Aircraft markets were less volatile last year, but recovery in airliner values remains a distant prospect, especially with new jets now available at bargain prices
It may have come as small comfort to stressed fleet owners, but aircraft values appeared to stabilise last year after their dramatic tailspin at the end of 2001. The market it seemed had reached rock bottom. However, with new turbulence now spilling out of the Gulf, the airline financial community has again been left asking whether there may still be worse to come?
In the immediate aftermath of the 11 September 2001 terrorist attacks, aircraft appraisers rushed to mark down values by around 15-30%. Yet while some types, led by the out-of-production narrowbodies, have continued to shed value rapidly over the past year, the overall market began to stabilise in the first quarter of 2002.
"We are at the bottom now and things will bounce along there for a couple of years," believes Les Weal, chief analyst at the London-based Airclaims consultancy. He adds that after the initial collapse there has not been much by way of further "significant change" over the past year.
The question now is how long it will take before supply and demand swing back into balance, and that remains an unknown. Estimates have ranged from as soon as late 2004 through to 2006. With the uncertainty surrounding the fallout from the Middle East crisis, analysts are tending towards the more conservative end of the spectrum.
The failure of Ansett, Canada 3000, Sabena and Swissair clearly put pressure on values going into 2002, and still more aircraft have come back on to the market with the fleet cuts which have accompanied the descent of US Airways and United Airlines into Chapter 11. Given the flare-up in the Gulf, there are no guarantees that others will not join them there, warns credit analyst Philip Baggaley, who follows aircraft-backed debt at Standard & Poor's.
Further stress could yet force the bankrupt carriers to "shut down and dump further planes on the market", argues Baggaley, while others such as American Airlines also remain under severe pressure. American alone accounts for a fleet of over 860 aircraft with orders and options for over 460 more.
Idle fleet
Even without further bad news, looming in the background is a desert fleet of record levels. Airclaims reckons that going into the 2001 crisis there were 1,200 mainline and regional jets sitting idle, although not necessarily in storage. That has mushroomed to above 2,000, representing 12% of the active world fleet. Mainline aircraft make up 1,760 of those. Although around 200 aircraft were finally scrapped for good over the last year, the continuing stream of new units off the production line has helped maintain the level.
However, the headline figures exaggerate the numbers of active aircraft actually in storage, argues Michael Allen, chief operating officer at the BACK Aviation Services (see comparative table right). He points out that there are 150 mainline aircraft and another 50 regional jets, which, while technically idle, are only "temporarily inactive", usually sitting with lessors or financiers. The consultancy counts these as part of the active fleet unless they stay on the ground or are moved to a storage facility. The same is true of aircraft parked by operators for less than 90 days, which Allen says may be under-utilised but are still, in fact, active.
Most significantly, BACK has been more aggressive in retiring older aircraft, which takes a further 3-400 jets out of the equation. Rather than wait for them to leave the register, BACK takes a view on which airliners have reached the end of their economically useful life. "It's impossible to look at storage without looking at retirements," adds Allen.
BACK therefore calculates that the underlying number of mainline aircraft in storage and ready to return to the world fleet stands at under 1,200 with another 100 regional jets. Nevertheless, even on this basis, the stored fleet has still doubled over the past couple of years and there is no doubt that the headline Airclaims figure gives a good indication of the extent of under-utilisation.
Perhaps most telling is the fact that even some younger types are now candidates to be scrapped for parts. "In 2002 we saw the first 737-300 broken down and it was only 17 years old," says John Trevett, head of consultancy at the UK appraisers IBA, although he stresses that the norm would still be after a life of 25 years. Trevett adds that 737-200s and 727s are high on the list with many parked and little demand for parts.
Weal at Airclaims also notes that while "every aircraft is under pressure", the market has clearly softened less for current types than those now out of production (see values table). Many older types have clearly now had their day, particularly Chapter 2 and hushkitted equipment. Many have already been retired earlier then originally planned. Heading the list are narrowbodies such as the McDonnell Douglas DC-9, Boeing 737-200 and 727, as well as widebodies including the DC-10, 747 classic and older Airbus A300 and A310 models.
One of the hardest hit by the current cycle has been the ageing 747-400. Airclaims estimates that a typical 1999 model has shed around 40% of its value over the past couple of years. Appraisers believe that a new benchmark has been set by United's recent sale of seven 747-400s to Thai Airways for only $330 million. Weal says that Airclaims had previously priced the aircraft at the low end of the $60-70 million range but that the Thai deal came closer to $47-50 million.
There is clearly an oversupply of the 747 in the market, with many airlines choosing Boeing's own smaller and more modern 777s as an alternative. "This highlights why Boeing is pushing ahead quite quickly with the 747-400 freighter conversions," says Weal.
Values for the 757 and 767 have also fallen, tracking the financial difficulties of the US majors, which hold a high percentage of the world fleet. "The 767 has a product future as a military tanker rather than as a commercial aircraft. The 757 is also suffering with quite a small backlog," adds Trevett.
Old generations
Some of the most significant declines have centred on the previous generation of 737-3/400 classics and McDonnell Douglas MD-80 narrowbodies. The last units only rolled off the production lines in Seattle and Long Beach in early 2000, and the expectation had been that such types would remain in active service for years to come, moving to those carriers who were not yet in a position to afford the Airbus A320 or 737NG next generation families.
However, the cut-throat battle for new equipment sales has begun to bring new aircraft within the reach of carriers with less attractive credit ratings, such as many in Africa and Latin America, and also a booming low-cost sector.
"There is a whole generation of aircraft that is being skipped," says Bryson Monteleone, chief financial officer for US consultancy Morten Beyer and Agnew (MBA). "The 737-300/400s only stopped production four years ago. They do not have the range of the new generation but have the ability to act as good workhorses for any fleet and they are standing idle."
Allen at BACK takes the example of the MD-80, now being pushed out by the lure of cheap newer types. "Douglas built really great tubes and you can fly them for a really long time. Airplanes like that should have another 10 years or more left, but they could wind up getting into trouble,"he says.
Europe's Ryanair and easyJet have both taken advantage of "bargains" on new aircraft, with discounts rumoured to be around the 40% mark against the current list price. When Ryanair was looking to replace and expand its fleet of ageing 737-200s, Boeing's bid on new aircraft, fought fiercely with Airbus, beat second-hand offers for 737-300/400s. Ryanair has gone on to build up firm orders for 125 737-800s and 125 options.
At the end of last year easyJet also took the opportunity to acquire new aircraft, with an order for 120 firm and 120 options for the Airbus A319. They will replace the current 737-300 fleet and eventually the 737-700 too. As part of the deal, Airbus included assistance on the "reduced residual value risk" on the 10 owned 737-300s.
Airbus parent EADS stressed that it did not provide any financing support for the deal, but declines to give details of the grey area of lifetime residual value guarantees. However, easyJet makes clear that the deal was structured in order to guarantee that there would be no additional cost compared with the option of adding further 737-700s.
Boeing trimmed production over 2002, coming down from over 500 units to 370 excluding the 737BBJ business jet (see Market Analysis table page 48). At its height, including the McDonnell Douglas line, Boeing had peaked at close to 600 deliveries per year in 1999. Airbus has held its output relatively steady at the 300 mark, buoyed by its busy A320 family lines. If production stays at that level this year as planned, then Airbus output for the first time will run ahead of Boeing as it comes down to 280 or below. Annual output would then be pegged at below 600 mainline aircraft, compared with close to 900 at the peak of four years ago. However, with airline markets weak, some worry that this may still represent an oversupply.
"I would suggest we will continue to have a surplus of aircraft in 2003. In 2004 we will have oversupply in the market because manufacturer production hasn't been cut as much as we expected," says Philip Scruggs, vice-president marketing at International Lease Finance Corporation (ILFC).
A320 oversupply
Glenn Hickerson, advisory board chairman at GATX Air, also picks out the "oversupply" for the A320, where lease rates are already slipping. Output numbers for the Airbus flagship narrowbody were virtually unchanged last year and are slated to fall by less than 1.5 aircraft per month this year. "The A320 lease rate is half what it was 18 months ago," says Hickerson. Airbus responds that the output simply reflects a strong backlog. "Since 11 September we do not produce aircraft on a speculative basis," says vice- president finance Nigel Taylor.
However, values have been falling for the A320 family and 737NG, once seen as the darlings of the leasing and finance community due to steady demand from carriers. Airclaims data shows value falls in the range of 15-25% for the 737-800 and A320 depending on age.
Although owners have hesitated to make fire sales in the current market, some have already taken action to soften the impact of falling values on their balance sheets. Carriers and financiers alike have been taking provisions to reflect the lower book values of their fleets. JP Morgan airline analyst Chris Avery points out that the US majors have made pre-tax provisions and write downs of $5 billion over the past two years. He adds that lessors will be the ones to watch to see what they will do regarding the values of their portfolios.
Leased aircraft that were returned after the 2001 round of airline failures are now largely flying again, albeit at distressed lease rates. Kieran Corr, managing director at Irish lessor Pembroke Group, points out that 80% of grounded Sabena and Swissair aircraft are now back in service.
Now lessors are turning their attention to the potential fall-out from the US market. At year-end GE Capital Aviation Services (GECAS) revealed that its exposure to US Airways was $1.9 billion and to United $1.7 billion. Boeing Capital also revealed that 10% of its portfolio had exposure to United, with less to US Airways. UK bank Abbey National, which is preparing to sell its leasing arm IEM AirFinance, wrote down the fleet portfolio by £38 million ($60 million) at the end of last year.
"The performance of lessors over the next 24 months will determine where aircraft production will go," Avery concludes. "They have a different business mandate. If lease rates do not recover and they renew lease rates at distressed levels, it will challenge the value of the planes as they are being valued on the books of the lessors."
Allen at BACK suggests that there could be a clash between manufacturers and their leasing company customers as both attempt to place aircraft in a weak market. "Especially if Airbus keeps production where it is, they could come into competition with the lessors," he says. n
REPORT BY MARIA WAGLAND IN GENEVA AND LONDON
Source: Airline Business
