of the major airline failures of late, including Aero Lloyd, Ansett Canada 3000, Sabena and Swissair, as well as the bankruptcies at Air Canada, United Airlines and US Airways, all centred on A320 operators.
Simon Finn, head of valuations at appraiser IBA, says that those exposed to the displaced A320s have not always been quick off the mark in remarketing the aircraft and despite signs of demand from other airlines many remain unplaced. "This overhang does little for values of the A320 in the present weakened state of the market," he says. "Problems in obtaining manufacturer approval for changes to the aircraft before they are acceptable to prospective new operators have only served to exacerbate the situation."
Over 100 A320 family aircraft were available for sale or lease during 2003, according to data from Airfax, a market monitoring service. But by year-end the number stood at only 44. Without the airline failures, it is possible that the excess would have been fully absorbed.
The 737NG has not had an entirely smooth ride either. Finn says that owners of 737NGs have been forced to work hard to prevent an excess developing. "They have continued to place aircraft with low-grade credits on short-term lease and lease rates have remained low as a result," he says. Nevertheless, there are signs that this is beginning to change as the lack of visible excess creates an environment where lease rentals look set to improve. Kelly notes that while 737NG values have already stabilised, the same is starting to be seen in the A320 family.
Figures from Airfax show that over half of the 737 CFM-powered classics that were parked since 2001 have been reabsorbed, often by low-cost start-ups. The future of ageing classics, powered by Pratt &Whitney JT8Ds, is far less healthy, with appraisers expecting the majority of these never to return from the desert. More may join them as operators upgrade to newer 737s.
While the success of the low-cost sector has been a massive fillip for the 737 and A320, there is some unease within the industry about the heavy concentration of new orders for these types with only a handful of operators. Kelly notes that the MD-80 has suffered due to its 40% concentration in the fleets of Delta and American Airlines
Marginal aircraft
Both the MD-80 and MD-90 are suffering, mainly due to their marginal Chapter 3 noise standard compliance. The former MD-95, now known as the Boeing 717, is also hurting, with just eight orders in 2003 and a backlog of 36. This model, along with the A318 and 737-600, is struggling against the Embraer 170/190. The Brazilian manufacturer has a backlog of 245 aircraft.
In the medium-range sector, there have been two key developments towards the end of 2003. First, Boeing announced it was ceasing production of the 757, an aircraft that was rapidly falling out of favour. Some of the big majors in the USA, such as Continental, Delta and Northwest Airlines, still have sizeable fleets of these aircraft, but the type is losing ground in Europe due to changes in the charter holiday sector, once a mainstay of the 757.
Increasingly, leisure carriers favour the 737/A320 as they look to add frequency to counter the low-cost threat. Thomas Cook Airlines is in the process of selling its fleet of a dozen P&W-powered 757-200s, while others, such as MyTravel, have made it clear they will focus on the 737/A320.
Finn at IBA says that some of the Rolls-Royce-powered 757s may find a niche in the cargo sector, where DHL is already a major operator, but that the P&W-powered models will struggle to find new homes. "There are 757s today in the sub-$10 million category - sometimes as little as $7-8 million - that just a few years ago were valued at around $14 million," says Finn.
7E7 impact
In the medium widebody market, Boeing's decision to go ahead with the 7E7 could have wider implications. DVB believes that the 7E7 could "significantly impact residual value expectation for the current generation of jetliners in this sector". Boeing is pitching the 7E7 as a replacement for the 767, A300/A310 and the 757 in some markets. DVB has been researching new finance packages that would take into account the financial, economic and risk implications of this new-technology aircraft.
In the meantime, Kelly at AVITAS says that with a 767-300ER available for as little as $200,000 a month, operators are being attracted by the good value on offer. He adds that the A330-200, which offers better performance and capacity than the 767-300ER, is also available at attractive monthly rates, possibly below $400,000. Jeffrey Knittel, president of lessor CIT Aerospace, says that some customers are favouring 767 or A330s over larger widebodies due to their ability to support thinner, long-haul routes.
Kelly warns, however, that P&W-powered 767s and, for that matter, 747-400s are becoming harder to place as customers prefer the GE-engined models, for which they are prepared to pay a 10-20% premium. Airbus A300/A310s, meanwhile, are now pretty much confined to the freighter conversion market, with appraisers estimating price tags below $10 million.
In the long-range sector, appraisers are looking favourably on the extended-range versions of the 777, the -200ER and -300ER, although their success may be at the expense of the standard -200 and -300 models. "Customers are looking for the extended range and flexibility," says Finn. Kelly adds that the 777-200ER is the "favourite widebody" at AVITAS and that although still in its early days, the 777-300ER is likely to prove just as popular.
Kelly notes that Airbus has struggled to repeat its short-haul success in the long-haul sector. He adds that although the A340-600 has slowly been gathering pace since its launch in July 2002, he would like to see the customer list rise above 20 - it presently stands at six.
As the 777-300ER and A340-600 start to find favour, they are likely to put further pressure on the 747-400, which also faces the prospect of the A380 coming on stream in the not-too-distant future. Finn points out that airlines may have paid up to $120 million for their 747-400s but have since seen the value drop to around $60 million for a typical aircraft. Most owners, he argues, are therefore likely to lease the aircraft out for the time being as they wait for the gap to narrow between the fair market value and that still on their books. Kelly notes that one deal last year struck by Dubai Air Wings for executive use saw a 1998-vintage 747-400 go for $55 million
One of the big questions hanging over the industry is how many of the 2,500 aircraft that were parked during the downturn will come back. DVB estimates that there were over 2,200 commercial aircraft still idle towards the end of 2003, representing over 12% of the world fleet. In August 2001, just before crisis struck, the figure was 1,239 or 7.6% of the total fleet.
DVB estimates that the current total includes around 1,600 Chapter 2-era aircraft that will be not be coming back to Western fleets. These include 737-100/200s, 727s and McDonnell Douglas DC-8s and DC-9s.
This leaves 380 "previous generation" aircraft including 757s, 737 classics, A310s and Fokker 100s that meet Western regulatory standards, but which DVB considers "speculative aircraft" as regards financing terms. Some may be suitable for cargo conversion. Around 220 current generation aircraft, including 737NGs, A320s, 747-400s and A330s/A340s are in storage. "These aircraft have been parked mainly as a result of airline bankruptcies or as airlines deemed them to be temporarily surplus to their capacity needs," DVB says. It includes the Boeing MD-11 in this group for its "excellent" freighter potential.
Permanent retirement
Of the current total, DVB estimates that around 600-800 will return to service eventually, leaving about 1,500 aircraft for permanent retirement. Adam Pilarski, senior vice-president at AVITAS, says that, whereas in previous downturns there has been a tendency for aircraft that everybody thought were gone for good to miraculously reappear, it is likely to be different this time. He notes that new entrants such as JetBlue want modern, new aircraft. "It's a new paradigm in that sense," he says.
Another difference, he adds, is that there is not a huge number of desperate sellers. "There are a lot of people bottom fishing but there is not much to catch," he says. Even at the height of the downturn, with carriers tending to head towards Chapter 11 court protection rather than the full bankruptcy proceedings of Chapter 7, the amount of distressed selling was limited, and with values perhaps having gone past the bottom of the cycle, the day when two airlines chase one aircraft and values head upwards may not be far away.
Report by colin baker in london
Source: Airline Business
