Despite the uncertainties endemic in a cyclical industry, it is possible to make accurate predictions. In 1989, at the height of the bull market, SH&E advised clients that there would be more than 650 surplus narrowbody aircraft around 1992-93. We correctly saw the surplus capacity created by the increased supply of available seat km from new aircraft deliveries. We were also among the commentators who correctly predicted that the airline industry would not have the earning power and balance sheet strength to finance more than 800 new commercial jet aircraft per year.
This industry is just emerging from a particularly severe and brutal winter and we are all expressing profound delight that spring is here. However, this spring is perhaps somewhat different from those we have experienced before.
Today, the aviation industry's expenses and revenues are radically different from those just a few years ago. For example, except for very short term spikes, real fuel prices are lower now than at any time since the early 1950s. In real (and absolute) terms, it costs less to fly the Atlantic than at any time in history. As the greater efficiencies of modern equipment permit lower yields, yields have continued to fall every year since 1960. Yields fell by an average of 2.6 per cent a year between 1960 and 1990, and Boeing forecasts a 0.8 per cent decline every year until 2010.
Airlines can only reduce their costs so far, but they continue to attempt to find ways to operate more efficiently. The US carriers' efforts to reduce commission expenses represent the latest attack on costs.
Clearly the changing economics of the airline industry, with improving unit costs and strengthening demand, have had an effect on aircraft prices and values.
It is important to distinguish between aircraft values and aircraft prices. The International Society of Transport Aircraft Trading (Istat), the only international certification body for aircraft appraisers, has fostered the adoption of two definitions of value - 'base value' and 'current market value'. Base value is the intrinsic value of an asset as represented by its earning power, whereas current market value reflects an aircraft's price as indicated by present levels of supply and demand. By understanding this distinction, aircraft owners and lenders might avoid disappointing returns from their investment decisions.
Today, we have very few straight cash transactions; many deals are leases or paper transactions in which it is difficult, if not impossible, to glean a true sales price. It is, however, quite possible to impute a value from these transactions.
Generally speaking, we are seeing a normalisation between values and prices. For the last couple of years, the majority of aircraft were trading at prices considerably below their respective values, but now base values and current market values are converging.
There are exceptions to the generally accepted rule that prices rise when demand exceeds supply. For example, late model Boeing 727-200 Advanced aircraft are now in short supply. However, almost contrary to normal economic wisdom, sale and lease prices have not risen - in fact, they have tended to decline.
The wide availability of older, lower cost aircraft is pulling down the prices of the newer, more desirable equipment because astute lessees have decided to opt for slightly older, more available aircraft. For example, if an operator was considering DC-9s and found that they were either not available or too expensive, the operator would actively consider the B737 market. This situation is bound to change, and we expect later model Stage 2 aircraft to become more expensive over the next couple of years.
There has been a substantial recovery in the used aircraft market already. Availability has decreased in all segments over the last few years, and the total number of jets available for sale or lease has dropped from an all-time high of 854 in May 1991 to only 534 in December 1994, according to Airline Monitor/Feasi (see chart). Many aircraft have been parted-out, but many stored, abandoned and forgotten aircraft have been returned to service.
Stage 2 narrowbody aircraft
Older Stage 2 aircraft, dating from the late 1960s to early 1970s, are generally selling at prices primarily dictated by the value of their engines. SH&E has sold over 60 aircraft in this category in the last three to four years. Later model Stage 2 aircraft are in short supply, but the values are only now beginning to reflect this.
Stage 3 narrowbody aircraft
Values of the MD-80 series have firmed up in recent months and there are very few available for sale or lease. However, there is a possible cloud hanging over MD-80 residual values, because there are few new orders for McDonnell Douglas commercial aircraft, and the MD-80 engines are only marginally Stage 3 and do not meet the nitrous oxide emission limitations recently imposed in Europe.
The Stage 3 capable B737 models are in very short supply and we expect that trading prices are going to exceed base values before long. This situation will be exacerbated by the recently announced production cutbacks at Boeing. The B757, although in production for many years, is still very attractive in many diverse markets and we expect values of later models, especially Rolls-Royce powered variants, to be stable for quite some time.
The Airbus A320 market is also strong. The earlier excess has been absorbed and the aircraft's excellent dispatch reliability is proving to be a significant attraction, especially in less technologically developed countries. Its crew commonality with the A330 and A340 is also very attractive to carriers seeking to minimise training costs while retaining maximum flexibility.
Older widebody aircraft
Certain older widebody aircraft continue to experience price declines, albeit at slower rates. These aircraft include the A300B2/B4, L.1011, DC-10-10 and the B747-100 and early -200 models. Admittedly, some will be converted to freighters, but such demand will be small compared to the availability of these aircraft. Limited user bases and very high maintenance expenses are the two most significant reasons for the relative unattractiveness of many of these aircraft. However, it is possible that some carriers will expand their longer haul, 'charter-like' service by deploying inexpensive older widebody equipment.
Newer widebody aircraft
It is quite surprising that approximately 80 per cent of longhaul missions flown fall within the capability of the high gross weight versions of the B747-200 and, for less dense markets, the DC-10-30 and DC-10-40.
The fuel efficiencies of the newest widebody aircraft are not so important in light of continued low fuel costs. Two-crew cockpits are not proving to achieve the cost savings which everybody expected, since either regulatory or union agreements frequently demand the carriage of a third cockpit crew member, even on comparatively short flights such as New York-London.
Thus we expect DC-10-30 and DC-10-40 prices to firm up over the next few years, and the seemingly high values of the later B747-200s and B747-300s will be retained.
The values of older B767-200 and A310 aircraft have fallen in the recent past. There are two principal causes for this decline: carriers have overbought aircraft with these mission capabilities, and falling prices of substitute aircraft like the DC-10-10, A300 and L.1011-1 are helping to pull down used B767-200 and A310 prices.
The relatively few new orders that have been received by the manufacturers in 1994 and early 1995 are having significant impact on the market for new technology widebodies. For example, Boeing received no new orders for the B777 last year and although the A330/A340 programmes are progressing, the numbers are discouraging. A dearth of MD-11 orders led McDon nell Douglas to suggest that it might shut down production temporarily, although MDC has since decided not to take this step. Further more, the B747-400 is becoming more expensive relative to used alternatives.
While we believe that there will be a continued demand for newer widebody aircraft, their prices will be under pressure as their market penetration appears to be lower than some originally anticipated.
A cool summer
SH&E believes that spring is here but that summer is going to be cool, rather than another heat wave. Aircraft values will firm, but it is going to be a few more years before we see anything resembling the heated markets of the late 1980s.
SH&E believes that spring is here but that summer is going to be cool, rather than another heat wave. Aircraft values will firm, but it is going to be a few more years before we see anything resembling the heated markets of the late 1980s.
Source: Airline Business
