IBA Insights

IBA Identifies Key Aviation Themes for 2019

IBA Report: issued January 2019 by Dr Stuart Hatcher, Chief Operating Officer

Economics & Traffic

Oil price certainly contributed to an increase in airline failures for 2018. Price remains at the mercy of market sentiment and underlying market supply and demand. With tighter co-operation between producers, we should expect less market elasticity.  Brent pricing at US$50/b is unsustainable for any exporter to balance their budget despite low extraction cost – so it is expected that pricing will settle ~70-80 USD.

Slowing GDP growth will temper world trade and slow passenger growth for 2019.

Whilst raising interest rates will indicate an improving economy and should improve lease yield, a strengthening dollar will hinder airline profitability and bankruptcies will follow.

Forex issues are expected to remain for 2019 whilst the USD remains so strong. Airline costs are expected to rise and failures to increase unless Oil can buck trend and fall by >10%.

Yields remain too low for sustainable profitability outside of US market whilst the USD remains strong. 2019 is expected to offer some stability on oil price fluctuations, but airlines must remain flexible to managing capacity and fares.

Airline failure outlook still looks challenging for operators in countries bordering the Indian Ocean and South East Asia; South Africa, Kenya, Mauritius, UAE, Pakistan, India, Sri Lanka, Bangladesh, Thailand, Malaysia, Indonesia, Philippines; but also challenging in other areas such as Argentina, and Mexico. Some European carriers will be unable to compete against the large legacy groups or LCCs will continue to struggle and failure/consolidation is inevitable; if not for pure airline economics, the value of slots remains a strong driver.

OEM Performance

With production set to get back on track for neo & Max aircraft, as always there is room for more single aisle orders as fleets age. All orders are speculative now given backlog length; related to age rather than demand.

Airbus expects A320ceo/neo to reach a monthly production rate of 60 by mid-2019, which will push deliveries to 700 for 2019 and 720 for 2020. This looks possible if 2H2018 is anything to go by!

Boeing expects 737 production to reach a monthly rate of 57 by mid-2019, which will push deliveries > 650 for 2019 and > 680 for 2020. Based on 2018 performance this appears possible.

The widebody market remains challenging. Low oil prices increase demand for older types, but configuration costs are still to be avoided. Older A330s prove useful and cheap enough to transition and despite large parked fleet, they remain flexible much like the 767. Freight conversions of 767s and A330s are likely to accelerate. 777-300ER remains a mainstay of the fleet but demand for new 777-8/9 continues to be poor and the market is avoiding re-configuration at lease end at all costs. Extensions are key.

787 and A350 aircraft remain top of the list and potentially will shift heart of the market away from the 777. For us the 777-300ER remains on watch! How these assets trade in 2019 will be under close scrutiny.

The NMA launch could make an appearance in 2019 to either give a boost to the large narrowbody/ small widebody market; or seal its fate. There would seem to be many good reasons to go with it, but clearly there are some big questions that remain unanswered and Boeing may not want to create the market alone. How often do we know so well in advance of a potential market disruptor coming down the line that isn’t merely a modern replacement!

In the regional jet arena IBA predicts that OEMs will focus on specifications and production costs, which in the first instance aims to build a cost effective aircraft that is compliant to future parameters, rather than wait for a change to happen. Weight, seats and size must be addressed. With ~12% of latest generation ATRs parked, orders are expected to remain low.

Lessor

Leasing continues to grow and attract many new entrants. Whilst the number of new Chinese entrants has diminished (and likely leading to some large Chinese sell-downs) plenty are preparing for a potential market correction in lease rates and values – both in a good direction for start-up lessors. The potential GECAS sale remains high on the agenda for 2019 as does the potential IPO, partial sell-down or complete disposal of several top 50 lessors. Prices are high so it would seem to be a good time! Stronger signals for investing in the space are emanating, most strongly from North America and Japan, whilst Korea still continues to threaten expansion in this sector.

Retirements

Retirements are on the up for first time in seven years. Age continues to rise for narrowbody, widebody and regional jets, turboprops continue to decline. Demand for parts to maintain ageing fleets will continue to fuel demand, particularly to source engines which remain in very high demand. Operators continue to find more cost-effective solutions to maintain the fleet and hold off from taking on operational risk and higher ownership costs of new technology.

Lease Ends

Lease ends for narrowbodies remained inline with the trend and the bow-wave continues to shift to the right. This could cause a signifi cant problem for both lessors and lessees alike, as MRO space is unlikely to be able to handle return demand. Likely that both parties will have to accept weaker physical conditions at return, which could play into the hands of lessors looking to maximise cash at lease end, but may lead to a higher number of retirements/ part-outs if the asset cannot be placed quickly. Both the A320ceo and 737NG are affected. If US dollar remains strong then non-US based lessees will struggle to handle higher cash return conditions if on lease-end compensation terms. Extensions will maintain the trend, but the wave will simply get bigger until the aircraft reaches natural retirement!

Widebody leases don’t exhibit the problem to the same extent because fewer extensions have been triggered. The large number of aircraft parked that have come from a lease end does indicate further challenges that lessors face in being able to place them. Configuration cost being a strong factor.

Trading, Values and Lease Rates

Lease rates have finally shown some level of improvement after a long period of decline/ stagnation. New aircraft have firmed as rising interest rates have some effect, but a strengthening market has firmed up older variants of the A320 and 737-800. Lease rate factors remain incredibly low and some buyers are prepared to make what would seem to be rash decisions. Clearly market share, lower return on investment criteria, ability to invest in dollar denominated assets, the ability to fund through alternative methods and attraction to high cash flows will work for some participants. For others that expect the market to remain bullish for some time yet or rely on unrealistic market scenarios, time may be running out. For the widebody market, lease rates remain under pressure for ageing assets due to high availability.

Overall, the volume of sale leasebacks remains down for top 50 lessors as they expand through lessor acquisition, and direct purchases. Some of the top tier will still use the sale leaseback market although they won’t necessarily participate in an open RFP.

Values remain strong for the time being and many have had to react to much higher market participation. Some older assets in high demand have seen increase >20% across the course of 2018. How this shapes up for 2019 remains complex. Oil is expected to rise but hold, the US dollar isn’t expected to weaken enough just yet to improve the fortunes of those at its mercy, and traffic demand is set to remain fi rm. New technology will continue to be delivered at an ever-increasing rate and freight demand for narrowbodies is set to continue for the time being. We are expecting a market correction for values as new technology becomes more available (and reliable). The bottom of the market needs this to happen to feed into the freight programs and parts markets. It could happen much quicker of course if there is a sudden change in traffic demand, oil price or finance availability. That is harder to predict.

What seems apparent is that the market is expecting a slowdown to happen. The pain seen in India, Europe, South America and South East Asia hasn’t escaped many. Payment defaults are on the rise and contingency plans are being prepared. Pricing remains high still despite what appears to be a market-wide epiphany. For some its just the realisation that it has been some time since the last one and any signal is identifying the end of the current cycle. Of course it helps that most are under the impression that we follow a cycle and a fall will precede a rise once again. Consequently investors are angling to get their hands on a good deal. The problem is that providing funding remains in such abundance, the downturn could arrive and there be so many buyers looking for a bargain that pricing may not shift that much for the high demand assets. Lease yields are more susceptible to market demand though, and if they collapse quickly after rising for the first time in three years, we would hope that realisation sets in quickly and not prolong the inevitable.

2019 may still not be the year for that because it still ultimately requires investor confidence to falter. Increasing defaults in the ABS market (providing the managing lessor cannot replace with performing leases) could trigger that.

If you have any comments or questions, contact stuart.hatcher@iba.aero to discuss further.

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