2013 New Year Outlook: The Dawn of a Golden Age in Aviation
By Dick Forsberg, Head of Strategy
With the holiday season over, it’s time to dust off the crystal ball and look ahead at what the coming year may have in store. The industry has survived, and in many cases actually prospered, during the past 12 months which once again were filled with economic and financial uncertainty and challenge. Will 2013 be different or should we get used to living in turbulent times?
Let’s start by putting the current market conditions into perspective. All of the long-term industry trends, from traffic growth in emerging markets and the shift of regional influences to the development and delivery of future generations of commercial aircraft and the deep pools of capital looking for secure risk-adjusted returns, suggest that we are entering a golden age of aviation, for which the past 20 years have been a mere warm-up act.
Over 56 million people globally are now employed in aviation and related tourism industries; if aviation were a country, it would rank 19th in terms of GDP; by 2026, the industry will contribute US$1 trillion to the world economy. Aviation has proven to be highly resilient to economic stress, with only three years in the past 40 when passenger traffic has declined; demand is widely forecast to maintain an average 5% per annum growth rate over the next 20 years; commercial airlines provide essential infrastructure links in many of the world’s fastest-growing economies and are a key component of that growth. Over 30,000 commercial jets will be delivered over the next 20 years to meet the demands of growth and fleet replacement, requiring $4.5 trillion of financing.
If the past decade has taught us one thing, it is that we should not be overly concerned about the sustainability of the airline industry. Once again in 2012, the world’s airlines managed to confound their critics with an expected collective operating profit of almost $14bn and net profit of nearly $7bn, not far short of the results for 2011 and well ahead of the consensus numbers published at the start of the year. This is mostly thanks to US and Asian carriers, where the bulk of the gains have been recorded, whilst European airline profitability flat-lined again. Nevertheless, even where profits remain elusive, cost and efficiency improvements and structural changes continue to feed through to the bottom line, despite fuel prices that have remained, on average, at virtually the same level as 2011. The reality is that airlines can and do manage to deal with expensive fuel; they are less well able to deal with price volatility, which can leave them exposed on their forward booking pricing, whilst the hard lessons of previous hedging activity have significantly reduced the extent to which airlines try to “game the markets”.
The price of fuel is likely to remain at or around the same level in 2013 as it maintained throughout 2012, providing airlines with the stability they need to plan capacity and manage their seat inventories effectively. If they can maintain a tight grip on capacity and keep load factors close to the extraordinary near-80% level achieved in 2012, the industry is likely to see similar levels of profitability in 2013. Of course, there will be some airline failures, mostly around the margins, with some all-cargo operators perhaps at greatest risk due to the continued softness in world trade, but for the majority of airlines, the focus will be on specific revenue and cost improvement rather than simply survival.
Whilst capacity grew more slowly than traffic in all of the world’s regions last year, it will be challenging to achieve the same result in 2013. On the one hand, demand is likely to be held back in under-performing economies, including a number of the largest emerging markets. On the other hand, the rate at which new aircraft are delivering continues to increase, with total production going up by around 10% and widebody output almost 20% higher. The swing factor, which is entirely in the hands of the airlines, is the application of new deliveries to growth versus replacement. Over the past couple of years, fleet replacement has absorbed almost 40% of new deliveries, which is a typical proportion for this point in the cycle. If, as expected, this level continues through 2013, the overall supply/demand balance ought to be maintained, with positive implications for yields and profitability.
At the same time, the market supply/demand balance for some specific aircraft types should also move back into equilibrium during 2013. Many lessors and investors have experienced pricing and placement pressure around A319s and A320s over the past 12 months, however the backlog of unplaced lessor orders is declining, as is the number of aircraft being offered following lessee defaults – a problem that is just as likely to affect 737NGs as A320s in the future. A successful emergence of American Airlines from Chapter 11 and affirmation of their Airbus and Boeing single aisle orders would also make significant inroads into any remaining excess capacity in the market.
Consolidation amongst airlines and operating lessors will continue to spread during 2013. For airlines, most of the action will take place in emerging markets, especially India and other fast-growing Asian aviation centres. For lessors, the initiative will stay with Asian investors, as China and Japan still have significant muscle to flex as the balance of market power gradually moves eastwards. The completion of ILFC’s sale to a Chinese investor consortium would result in a grand total of more than $14bn of capital being committed to lessor acquisitions during 2012 – all of it from Asian investors. However, as we have seen before, acquiring ILFC can be a complicated process and the combination of size, complexity and a material political dimension in the current bid makes the outcome far from certain.
Even without an ILFC sale, Japanese and Chinese lessors already control close to 30% of the global leased fleet and, with more than 35% of aircraft deliveries going to Asian markets over the coming years, this share is set to grow considerably.
The annual financing of new deliveries is about to surpass $100bn for the first time, yet many of the traditional sources of funding are constrained by market or sector issues or face structural changes that will make their products more expensive and/or less accessible. Leasing, which has financed 35-40% of new deliveries over the past decade, is set to increase its share at the same time as the overall size of the financing gap is increasing, which presents an unprecedented opportunity for lessors and investors in lessors.
Lenders in emerging markets, especially Asian and Middle East banks, will play a significantly more prominent role in 2013, however overall capacity in the banking sector is unlikely to increase by much, if at all, as current lenders will still be dealing with legacy and macro issues and Basel 3-related balance sheet restructuring. New and nascent funding channels will therefore need to be developed. The US capital markets will be there in quantity for North American customers, but in the near term the rest of the world will not find it easy to exploit these products outside of export-credit related structures. It is also probably too early for the ABS markets to re-open, at least through the first half of the year. On the other hand, new pools of capital from institutional investors will increasingly find their way into the aviation space as the risk adjusted investment returns and their attractiveness relative to other asset classes become more widely recognised.
To close, here are a few more specific predictions for 2013, courtesy of the crystal ball, most of which I’m sure I will be reminded of in 12 months time:-
For the first time, more than 3 billion passengers will take to the skies during the year
American will join with US Airways in a merger agreed prior to their exiting Ch11
Boeing will significantly close the sales gap between 737Max and A320neo
Bombardier will sell more turboprops than commercial jets
ILFC will still be owned by AIG at the end of the year
There will be more consolidation in the aircraft leasing sector
Export credit agencies will approve over $10bn of new commitments
CMVs of most in-production aircraft will increase by between 5% and 10%
Boeing will formally announce the 787-10 but not the next 777 development
The aircraft economic life debate will continue to be energetically pursued