IBA Report: issued January 2020 by Dr Stuart Hatcher, Chief Operating Officer – Managing Director Aviation
Economics & Traffic
A settled oil market is forecast for 2020. Price spikes generated by Middle East tensions are expected to continue but fluctuations tend to be short lived, lasting only a few days. Oil prices will remain sensitive to geopolitical relations and the economies of countries reliant on oil production will continue to be influenced by politics. The forecast for Brent pricing at $61 is down from 2019’s average of $64. Despite short term volatility around the $60 mark, price growth has been steady since 2016.
Shrinking GDP growth rates are expected for 2020 although they will remain positive at 3.4% from the 3% seen in 2019. Brexit’s likely impact on UK and European performance remains unclear but the negative effect of trade restrictions on growth has already been witnessed. The slowing GDP growth will moderate global trade and limit passenger numbers in 2020.
2019’s projected interest rate rises failed to materialise and, in fact, the Federal Reserve cut rates three times. In 2020 continuing low interest rates will encourage further investor interest in ABS, freight conversions, parts and MRO.
Forex issues are likely to persist. Further currency weaknesses against the USD lie ahead in the second half of 2020 as the US presidential election looms. A variance as low as 10% is enough to cause operators significant cost issues with fuel and maintenance and to negatively impact reserve and lease rates.
Yields, all the while the USD maintains its strength, yields will remain too low for sustainable profitability outside the US market. Despite the stable oil market anticipated for 2020, yields are expected to fall further still with more airlinesirlines triggering default events.
Airline failures reached record numbers in 2019, with 27 operators ceasing or suspending operations, 15% and 31% higher than in 2011 and 2008 respectively. At 16, the average failed fleet size was 50% higher than at any time during the last 21 years.
The primary causes of failure cited were both cost and demand driven. Increased labour, oil, forex and trade uncertainty costs were said to be key, as were inadequate business models and capacity management strategies to succeed against strong competition. A lack of availability of new technology also had an effect. Weakening GDP growth hit demand as did difficult tourism conditions: geopolitical risks, weather and climate change considerations were all named as factors. Whilst the shortage of new technology is an acknowledged feature however, the oil price is sufficiently low to question its validity as a primary cause of airline failure.
OEM performance during most of 2019 endured challenging ordering conditions, both Airbus and Boeing suffering early cancellations. The final quarter saw Airbus striving to recover and surpass their 2018 position, good ground being made via increased expansion of the A320neo family with launch of the XLR. This was a welcome deflection away from the A380’s painful demise though, to counter this success, the A330neo’s backlog increased despite prevailing depression of demand for widebodies.
Boeing’s positive start to the year was inevitably dealt a blow by the MAX’s grounding and uncertainty over the timing of final approval being granted for the MAX to fly again continues to pose a threat. Failure to make progress with the 777X was fortunately balanced by positive order numbers for the 787 despite the lacklustre widebody market.
Considering the industry’s heavy reliance on a strong Airbus/Boeing duopoly to challenge technological advancements and develop simplified product strategies, Boeing’s focus in 2020 must be to get their program back on track. An effective communication plan involving both consumers and the industry is crucial, as is regaining the ground Airbus have started to steal in the narrowbody new technology sector. Both OEMs will contend with strong discounting measures which will test pricing stability throughout the year.
Retirement trends in 2019 continued patterns witnessed in 2018 with little movement in overall numbers. The forecast for the next few years is, however, for retirement numbers to grow due to various factors: demand is expected to weaken, aircraft in storage will be scoured for good components, OEMs will increase production rates, the MAX will re-enter service and achieve full performance over the next two years and the environment protection debate will garner increased support. In contrast, freight demand will be strong for the best 737-800s and A321s and new start ups will be able to take advantage of the many inexpensive A330s available.
Lease ends for narrowbodies fulfilled expectations, the bow-wave shifting from 2018’s 577 to 742 in 2019 and new leases and lease extensions will create high lease end numbers for 2020-2025. Referring to Chart 3 on Page 4, leasing carries on growing with the fleet and enables a wide operator base. However, as lessor numbers increase, pricing and discipline will continue to be negatively impacted. Operators suffering the consequences of unreliable new technology may have used lease extensions to help them endure a difficult period. However, less savvy lessors’ lack of understanding of the advantages and disadvantages of extending leases means rates can be forced down by some lessees.
Although problematic, the widebody space encountered fewer than expected lease end numbers and the widebody lease end pipeline is considerably flatter than that for narrowbodies. Lessors are generally unenthusiastic about expanding their widebody portfolio; the risk of secondary lease placement and configuration costs are a deterrent. Previously appealing lease prices have been moderated by sale leasebacks and extensions though widebody leases maintain their attraction for lessee credit purposes. Experienced lessors often tolerate a widebody exposure of 10% whilst far greater proportions are accepted by less established lessors.
Trading, values and lease rates
Economically, the benefit of oil price stability will be diluted by ongoing falling yields so the buoyancy of airline business models and markets will determine survival or failure. For those outside the USA, currency fluctuations will be an additional trading consideration and whilst demand will grow its rate will decelerate as GDP growth shrinks and capacity shows a marked hike.
The record airline failures seen in 2019 resulted in Europe’s and India’s leisure markets experiencing reduced capacity so, although failures will continue in 2020, they will be fewer. SAA and Hong Kong Airlines face almost certain restructuring to stay in business and Norwegian’s future remains in the balance.
Airbus’ 2019 order book was healthier than forecast whilst Boeing reeled from the MAX’s grounding and still bears its burden. Launch of the NMA is likely to be pushed yet further back with Boeing’s focus having to be narrowed to prioritise reputation rehabilitation. Uncertainty over the timing of the grounded MAX’s return to service contributes to Boeing’s trading difficulties, some citing the end of quarter one as a likely date whilst others anticipate a longer timescale. Boeing’s decision to suspend MAX production a significant time after the aircraft’s grounding suggests the company expected its return to service to be quicker than it actually has been.
Lease end shifts for both narrowbody and widebody markets behaved as forecast and 2020 will witness a greater number of contractual lease ends for the A320ceo in the face of the neo’s impressive ongoing performance. 737NG lease ends are likely to be pushed out further as the MAX takes time to re-establish itself. There will be a minor adjustment in 777-300ER lease ends pending FAA approval of its replacement.
Lacklustre sale and leasebacks have been the norm over the last few years with falling yields and unsustainably high pricing. We expect 2020’s market to be more bullish as extra MAX numbers become available to stimulate sale leasebacks and other trades.
The ABS market’s strength will endure as long as more attention is focused on the credit quality of the lessees entering the structure and caution is exercised over concentration risks. ABS version 3.0’s popularity remains but increasing default incidents will create difficulties for the servicer.
Lease rate levels are commonly lower than those enjoyed only a few years ago with too many lessors holding similar inventories. Sharp falls are expected for newer aircraft on a first lease. Older widebody aircraft such as the A330- 200/300 and the 777-300ER will face pricing corrections triggered by record storage levels and poor lease yields proving current book values are unjustified. The conversion potential of ageing A330s could help to reset the depreciation profile and reassess the aircraft’s long-term markets.
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