Aircraft values have staged a recovery in 2004, and some of the more popular types are beginning to run short as traffic stages a comeback

T he airline business is facing a paradox. While the industry as a whole is still struggling to make decent money, and in North America is still losing it by the sackload, the market for aircraft is tightening significantly and values are on the up.

This is because traffic has come back strongly, and load factors are at very healthy levels. There was a double-digit rebound in traffic last year and load factors running at well over 70% were commonplace in all markets.

For many carriers, turning this traffic in decent yields, and hence revenue, is proving difficult. But that, of course, is another story. For aircraft values, the effects of the traffic surge in 2004 are already apparent. "I would say 2003 was the trough of the market, but 2004 was a very pleasant surprise," says Adam Pilarski, senior vice-president at appraiser AVITAS.

This recovery in values has happened despite the fact there are still plenty of aircraft in storage. Figures from AvSoft, the Airline Business sister fleet data provider, show that over 1,900 aircraft are still currently parked (see table page 54). That nevertheless marks a significant reduction from a year ago – down from nearly 14% to 12% of the world fleet. The aircraft that go to make up this inactive fleet also tells a story.

Many of the stored aircraft are old, or, as Ed Greenslet of consultants Airline Capital Associates terms them, "the living dead". For instance, there are more than 500 Boeing 727s in storage, few of which are likely to see a return to action. Nearly half of all 727s are now idle, and despite the pick-up in market conditions, this percentage in fact edged up last year.

In contrast, the market for modern types is very tight. AvSoft figures suggest there are only around 60 in-production narrowbodies going spare, with the percentage share of stored aircraft halving from 3% to 1.5%. The spike in kerosene prices has, of course, made more fuel-efficient modern types more attractive than their fuel-guzzling older siblings.

Greenslet points to the pick-up in lease rates as further proof of a tightening market. They have risen between 20% and 40%, depending on type. "Lease rates are the equivalent of the spot market for aircraft," says Greenslet. "They are volatile but they reflect the underlying direction."

As the market for some of the key aircraft types gets squeezed in the second half of this decade, value appraiser AVITAS is forecasting market values (which reflects transaction prices) to move above base levels (which reflect the theoretical value to the airline). "We're not quite there yet, but I would expect the gap to close in 2005 and in 2006 we will be very close," says Pilarski. This would be a reversal of the picture in the last few years, where market values have been under pressure in a depressed marketplace.

Looking at an Airbus A320-200 built in 1999, for instance, AVITAS reported a base value of $22.5 million in 2003, but a market value of just $17.6 million – a differential of $4.9 million. This divergence is still apparent for 2005 figures, with base value of $17.6 million and market value of $13.7 million. However, AVITAS sees a near convergence in 2006 ($16 million against $16.7 million) before market values edge ahead of base values, maintaining this position until converging again in 2012.

Simon Finn, head of valuations at appraiser IBA, says that with few modern narrowbodies available, and little availability from leasing companies, the market is extremely tight.

Narrowbody battles

In the key battle (as far as manufacturers go at least) of the Airbus A320 versus the Boeing 737NG, Finn says there is still a "perception" that Boeing types have the edge in terms of value. He puts this down in part to the "unusual environment" in the USA, where most of the big players tend to be 737 operators. The ability of US airlines to exist in Chapter 11 court protection gives some comfort to investors. In Europe and the Asia-Pacific, the main markets for the A320, there is no such safety net.

Ironically, the two US majors most in danger of bankruptcy, US Airways and United Airlines, are both A320 operators, and AVITAS estimates that these two carriers account for some 9% of the in-service fleet. "The prospect of liquidation at either remains something of a threat in the background," says AVITAS. It also sees the fact that the type has been in production for 18 years with no significant upgrades as another negative factor for the A320.

Even so, appraisers see few if any fundamental differences between the two families, especially given the tight market, and even older A320s and 737 Classics are faring well. Finn at IBA says that rates for older A320 models have seen lease prices climb from $120,000 to $140,000 a month over the last year. He says he can easily see this going up to $160,000 a month.

Finn also points to the 737-300 and especially the 737-400 as models to watch. There has not been enough outright trading to judge prices, he says, but notes that with lease rates up by around 15-20% over the past year, a pick-up in values is likely. "They are close to the 150-seat mark which many operators seem to want, and are ideal for short-haul domestic."

Leasing companies report some signs of life in the Boeing 757, a type that has been under pressure for a number of years. In fact, the last models came off the Boeing production line last year after the US manufacturer decided to cease production. The aircraft is also still popular with some operators for thin long-haul routes, such as those flown by Continental Airlines across the Atlantic. Activity in the 757 market was restricted to developing markets last year, however, with takers including Brazil Rodo, Uzbekistan Airways, Varig and Vim-Avia of Russia. Finn warns that the US market, the largest home for 757s, seems to have fallen out of love with the type for domestic service. "It is too big for what they want," he says.

There are a number of 757 freighter conversion programmes, although so far Boeing‘s conversion of 21 ex-British Airways 757s in the early part of this decade remains the only completions in this area. Finn warns the freighter conversion market may be limited by the fact that the 757 is less suited for unit load device air freight containers than its Airbus equivalents.

Low initial costs

Surprisingly perhaps, there are still signs of life in the Boeing MD-80 market, with 2004 customers including Allegiant, American Airlines, Bulgarian Air Charter, Italian charter carrier Eurofly, Far Eastern Air Transport, Turkey's MNG and Spirit Airlines. Finn is surprised so many carriers are opting for a fuel-guzzling older type (principally the MD-82 which was the most widely produced) at a time when kerosene prices are at record highs. MD-80 values were decimated during the downturn, suggesting that the low initial costs may explain the attraction. Finn does not see any chance of a recovery in values in this market, despite the continued activity.

In the widebody sector, Finn says aircraft with extra range capabilities seem to be performing best, even if the airlines do not use the extra available miles. Flexibility and an eye to the remarketing potential may explain this.

An example of this phenomenon is the Boeing 777, where AVITAS reports that the 777-200 market remains soft, while the Pratt & Whitney-powered 777-200ER is stable and the market for 777-200ERs equipped with GE and Rolls-Royce engines is firm. "The market for the 777 has improved over the last 18 months despite the concerns over the future of United Airlines," AVITAS reports, adding: "The 777-200ER market is significantly stronger than the 777-200 due to its longer range, broader operator base and strong order backlog."

AVITAS reports that 67% of the 777-200 fleet is based in the Asia-Pacific region, where it has been popular on relatively short but high traffic volume routes. The 777-200ER has a pretty even geographical distribution, with North America and the Asia-Pacific market both accounting for 30% and Europe 25%. No GE-powered 777s have been available for over a year, AVITAS reports.

Looking at the new long-range 777-200LR Worldliner, Finn has worries about the lack of demand, with Taiwan's EVA Airways (three orders) and Pakistan International Airlines (two) so far the only customers, with PIA due to become launch operator later this year.

Finn says he does not expect the model to achieve much of a premium on the 777-200ER, warning that it is in danger of becoming a niche product. Boeing predicts up to 300 sales of the Worldliner over the next 20 years.

Offloading aircraft

Appraisers report that US carriers have quietly been offloading aircraft into the market, with more public evidence coming from the two majors in Chapter 11 who are obliged to disclose their deals. United, for instance, has disposed of 737 Classics, 747s 767s and 777s. The pressure on values is mostly on the narrowbody sector, however. "Yields are better on the international flights so US carriers tend to be cutting more domestic aircraft," says Pilarski. "There is also movement in the US to the 70-90 seat market, putting pressure on the smaller, older narrowbodies."

Finn says that the appetite for the A330 has also been strong, with its better seat mile costs persuading some airlines to change from the smaller Boeing 767. However, the extra range 767-300ER is picked out by appraisers as a strong performer, with leasing rates up from around $240,000 to $400,000 per month over the last year and a half. "We expect this to result in a rise in values, although we haven't seen proof in trading yet," he says. Of course, this sector of the market is hugely influenced by the impending arrival of the Boeing 787 and the Airbus A350.

Finn says that although the arrival of the 787 will impinge on the values for aircraft such as the 767, the effect may be less than some suppose. The 787 will go into service in 2008, and Finn says it will take a while to penetrate airline fleets. "There will be a need for interim lift for the next five or six years. The 767 will not die overnight."

Finn plays down suggestions that the twin-engined A350 will put pressure on future A340 values, pointing to the continued demand for four-engined aircraft for the polar routes. However, he warns that the 787-9, due to come into service early next decade, could put pressure on the 777-200ER, as it would basically be a more effective way of doing a similar job.

Although it is early days, appraisers have been trying to put a value on the Airbus A380. AVITAS has taken a "should cost" methodology based on comparisons with alternatives such as the 747-400 and A340-300/500/600 and estimate a figure of $170 million. After 10 years, presuming an inflation rate of 2.5%, the estimated value is $90 million, and after 20 years, $45 million.

IBA estimates a leasing rate of $1.5 million per month for the A380, although interest from leasing companies has been limited to a 10-strong order from ILFC. Finn believes the value of the A380 may spike up to $180 million once the next wave of orders come in. He warns, however, that the appeal of the secondary market looks limited at the moment. Appraisers do have some concerns about the large number of A380s that have been ordered, sometimes serving markets that are traditionally regarded as thin.

Asia-Pacific demand

Despite the imminent arrival of the A380, which will enter service in 2006, the 747-400 has fared pretty well lately, driven in part by the strong demand for freighter conversions from the Asia-Pacific region. "Those that bought in 2003 and especially 2004 had perfect timing," says Finn. For example, equity fund Guggenheim Aviation, which bought four 747-400s for conversion last year, looks as if it may have timed things well. IBA estimates that 747-400 freighters are bringing in around $600,000 a month.

It appears that 2004 ended up being a strong market for values and the improvement looks set to continue. By the end of this year some of the most popular types may be in very short supply indeed, even if the yield environment remains challenging.

Pilarski admits that the yield situation is putting a cap on values for the present. However, with more muted, but still strong traffic growth forecast for 2005, the shortage of modern aircraft types could see a further hardening of values, particularly if high fuel prices continue through the year.


Source: Airline Business