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Aviation Finance – Markets

(Market review as at 31 March 2017) 

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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). During the first two months of 2017, this trend has continued with a 7.0% RPK growth. With a 5.1% increase in capacity (in available seat kilometres; ASK), the global airlines an enjoyed excellent passenger load factor of 79.9% for the January/February months.

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 (11.4%), although the Anglo-American restrictions on on-board use of larger electronics (laptops) for certain flights from the Middle East could cost this group of operators some (business) traffic. Second was Asia/Pacific with 9.5%, followed by Europe with 7.3%. Africa grew 5.4%, Latin America 3.9% and finally the mature North American market only 1.7%. The domestic air transport market in India recorded a remarkable 21.9%, far ahead of the strongly recovering Russian domestic market (14.1%) and even the Chinese domestic market (13.1%). The domestic Brazilian market suffered a 2.8% loss in traffic.

Widespread ticket discounting, slowly increasing fuel costs but mainly sometimes extremely high labour cost increases have resulted in many of the major airlines reporting lower financial results for the first months of 2017. In Europe, Italian flag carrier Alitalia came closer to a crisis situation, but also in South-East Asia some carriers moved closer to the “watch list”.

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 the full year 2016 only came out at 3.8%, monthly growth increased significantly. During the first two months of 2017, this trend continued as well and growth over this period came out at 7.2%. 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, at the end of the first quarter of 2017 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. During the first three months of 2017, the order intake of 366 new commercial jets reached the same level as during the same period a year earlier. Demand for new jets is not likely to benefit from the stimulating effect of aircraft launches. The potential impact on order volumes that the expected launch of a Boeing 737 MAX 10 X might have seems limited. At the end of the first three months of 2017, the backlog for western-built commercial jets stood at ca. 13,225, down from previous record levels in 2015/2016.

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 just over eight 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, although the expected launch of the 737 MAX 10 X makes an attempt to close the gap. 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.

While it is too early to draw any conclusions for the year 2017, it looks like the twin-aisle market is weakening. Orders from some major airlines for new technology twin-aisles have been deferred as the still low fuel prices allow these operators to continue the operation of older equipment. As the market for used twin-aisles is clearly softening, airlines can lease older twin-aisles at – for them – very attractive lease rates. We are increasingly concerned about future values and lease rates of twin-aisle aircraft families such as the Airbus A330 and Boeing 777.

Used equipment market

As a result of the long lead times for new aircraft and stimulated by still-low fuel prices, the – predominantly single-aisle – 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. With expected value corrections for certain aircraft types “around the corner”, there is reason to be concerned about this development.

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. As discussed before, in the twin-aisle segment of the market, the circumstances are less favorable.

Overall, the start of 2017 was still fairly good for commercial aviation but we do signal more and more clouds in the sky, a sky that has been bright blue for many years already.