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Aviation Finance – Markets

(Market review as at 31 December 2016) 

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Traffic growth and airline profitability

Despite political unrest, terrorism, increasing populist rhetoric and an increasing threat of protectionism, global airlines in 2016 once more enjoyed a solid 6.3% demand growth for air travel (in revenue passenger kilometres; RPK) according to the International Air Transport Association (IATA). This number is slightly down from the 2015 peak level (+7.4%) but above the longer-term trend of 5.5%. With a 6.2% increase in capacity (in available seat kilometres; ASK), the global airlines saw their passenger load factor further improve from an already high 80.4% in 2015 to 80.5% last year. Furthermore, North American and European carriers enjoyed load factors around 83%.

Worldwide traffic growth

Image of aviation markets: worldwide air traffic growth as at 31 Dec 2016

 

Similar to previous years, the Middle East airlines recorded the highest RPK growth (11.2%). Second was Asia/Pacific with 9.2%, followed by Africa with 6.5%. Europe grew 4.6%, Latin America 3.6% and finally the mature North American market with 3.2%. The domestic air transport market in India recorded a remarkable 23.3%, thus twice as much as the Chinese domestic market (11.7%). The domestic Brazilian market suffered a 5.5% loss in traffic. Despite widespread ticket discounting, slowly increasing fuel costs and sometimes extremely high labour cost increases, IATA still projects a record US$35.5 billion net industry profit for the year. 57% of this profit is expected to come from North American carriers.

While on an aggregate level the world’s airlines enjoyed a profitable 2016, individual airlines presented mixed results. In Europe, Air Méditerranée ceased operations due to financial problems. In Asia, TransAsia Airways also suspended all operations as a result of intense competition and two plane crashes. In North America, Republic Airways Holding filed for Chapter 11, blaming a lack of pilots. Tourism came under pressure in countries like France and Turkey due to terrorist attacks. Political unrest in Turkey put further pressure on the local airlines but this did not result in bankruptcies. On a more positive note, in the US Virgin America merged with Alaska Airlines, and after the US lifted the ban on aircraft sales to Iran in 2015, flag carrier Iran Air placed a significant order volume for both Airbus and Boeing aircraft in 2016.

One of the biggest surprises in 2016 was the increasingly strong recovery of the air freight market. While the overall increase in freight tonne kilometres during full year 2016 only came out at 3.8%, monthly growth during the year increased from almost zero at the start of the year to just under 10% in December. Initially, incidental factors such as smartphone shipments or a disruption in the maritime container market were seen as the cause for the mid-year recovery. Despite increasing protectionism and pressure on international trade growth, the recovery of air freight may be more sustainable.

Aircraft orders and technology

After an already slow 2015 in terms of commercial jet sales, 2016 did not bring the aircraft manufacturers any improvement in new order volumes. However, Airbus and Boeing still enjoyed record backlogs as a result of the order boom in 2013/2014. Last year the order intake was limited to ca. 2,100 (including ca. 230 type swaps) – a 40% drop compared to the record year 2014. Demand for new jets in 2016 did not benefit from the stimulating effect of aircraft launches, and the so-called book-to-bill-ratio dropped to just under 100%. At the end of 2016, the backlog for western-built commercial jets stood at ca. 13,700, virtually unchanged from a year earlier.

While it looks like this may be a sign that the commercial jet market is in a downturn, we do not believe this to be the case. The current order backlog still equals almost 57% of the current in-service fleet, or almost nine years of production (at 2016 production levels). New deliveries achieved a fresh record level during 2016, especially in the fourth quarter. Despite problems with third-party suppliers, the aircraft manufacturers delivered 1,579 new jets. Depending on demand, the manufacturers fine-tune production rates of individual types.

Once more, the Airbus A320 was the most popular aircraft family last year, with a gross order intake of 601 for the new A320neo family and 189 for the current A320ceo family. After cancellations, the net order intake was 561 neos and 46 ceos. Airbus noted a clear shift towards the higher capacity A321 version of their single-aisle range. The Boeing 737 family followed with 550 orders of which 534 were for the new MAX and only 16 orders for the current B737NG. Boeing still lacks a direct competitor to the A321. Together the A320 and B737 families represented 77% of all new jet orders placed in 2016.

In the smaller single-aisle segment, Canadian manufacturer Bombardier had a relatively successful year for its new CSeries, reporting a total of 129 gross orders for the type. Mitsubishi’s MRJ programme suffered further delays resulting in only ten additional orders. Embraer reportedly sold 50 E-Jets of which only five from the new E2 series.

In the medium twin-aisle segment, the Airbus A330 family clocked up 106 gross orders (83 net). The new A330-900 booked 42 net sales, but the old technology -200 and -300 still added 14 and 27 net orders, respectively. The all new, long-range Airbus A350 booked a gross total of 51 orders, but cancellations for mainly the shortbody -800 version (-8) reduced the net total to 41. In the same twin-aisle segment, Boeing sold 80 more of their 787’s, but 22 cancellation reduced the net total to 58. Larger aircraft were not in fashion in 2016. Boeing booked 23 gross orders for the current generation 777 (net 17) but none for the new 777X. Freighter sales kept the 747-8 programme going, but net total sales only reached 17. Airbus booked two new orders for the A380, but lost two as well.

Used equipment market

As a result of the long lead times for new aircraft and stimulated by still-low fuel prices, the used equipment market continued to prosper during 2016. The number of transactions involving aircraft with leases attached significantly exceeded the number of transactions involving “naked assets” (aircraft without lease).

The majority of transactions took place between financially driven parties, such as investors and lessors, without the aircraft involved changing operator. Investor appetite for used aircraft, especially from Asia, triggered many transactions – ranging from individual aircraft and small portfolios to entire leasing companies. Aircraft lessors control just under 40% of the global commercial jet fleet. The major source of lessor fleet growth is now sale-and-lease-back transactions, rather than speculative direct orders. Consolidation continues amongst the top 10 of the league, and more can be expected.

At the same time, new lessors are entering the market, frequently driven by Asian investors, the latter often looking for US dollar-denominated assets as protection against foreign exchange risks to their local currencies. For aircraft financiers the market remained highly competitive, with pressure on margins and a push (not supported by DVB) towards more liberal finance terms, especially in the form of higher advance rates.

Except for some low-capacity versions, most current single-aisle aircraft values continue to show a moderately strong performance. The new generation has not yet gained enough momentum to put pressure on used equipment values. The still relatively low fuel price is a contributing factor to this as well. In the twin-aisle segment of the market, the circumstances are less favourable.

It seems that various factors are undermining the market for current-generation twin-aisles: potentially these include (i) the lower liquidity of twin-aisles, (ii) the more advanced market penetration of new technology aircraft, such as the B787 and A350, in this segment (iii) the higher transition costs and (iv) the (in historical perspective) currently high percentage of leased twin-aisles. The rise of new airline business models, mainly based on the use of efficient single-aisles, may put further pressure on this segment. Compared to five years ago, the storage percentage (stored fleet/in-service fleet) for single-aisle aircraft has dropped from 11% to 7%; for twin-aisles, however, the percentage increased slightly from 10% to 11%.

Overall, 2016 was a fairly good year for commercial aviation but most likely the past months may have marked the peak in many aspects of this relatively mild aviation business cycle.