Aviation Finance – Markets
The golden age for commercial aviation continues
(Market review as at 30 September 2016)
The “Golden Age” of commercial aviation continues during 2016. While geopolitical and economic events caused significant uncertainty in many parts of the world, passenger traffic continued its growth path. Despite slowly increasing fuel prices, airline profitability on an aggregated level is still at very comfortable levels. After an almost unprecedented period of relative prosperity in our industry, questions are raised about the longevity of this “boom”, especially by those observers that had seen how the almost ten-year “boom” in the shipping industry ended in 2008. In the early months of 2016, some of our industry leaders, mainly from the Original Equipment Manufacturers (OEM) as well as North American airlines, expressed their opinions dismissing concerns that the aviation business cycle is on the cusp of a downturn. At the opposite end of the spectrum, reputable analysts could be found, who questioned the assumption that we “are entering the magical world of no aviation cycles”.
During the first months of 2016, the global economy evolved in line with the International Monetary Fund’s (IMF) expectations. Improvements in a few large emerging markets suggested a potential modest upward revision of the 2017 global growth projection. The IMF also noted some pick-up in Chinese infrastructure investments and higher oil prices. On 23 June 2016, after the United Kingdom voted in favour of an exit from the European Union (Brexit), things changed and an important downside risk for the world economy materialised. Also the financial markets were caught by surprise.
Because of the expectation that the uncertainty resulting from Brexit will take its toll on confidence in general and in financial conditions in particular, the IMF in July adjusted its World Economic Outlook (WEO) downward by 0.1 percentage points compared to its April 2016 WEO. European economies are expected to be impacted most, with only modest effects on the United States and China. In its July 2016 WEO, the IMF projected a 3.1% increase in world output for 2016, increasing to 3.4% for 2017. Another interesting and highly relevant change in the IMF projections is the assumed oil price: for 2016 the average projected oil price was increased from US$34.75 to US$42.90 per barrel, and for 2017 from US$40.99 to US$50 per barrel. In its July report, the IMF concluded that from a macro-economic perspective, Brexit substantially increased economic, political and institutional uncertainty, with projected negative consequences, especially in European economies.
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Traffic growth and airline profitability
Given the economic uncertainties mentioned above plus the high level of terrorist activities and political unrest (e.g. Turkey), it is almost a miracle that passenger traffic has continued its solid growth path. Over the first half of 2016, global revenue passenger kilometres increased by 6.0%. The growth in air transport can partly be explained by the lower ticket prices that airlines are charging their customers.
According to IATA (International Air Transport Association), the trade association representing some 265 airlines or 83% of total air traffic, average return fares (before surcharges and taxes) in constant (2015) US dollars will drop from US$407 in 2015 to US$366 in 2016. While average fares have been falling for decades, obviously it has been the lower fuel price that enabled airlines to lower ticket prices by such a huge amount.
The projected total spend of air transport in 2016 is anticipated to be about US$740 billion, 1.3% lower compared to the US$ 750 billion from 2015. In “real” volume terms, both the revenue passenger kilometres (RPK) as well as the number of passenger departures are projected to increase. The RPK volume will rise from 6,679 billion in 2015 to an estimated 7,093 billion this year, a 6.2% increase. The number of passenger departures will increase by ca. 6.0% to 3,783 million.
Air passenger market – revenue passenger kilometer growth year-on-year
The impact of terrorist actions on global travel and tourism in 2015 and 2016 seems to be relatively modest, compared to the impact of similar kinds of atrocities in the past. Despite the apparently increasing frequency and high-profile nature of these atrocities, it seems the impact on travel and tourism is mainly felt locally. The World Travel & Tourism Council (WTTC) expects that for 2016, the direct gross domestic product contribution of the sector is still to grow by 3.1%. According to the WTTC, only three countries have seen their outlook deteriorate during the first months of 2016, i.e. Brazil, Turkey and France.
From a financial perspective, the airlines are now at a completely different level compared to the industry’s decades-long tradition. While during the first decade of this century (2000–2009) significant losses were booked, this has changed dramatically after 2010 when, according to the International Civil Aviation Organisation figures, the global airlines booked a net income of US$17.3 billion. In 2015, partly as a result of low oil prices, the net income doubled from the year before to US$35.3 billion. For 2016, preliminary IATA figures indicate a potential net post-tax profit of US$39.4 billion. Between 2014 and 2015, the return on invested capital jumped from an already unusually positive 5.9% to 9.3%. For 2016 an additional increase to 9.8% is projected.
It should be noted that the main source of profitability is the North American market. It is interesting to compare the absolute post-tax profit per region with the profit per passenger. By both criteria, North America stands out. Apart from the benefit of lower fuel cost, the North American result can be explained by the increased market power of major airlines after a wave of consolidation. This has enabled improved pricing power as well as higher load factors and more income from ancillary services.
Traditionally, when airline profitability went up, also the new order volume for commercial aircraft increased. In the past year, this relation was broken. While the industry profit doubled between 2014 and 2015, the number of new aircraft orders dropped from about 3,600 to about 2,400 (new orders for western-built jets by all commercial operators and including type-swaps).
Over the first nine months of 2016, this trend has appeared to continue with ca. 1,280 orders vs. almost 1,570 over the same period in 2015 – a drop of 18% and even 46% compared to the record year 2014. Both the Boeing 737 and the Airbus A320 booked decent order volumes over this period. Airbus sold ca. 300 neos and 130 ceos but there was a significant number of “type swaps” included in this number. Boeing sold ca. 210 MAXs and 110 NGs. Bombardier finally seemed to have hit the jack-pot with ca. 130 orders for the C Series. Widebody aircraft sales were particularly hit in 2016, with only 125 orders over the first eight months.
Commercial western-built jet orders (all civil operators and including type swaps)
It has been suggested that the current relatively low fuel price has taken away a major incentive for airlines to order fuel-efficient new technology aircraft. It is difficult to find convincing proof for this. Jet fuel (US Gulf Coast, FOB) reached a low in January 2016 at just over US$0.80 per gallon but subsequently showed a steady climb to reach US$1.45 in June, after that the price fluctuated between roughly US$1.20 and 1.40 per gallon. Apart from the price of jet fuel, it seems the new order volume is held back by the record backlog already on order and the resulting significant lead times for the delivery of the more popular jet types. Overall, the backlog for commercial jets is equal to approximately nine times the production volume of 2015. Another stimulating factor absent in 2015 and the first half of 2016 was the launch of a significant new aircraft type. Most developments that were announced focused on high density interiors.
The stagnant order intake certainly is not caused by a lack of commercial funding. Both debt funding as well as equity is abundantly available at historically low cost by a broad range of lenders and investors. The only source that could not easily be tapped was government export credit financing. Both the Export-Import Bank of the US (EXIM) and the European export credit agencies (ECAs) had their problems. The US Senate did not nominate a third board member for EXIM, essentially taking away the bank’s ability to approve big transactions. In July 2016, legislation was proposed allowing the bank’s board to approve transactions with a quorum of only two members. This proposal still has to be formally accepted.
In Europe the problems are of an entirely different nature. In April 2016, the three main European export credit agencies halted all export support for Airbus aircraft because of “inaccuracies” in applications. ECA financing is expected to resume in the fourth quarter of 2016.
Probably timing of these two incidents could not have been better. Boeing reported that the percentage of deliveries supported by EXIM reached 30% during the global financial crisis between 2009 and 2012. In the period 2012 to 2015, this percentage had come down to a ten-year low of 11%, probably partly as a result of the 2011 Aircraft Sector Understanding that increased the cost of export financing for most borrowers and made commercial funding more attractive.
Megatrends in aviation
Bert van Leeuwen