BRENDAN SOBIE / WASHINGTON DC
The economic climate in the airline market is not all bad news - cargo converters expect the downturn to make 2003 their best year ever
If an ever-growing diverse group of aerospace firms looking for a ray of light in a depressed market is to be believed, 2003 will go down as the year of the cargo conversion.
Plummeting aircraft values, a string of airline bankruptcies, an unprecedented slump in passenger numbers, expected growth in air freight and pent-up demand for additional freighters are creating what many believe will be the ripest market conditions ever for cargo conversions. Specialised firms big and small, including newcomers targeting the sector, hope to tap into this demand by launching passenger-to-freighter modification programmes.
For Boeing aircraft alone, nine conversion programmes are expected to be launched in 2003. Boeing's own Commercial Aviation Services (CAS) subsidiary accounts for four of these launches, but has been forced to restructure all its teaming arrangements and cede prime roles on the 737-300 and 767-200/300 in response to growing competition from outsiders. "If we have no alternative to reduce the cost structure, we go the route of licensing," says CAS vice-president of freighter conversions Mike Stewart.
Competition has been the most intense on the 757-200, with five US companies planning launches. Three firms - Pemco Aviation Group, Precision Conversions and Structural Integrity Engineering (SIE) - all claim they will sign launch customers by the end of this month. CAS and B/E Aerospace subsidiary Flight Structures (FSI) are also in talks with potential customers and are ready to launch new or, in the case of CAS, restructured programmes.
All the firms are eyeing a group of lessors who, facing a glut of 757 returns over the next few years, are analysing if it is worth investing in conversions. The lessors are carrying out due diligence on the suppliers, and will take advantage of market competition. GE Capital Aviation Services (GECAS), for example, has bids in from all five firms.
"We look at technical expertise, as well as stability and longevity," says GECAS senior vice-president and manager of cargo programmes Christopher Damianos. "We look at much more than price. If you don't provide a sound design and product support, in the long-run it costs you more."
GECAS, historically the most aggressive of the large lessors when it comes to investing in conversions, is already co-launch customer for Israel Aircraft Industries' (IAI) 737-300 and 767-200 programmes. Damianos plans to decide on the 757-200, and possibly the 747-400, this year. But no provider expects GECAS to be its first customer this time.
Smaller lessors, and possibly banks stuck with aircraft returned as part of bankruptcies, are ready to supply 757s sooner, according to the conversion providers. Precision Conversions and SIE expect to take delivery of their first aircraft within the next month and redeliver the aircraft - plus secure a US FAA supplemental type certificate (STC) - by the end of this year. "The next 30 days will be pivotal in the 757 game," says SIE director of marketing Bob Convey. "Things are starting to become active."
Those comments are echoed by Brian McCarthy, Precision vice president of marketing: "We're negotiating with launch customers right now and we believe we're very close to a launch within the next 30 days."
But Precision and SIE have both already been plagued by delays and have an uphill battle against more experienced players.
FSI and Pemco have only begun preliminary design work and are not ready to meet Precision and SIE's ambitious schedule. CAS has a proven modification from the programme it launched in 1999 with IAI and Singapore Technologies Aerospace (ST Aero) following a major deal from express package carrier DHL for 34 conversions, and is also ready to deliver aircraft for new customers as early as this year. Stewart is in talks with several potential new customers.
But demand is not expected to peak until 2005 or 2006, when large lessors expect to convert large quantities of 757-200s. GECAS, CIT Aerospace, International Lease Finance (ILFC) and other large lessors have indicated to suppliers they are not interested in converting aircraft for a few years, although this spring GECAS plans to select a supplier or delay selection until year-end.
Large express carriers also are not quite ready to place the big 757-200SF orders the suppliers envisage. As the economy improves, and airline budgets loosen, big blocks of 757-200s could be converted in the second half of this decade to make up for the slow pace of narrowbody conversions. The pool of idle 757s will swell over the next few years as aircraft are returned from such operators as Condor, United Airlines and US Airways. Stewart acknowledges there has been "no big influx yet" of 757s and, for now, 767s are more readily available.
About 50 757s are already idle, but 13 are earmarked for delivery to DHL once converted. Conversion providers believe smaller lessors and banks with large portions of their portfolio idle - including 757s from the collapse of GATX Flightlease, National Airlines and Unicapital - could be enticed into converting aircraft before the larger lessors. Convey says his potential customer has too many aircraft on the ground to delay conversions any longer and must make "a strategic decision" in the next month. "It seems like the market is starting to mature," he says.
Precision and SIE hope their more than one year head start in development and $4.5 million price tag will give them a leg up in winning business from lessors and banks supposedly ready to invest in conversions. CAS is reworking its arrangement with IAI and ST Aero in an attempt to get its price nearer $4.5 million. "We're working towards a configuration that is competitively priced," says Stewart. "We have got some work to do to get our price down."
FSI and Pemco believe their experience in converting other aircraft types gives them an advantage over new entrants while their lower-cost structures allow them to stay price competitive. For example, Pemco is the only company besides CAS partners IAI and ST Aero with licensed original equipment manufacturer (OEM) data on the 757. "It's an advantage," Pemco chief executive Ron Aramini says. "Their [CAS/IAI/ST Aero] prices have prohibited them from half the marketplace."
The other suppliers have to create their own data from scratch and validate it on a prototype aircraft. Staffed with ex-Boeing employees, FSI specialises in this type of work, including developing a package carrier (PC) modification in the late 1990s for the Boeing 767-200 at a time when non-OEM 727 conversions were under fire from the FAA, leading to costly payload restrictions on operators, including FedEx. "We had to certify in that environment without the data," says FSI sales director of freighter conversions Dave Queen. "We've been down this path before."
But McCarthy of newcomer Precision says that while every leasing company once preferred an endorsed cargo conversion, "the value collapse of many aircraft has led people to the realisation they need an affordable solution in the lease economics we're in".
Competition is not so stiff on the 747-400SF given its heftier development cost, but both CAS and IAI also expect to launch programmes imminently, with airlines - rather than lessors - backing both ventures. CAS and IAI are talking to a handful of operators which have excess owned 747-400 passenger aircraft, but booming all-cargo operations. Stewart estimates a 747-400SF will cost $65 million - $40 million for the aircraft and $25 million for the conversion - but points out the overall cost does not seem so high to an airline stuck with excess aircraft in a depressed market.
Trade-ins for 777s
Redeliveries at both suppliers are to start in mid-2005. Eventually, lessors are also expected to invest in 747-400 conversions. Boeing's leasing division will be handed dozens of -400s in the next few years as trade-ins for 777s. Most of United's 44 owned -400s are likely to end up in the hands of creditors, which may invest in conversions themselves or auction the aircraft to other interested parties. GECAS, meanwhile, may decide on -400 conversions this year, but believes initial orders will come from airlines. "Both companies have approached us," Damianos says. "I would characterise it as early days."
CAS and IAI are also on the verge of signing suppliers. CAS has tapped Taikoo (Xiamen) Aircraft Engineering for the modification work and is in talks with other potential partners, including FSI and SIA Engineering. Queen says FSI is "actively" talking to CAS and IAI about potential partnerships and "is certainly not prepared" to launch its own 747-400SF programme.
Boeing hopes to turn the tide with the 747-400 after losing to IAI in launching the 737-300 and 767-200. Stewart says CAS "absolutely" expects to finally beat IAI on the -400 because this time it is "starting our business model" around the $20 million price tag. Boeing has supposedly learned a valuable lesson from the 737-300, 757-200 and 767-200, where it has been forced to repeatedly restructure programmes. "In the 747-400, we think we have a business plan in place…where we can hit targets without licensing to someone else," says Stewart.
CAS has already ceded the prime role for its proposed 737-300 and 767-200 conversion programmes. It is handing over sales and marketing functions for the 737-300 to Goodrich and Inter-Continental Aircraft Services (ICAS). The restructuring should be completed this month, freeing the new co-primes to line up launch customers later this year. Customers have the option of having the aircraft modified by ICAS in Taiwan or by Goodrich outside Seattle.
The idea, Stewart says, is to hand over to partners "where they have competencies at a better cost structure". CAS tried for nearly three years as prime to launch a 737-300 programme. After losing to IAI in 2001 a 15-aircraft launch order from GECAS, CAS reworked its proposal with Goodrich and ICAS to try to lower its price. But this was not enough - GECAS last month selected Pemco and its newly restructured 737-300 programme for six additional aircraft. "We did evaluate OEM solutions and we continue to, but with the 737 and 767 we ended up with the non-OEM," says Damianos. "For the customer, the conversion company doesn't matter." GECAS will take its first converted 737-300 from Pemco in May and three more by the end of this year. GECAS will also take two 737-300QCs from Pemco this year. GECAS has already placed all these aircraft, including two 737-300SFs at TNT.
GECAS is the second customer for Pemco's newly restructured 737-300SF programme following Iceland's Bluebird Cargo. Pemco, which for almost a decade has been the only 737-300SF supplier, has modified 35 737-300s, but last year secured a new STC with an enhanced cargo door. Aramini believes the new STC will help Pemco continue to beat Boeing in competitions and "expects to announce several new orders in the next few months. Boeing wants to get in the market and I don't know how they can," he says. "They are behind both us and IAI in the 737-300." But Damianos points out: "Before it's over I think there will be several hundred 737-300/400 conversions. With that kind of quantity, I think it implies there will be several suppliers."
GECAS plans to take its first two or three IAI-converted 737-300s in late 2003. IAI has also lined up five orders from an undisclosed customer, which will receive its first aircraft just ahead of GECAS. The lessor has the option of specifying 737-400s instead of -300s from IAI, but the first batch will all be -300s. "I don't see us converting -400s for a couple of years," Damianos says. "They are still relatively young. They are still popular in passenger mode."
Pemco and the CAS/Goodrich/ICAS team also plan to eventually expand into 737-400s. But given there are only 18 -400s idle, compared with over 50 -300s, Pemco does not envision offering -400SFs until late 2004 at the earliest. "So far the 737-400 lease and utilisation rate have not come down to make it an attractive freighter alternative," says Aramini.
For the 767-200/300, CAS has abandoned initial plans to modify the aircraft at its Wichita facility, which also has lost747-200 work to Taikoo. After losing to IAI in yet another GECAS competition, CAS decided instead to have 767 modifications done by Italy's Aeronavali. "If we did all the work in-house, we couldn't get a competitive price," Stewart says.
CAS earlier gave Aeronavali permission to market the design and Stewart says the two are negotiating a licensing agreement. Meanwhile, Aeronavali is in talks with potential launch customers. If a launch happens this year, work on the first freighter would begin in early 2004 with first redelivery as early as late the same year. This puts it a few months behind IAI's programme, which is set for initial deliveries in spring 2004. GECAS has committed to 10 767-200 conversions, four already placed at Colombia's Tampa Airlines, and has the option to also specify 767-300 conversions. Co-launch customer Airborne Express also has ordered five 767-200 conversions from IAI.
Airborne already operates 22 767-200PCs, which do not have a full cargo door, converted using an STC held by FSI. Queen says FSI has stopped converting 767s and is not interested in expanding into the 767 conversion business. European maintenance firm FLS Aerospace also examined developing a 767-200/300SF business last year. But FLS says the firm decided against pursuing the business after a deal with Sikorsky, which was to provide 767s for cargo conversion at FLS in exchange for selling helicopters to Ireland, fell through.
That leaves only CAS/Aeronavali and IAI pursuing potential 767 operators - at least for now. Plummeting aircraft values are expected to continue opening up conversion opportunities. At the same, demand is drying up for older programmes, prompting traditional players to expand product lines.
Airlines are reluctant to invest in more aircraft during economic downturn. Lessors, meanwhile, only seem to want to invest in conversions as a last resort. "We've got a large portfolio and we have very few now which are AOG [aircraft on ground] without leases," says Damianos. "Of the aircraft we can convert - even the 737-300s - I'm still in competition with my passenger colleagues. If they can find homes, we have to evaluate that. We're still remarketing aircraft to all parts of the world."
Source: Flight International