After a number of false starts, the pace of recovery finally picked up during 2013 across most sectors of our industry. Whilst the cycle has certainly been stretched to the limit since 2008, recent trends validate its continued existence and our progress up the recovery slope is gaining momentum. The latest confirmation that recovery is under way comes in the form of airline financial performance, with results for 2013, according to IATA, indicating a net profit of almost $13bn for the industry, which is a 75% improvement on 2012. This has been achieved despite disappointing economic growth in several of the largest emerging markets, high, albeit stable, fuel prices and continued weakness in the air cargo sector. Although there are significant regional variations across the airline community, a sustained focus on fuel efficiency, capacity restraint and labour costs is delivering meaningful and sustainable benefits to airline bottom lines.
IATA’s financial forecast for 2014 is upbeat, with a further increase in net profit, to $19.7bn, predicted. Over the medium term, the outlook for traffic growth, at least for passenger carriers, is positive. Airlines carried more than 3 billion passengers for the first time in 2013 and the most recent forecast from the airlines themselves predicts a 31% increase on that number by 2017 – that’s 930 million more bottoms on seats and almost 4 billion travellers every year. The average growth rate of 5.4% compares to 4.3% per annum achieved between 2008 and 2012, with 70% of the incremental traffic coming from domestic markets and 24% connected to China in some way.
These robust underlying growth metrics help to sustain demand for new aircraft. Order commitments continue to break records, keeping backlogs ridiculously high, despite production rate increases for the most popular models. Orders increased by 33% over 2012 to reach more than 3,300 in total and, even with deliveries 5% higher, the industry book-to-build ratio has risen to almost 2.4:1. However, with over 40% of deliveries being used to replace ageing, less efficient aircraft, capacity growth has remained in touch with traffic growth, resulting in system-wide load factors averaging more than 80%.
A significant share of new aircraft orders has been motivated by fuel efficiency – no surprise when fuel represents such a large part of every airline’s operating costs. Although consensus forecasts expect fuel prices to abate slightly over the next couple of years, fewer than 20% of contributing economists expect Brent crude oil to fall below $100 a barrel. That is a powerful argument in favour of the new technology aircraft and engines that are at the point of entering service in growing numbers. It equally well makes the case for the current in-production models that will continue to out-perform the previous generations of aircraft for the foreseeable future. New widebodies, just the same as new narrowbodies, will take many years to supplant their cousins that are entering service today and their transition is not expected to have any significant impact on either demand for, or values of, current generation aircraft, for the same reasons of critical mass and availability that apply to A320s and 737s.
2013 saw further solid growth in the aircraft leasing sector, with a number of platforms aggressively pursuing volume and making the sale and leaseback market an attractive and often red-hot financing option for airlines. As predicted a year ago, the supply and demand balance in the placement market has been restored, with a much less dramatic overhang of forward orders evident than was the case
12-18 months ago. With some serious over-booking of delivery slots by the OEMs, for A320s in particular, but also 737s, the lessor channel will remain the only source of additional capacity for the next several years and this has been reflected in the firming of placement lease rates and terms that has been evident over the course of the past 12 months. A number of airlines are now indicating their readiness to induct older aircraft at short notice as availability of new kit is simply not there. This will further help the recovery of values for used equipment which has begun, albeit more gradually than has been the case for newer vintages, with more banks now actively prepared to finance older aircraft. Used aircraft trading activity continues to increase, with more than 200 commercial jets between 5 and 15 years changing hands in 2013, excluding part-out activity.
There is no reason to believe that the resurgence in liquidity for aircraft financing seen in 2013 will abate in 2014, with margins expected to continue to come in as most financiers of scale are building or rebuilding their aviation positions and rebalancing their lending away from airlines with more emphasis on lessors. A welcome number of new lenders entered the sector in 2013 and additional players will likely swell the total in the coming 12 months, as regional banks increasingly migrate their roles from local relationship lenders to global diversified players. Although the export credit channel is not expected to secure the same market share as in recent years, they will still support significant volumes of new funding in 2014 with the help of the tailored bond structures that are featuring in more ECA transactions.
A major feature of financing in 2013 has been the capital markets, which are rapidly establishing themselves in international markets having previously been limited to North America. With the EETC and bond markets seemingly operating on steroids, the potential for a funding gap in 2014 once again looks to be very low, despite a $110bn requirement. Lessors will step up to 40% of this total, with half of the amount they provide being internally funded.
The recently announced acquisition of ILFC by AerCap is a very welcome one for the industry as a whole as it will finally remove a very large elephant from the room. This transaction has significantly lower execution risk than earlier proposals and, although AIG will retain a meaningful investment in the leasing sector for the time being, it does reduce the scale of the initial stage of the trade. Over time, AIG will be able to divest its shareholding in the investor market, a process that could begin within 12 months. The transfer of the ILFC portfolio to Ireland will raise the Irish share of aircraft lease management from 40% to almost 55%, whilst the US share will fall from 30% to below 20%.
Before presenting the output from my new 2014 crystal ball, it may be of interest to see how well last year’s predictions turned out. As it happens – not too badly! Just two wrong out of 10, with a question mark over a third. Firstly, Boeing did not really manage to move the needle in their Neo vs Max battle. They began the year with 40% of combined orders and 12 months later are at 41%, according to published sources.
The crystal ball also misread Boeing’s readiness to launch the 777X, which they snuck in at the tail end of the year, rather than doing the decent thing and waiting until early 2014. Also, in the interests of fairness, whilst Bombardier secured twice as many commitments for the Q400 as for their commercial jets, the jets won the race on firm orders alone. The question mark over CMV increases reflects a lag between the generally conservative level of value recovery that appraisers have been reporting during the year and a stronger improvement trend in market values, certainly for younger vintage models, that lessors and traders have observed since the start of 2013.
Now, to close, here are some thoughts about what 2014 may have in store against a backdrop of steady and accelerating recovery:
The airline industry will succeed in maintaining load factors and improving profits
Boeing will step up the pace on Max sales
Airbus will announce additional performance tweaks for the A350-1000
Flight tests will validate CSeries performance targets, but it will not enter service in 2014
There will be a 50% reduction in the number of parked freighter aircraft by year-end
Airbus will reveal a further narrowbody rate increase
The capital markets will finance at least 15% of 2014 new aircraft deliveries
Appraisers will reflect a further 5-10% improvement in production aircraft CMVs by year-end
Public lessor stock prices will rise further, with an average increase of 10-20%
ICAO will continue to move slowly on a global emissions strategy, but the European ETS scheme will remain in suspension
Head of Strategy, Avolon
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