REPORT BY COLIN BAKER IN LONDON
There are signs that the steep decline in aircraft values has bottomed out, but recovery still promises to be slow
While it is certain-ly the case that, since the events of 11 September, aircraft prices have fallen steeply, this merely exaggerated a trend which was already on a downward curve. Rates for key benchmark models had been softening since the start of 2001 as the US economy spluttered, and they were already 10-20% down when the crisis struck. By year-end, this had become 20-30%.
However, there are at least some more encouraging signs that values have now bottomed out - albeit at very much reduced levels. Latest figures from the Airclaims consultancy suggest that values have indeed stabilised in the first quarter of this year. As much as anything, this reflects how little aircraft trading activity there is taking place in the market. With prices fallen so low, few are prepared to sell their assets if it can be avoided.
"It is a dead market," says Ed Greenslet, veteran US forecaster. "Buyers are trying to fish at the bottom. They are looking for good stuff on the cheap - there is a disconnection between the underlying value and the market price. That gap will only close as traffic recovers." Greenslet adds that forecasts from his ESG Aviation Services consultancy had long projected a recession in the 2001-2003 time period, with consequent falling demand for aircraft old and new. While the drop may be steeper than anticipated, he points out that it is not outside the normal range of error.
A key difference from the last global recession in the early 1990s is that fewer owners appear to be finding themselves forced into making fire sales. "This time round, more people are holding on. There are fewer distressed sales. If they don't have to sell, they won't," says Edward Pieniazek, director of consultancy and information services at Airclaims.
Another factor behind the lack of transactions appears to be the increased financial flexibility on offer to carriers. For instance, there is clear evidence that sympathetic suppliers have been lending a helping hand to airlines which are facing tough times. General Electric, for one, has publicly committed over $4 billion to help airline customers with post-crisis "urgent cash flow needs".
Reluctant sellers
Airlines too have been reluctant or unable to incur the major book losses that they would suffer if they sell aircraft assets at prices well below their value on the corporate balance sheet. "If an aircraft has a book value of $75 million, and the market rate is $40 million, the airline can't afford to write off that amount," says Torbjorn Karlsson, head of business development at Cathay Pacific Aircraft Trading. He also points out that, with a significant number of aircraft financed around highly complex tax leases, the unwinding costs also inhibit sales. "It doesn't make it impossible, but it makes it expensive," he says.
Although they are currently suffering along with the rest, there is cautious optimism over the prospects of a market recovery for the better quality aircraft over the next couple of years. Market-watchers are generally confident that the value of popular current models such as the Airbus A320 and newer versions of the Boeing 737 will pick up as traffic improves and demand rises.
Uncertainty remains over the exact timing, however, and most are cautious about moving too early. "People don't know when the market will turn, so it is easier to wait and make hard decisions when there is more accurate information," says Karlsson at Cathay. Best guesses are that prices, at least for the better types, should be back on course within a couple of years barring any further disasters. "Market prices are not going to come back for a year or so. They are not going to be at the level before all this happened, although they may be pretty close," says Greenslet.
However, the long-term question- mark hangs over the growing band of ageing, fuel-hungry and noisy aircraft - a significant proportion of which are already languishing in the desert. Latest value estimates pulled from the Airclaims database at the end of March show how much further and faster prices for the older types have fallen (see table page 60). For example, Airclaims reckons that A320 values have declined by 15- 20% over the last year, based on aircraft built in 1999 and 1989. By comparison, 737-300s which are no longer in production, appear to have suffered a fall in the range of 30-35%, even where the aircraft have the same build year. However, that is dwarfed by the former McDonnell Douglas MD-80 family now discontinued by Boeing. Airclaims shows the MD-83 falling by 35-45%, again for aircraft of a similar vintage to the A320 example.
If such recent aircraft are suffering, then the writing is clearly on the wall for ageing Chapter 2 narrowbodies such as the McDonnell Douglas DC-9 or the Boeing 707, 727 and 737 classics. Older widebodies such as the McDonnell Douglas DC-10s and Boeing 747 classics are also likely to have had their last change of ownership. "Junkyard designs will never recover," says Greenslet.
Many of the oldest aircraft are anyway under threat from plans in Europe to step up noise restrictions and also concerns about future emissions standards. However, Pieniazek says these factors have already been built into aircraft prices quoted by Airclaims.
Even the scrap value of some of these models is becoming negligible. Pieniazek believes there is such a glut of Chapter 2 747 classics on the market, that there is little value left - even if they are broken up for parts. Lufthansa, for instance, has just put one in a museum, while four have gone to maintenance arm Lufthansa Technik for spares.
Value erosion
Karlsson at Cathay believes that the 747 classic is coming towards the end of its life, adding that there are few transactions in this market. He says that any operator who wants a 747-200 almost certainly already has one. With engines making up the bulk of the value for older aircraft, the fall from favour of the old Pratt & Whitney JT9-Ds (most of which are hushkitted or modified to Chapter 3) has further eroded the value of aircraft such as the 747 classic, which is equipped with these types of engine.
Even the 747-400 has been under pressure from the flexibility and economics available from newer intercontinental offerings. Airclaims estimates that the value of recent 747-400 models suffered a 30% drop during 2001. That is significantly more than the 10% decline in values during 1997, when financial crisis hit Asia, home to the largest 747 operators. However, during that crisis there were opportunities to switch aircraft to other routes, thus aiding tradeability. "The Asian crisis was localised; this time the downturn is co-ordinated around the world," says Karlsson.
Other widebodies have also suffered. The Airbus A330-300 is trading at a discount of around 15%. Values for the Boeing 777 too fell by nearly 20% over the year, but Pieniazek says there is much more room for recovery than with the 747, as the price fall for the 777 is "due to a soft market" rather than any fundamental with the aircraft.
Greenslet sees the current slump as a potential spur to hasten other significant changes to the market for used aircraft. For instance, he says the MD-80 family is replacing the 727 as the "bottom-of-the-barrel" aircraft. Pieniazek points to the 727's unattractive combination of three engines and three crew, which is making it difficult to place - even in the freighter market. The MD-80 family has also been under severe price pressure. "There is very little demand for this product," Pieniazek says.
Usually narrowbodies have more tradeability in the second-hand market than widebodies, which tend to be configured for particular routes and reconfiguration costs can be in the region of $5-10 million.
This time around, the difference appears to be less marked, perhaps reflecting the fact that there seems to be a surplus of narrowbodies. Ryanair is understood to have been offered 400 aircraft when it advertised for second-hand 737s towards the end of last year.
The high output of A320 family and 737NGaircraft mean that there are "simply too many available" to maintain narrowbody prices says Karlsson. Swissair and Sabena both had significant A320 fleets, and their demise has put a substantial number of these on the market. The MD-11, which was also a mainstay of the Swissair fleet, has also had its price depressed - and Pieniazek predicts some freight carriers will try and renegotiate prices on this type of aircraft.
Stored-up capacity
A large part of the supply and demand equation depends on how many aircraft return from the desert. Estimates of how many aircraft are currently idle range up to more than 2,000, and numbers are not always easy to guage. Some are simply pushed to the end of the runway and forgotten about, while others may be awaiting modification work. Figures from Airclaims suggest that by March, the number of idle mainline aircraft had reached nearly 1,900. Including regional aircraft and other old miscellaneous types such as Concorde, the number is well above 2,000. That is more than twice the storage levels reached during the last recession, which themselves set a new record.
The current idle total includes at least 300 current Airbus and Boeing types which are almost certain to return to service. There is a similar number of relatively recent Chapter 3 types which should also come back, but the consensus is that perhaps as many as 1,000 aircraft will never re-enter the world fleet. Aircraft such as the 727 and DC-8 now have over a third of their number in storage, while around 25% of the oldest 737s and DC-9s are currently not in active service. On average 12-13% of the mainline fleet is resting.
Against the background of falling demand, Greenslet adds that new aircraft deliveries in 2001 and 2002 effectively represent a surplus to requirements. But as older aircraft eventually work their way out of the system, the market will gradually stabilise, he predicts. "By 2005, we see the market supply and demand essentially in balance so that production closely matches need in the years 2006-2011," says Greenslet, adding that the key message for manufacurers is that production should not turn up until 2005 and then the annual increase should be "steady but relatively modest in size".
He estimates that in a balanced market, the surplus of idle aircraft should be around 3% of the world fleet, well below the 12% figure expected this year, but above the 1-2% seen during the boom between 1995 and 1997, as demand reached its height.
As ever, the strength and speed and of economic recovery is a key variable in balancing the aircraft demand and supply equation. However, airlines this time appear to have fared better than in the last recession, having been able to avoid aircraft sales at basement prices. And if - as seems likely - values have bottomed out, the pain should be limited. The main losers would appear to be those holding older aircraft, although in many cases these were already of marginal value. A 50% annual decline in the value of a DC-10, for instance, only wiped out $2 million.
It is still too early to say how this present industry cycle will compare with the boom-to-bust rollercoaster of a decade ago, but, despite the headline figures on value and storage, there are a few encouraging signs that the market may be a little more orderly this time.
Source: Airline Business
