mrcapital2promo.jpg.crop_display.jpg AFI KLM E&M

Mid-Life Aircraft Seen Differently Given Fuel Prices, Passenger Demand

Lower fuel prices and growing airline traffic mean fewer aircraft retirements and tear-downs, but prices for used parts are generally likely to remain stable

Global economies are enjoying decent, if not thrilling, growth, and airline traffic is healthy. Fuel prices are down, at least for a while. Interest rates are still low, but may start to climb. Lease rates on mature aircraft have strengthened, and the rush to part out these veterans has slowed. But how will the aftermarket, which has enjoyed plentiful parts and low pricing from early tear-downs, fare under these new conditions?

Indications are probably quite well. Strong travel demand requires both new orders and prolonged flying by older jets, which means aircraft are going back to more typical retirement schedules.

A slowdown in retirements due to lower fuel prices is logical, notes Phil Seymour, president of the International Bureau of Aviation. “If an airline has to do a $5 million heavy check or return the aircraft to the lessor, it might do the check at low fuel prices and continue to fly. But who knows where fuel prices will go in six months?”

IBA sees another side of the favorable airline environment. Lower fuel prices and better traffic are increasing airlines’ cash flows, leading to new aircraft orders. Seymour fears the classic boom-and-bust cycle: new capacity added when not needed two or three years out. Fortunately, leasing companies offer “a bit of a buffer against the bust.”

Now an airline seeking a new narrowbody might be told by the airframe OEM it has to wait five or six years. “So it goes to a leasing company and lease rates go up,” Seymour explains.

Leasing decisions are also important for the retirement, disassembly and used-part markets. Lessors collect maintenance reserves and control the maintenance decisions when an aircraft is returned. In the recent past, they often parted out the aircraft and kept the reserves.

But in the last two years, Seymour says lease rates on midlife, 12-18-year old Boeing 737s and Airbus A320s have risen 20-25%. More of these aircraft are being put through heavy checks and continue to operate. “They are not making the decision to part out as rapidly as before,” Seymour observes. The result is fewer retirements and disassembled aircraft.

The drop has been significant. In the first half of 2013, Seymour estimates that two to three 737s and A320s were being parted out each month. Now the rate is about one per month, a reduction of half to two-thirds. “That will continue,” he says.

At the same time, new 737NGs and A320s continue to be delivered until their 737 MAX and A320neo cousins arrive. So jets 20-plus years old and already parted out will continue to provide spare parts for quite a long time.

Seymour notes five years of early retirements and frequent disassembly were very good to specialists like GA Telesis, AJW, AeroTurbine and Apollo Aviation. “These companies grew hugely.” Now they are looking for other ways to prosper.

Often, the new strategy will be buying aircraft, then choosing leasing or disassembly. “It’s a win-win,” Seymour says. “If current operators want to extend leases, they can do that profitably. If not, they can part it out.”

Seymour believes, “the only way interest rates can go is up,” but does not expect sudden, dramatic increases. He thinks U.K. interest rates might rise only a quarter percent by year-end and after that edge up “in little pieces.”

Leasing veteran Bob Genise believes in older jets. With some colleagues, he recently created Aergen, a new leasing company focused on 10-15-year-old aircraft. The company raised $200 million in equity in December and acquired Avioserv, which trades in engine parts.

Genise thinks some mid-life aircraft will stay in service longer than anticipated, due to strong traffic. He points to JetBlue Airways’ recent 9% traffic growth and says low-cost and ultra-low-cost carriers are bringing passengers back in the vital U.S. market. “The economy is not great, but it is solid and people are flying,” he says.

Aergen will manage leased aircraft until the end of life and then manage the break-up of their engines. Avioserv’s capabilities and Genise’s own experience at Boullioun Aviation, Singapore Aircraft Leasing Enterprise and Dubai Aerospace Enterprise should enable the company to do that well, he believes.

Aergen focuses on 737-700s and -800s, A320s and A321s, and a few A319s. Owners seek to bundle A319s in with larger narrowbodies, although operators mostly want A320s and A321s. “Then we will make the decision at year 17, 18, 19 whether to part-out or extend the lease for another three or four years,” Genise explains. That decision will be based on comparative returns.

Genise also expects a slow increase in general interest rates, with no major spikes: “I don’t see them much higher in the next two years.” He is confident fuel-price relief will last. “Oil is stuck around $70. If it goes above that, there is plenty of oil that will come out of ground, so I do not think it will go really high for a while,” he says. “The Saudis do not expect $100 per barrel for 10 years.”

With lower fuel prices and older models more attractive, Genise wonders whether some airlines might defer taking a few of the new aircraft they have ordered. “They may not need all those A320neos and 737MAXs and [can] slow down their introduction,” he says. “They could slide them a little farther out.”

Deferrals would partly depend on any penalties imposed by OEMs, which depend on specific contract terms. Genise says carriers usually have more flexibility in taking deliveries than lessors. “New aircraft lessors do not have the ability to slide out, so they will be pushing to find aircraft homes. If interest rates go up, returns on new aircraft will not be good,” he says.

Air Lease Corp. strategic planning head Ryan McKenna scoffs at the notion of new aircraft deferrals. His company places new aircraft 2-5 years in advance, and McKenna says demand for new-technology aircraft—such as the 787, A350, 737MAX and A320neo—remains very strong.

Carriers do not make $150 million investments in new widebodies based on short-term conditions, or the spot market in fuel or interest rates, -McKenna stresses. They are deciding on deliveries five years out for aircraft that will operate for 15 years. “They are optimizing for their business model, whether it’s low-cost or full-service, for city pairs and [their] connecting strategy,” -he says. McKenna argues fuel prices are unpredictable over such long planning horizons. Carriers must look at demand, traffic and services they want to offer, all at lowest cost. New-technology aircraft promise lower emissions, as well as weight, fuel, and maintenance savings. “Modern technology is here to stay,” he says. “Nobody drops a Mercedes for a 15-year-old Dodge because fuel prices decline for a while.”

Air Lease Corp. is not seeing declines in new aircraft orders and would order more if it could. “There are no 787-9s, A350-900s, [737] MAXs or NEOs available,” McKenna says. He attributes the slowdown in retirements to strong passenger demand and scarcity of new aircraft. “And OEMs are putting fewer seats in new aircraft,” he says. “Moving from a 747 to a 777 loses seats, and manufacturers are putting more premium seats in new aircraft. If there were weakness in the new aircraft market, we would buy. We have $2 billion in capital, and we’re not in for the short term.” 

[CHARTBEAT:3]

Tadas Goberis, CEO of AviaAM Leasing, says returns on aircraft financing are now similar to those recorded in 2006-07 and even higher for certain aircraft. Lease terms on 737s and A320s are at pre-2008 levels. Goberis predicts that “in the next couple years, rates will stay at the same level or even go up slightly.”

Goberis expects some retirements, but no big change in fleets of A320s built in 1995-2000. A320s built after 2000 will continue to fly as long as economies grow. He thinks 737NG prices are generally too high for parting out, and limited tear-downs of 737‑600s and -700s will continue for 2-3 years.

But widebody markets are shifting with the introduction of 787s and renewal of the A330. “[Boeing] 767s and A340s will probably be parted out in large numbers due to unpopularity in secondary markets,” Goberis predicts. Early 777s may meet the same fate, relieving scarcity in 777 part stocks.

Goberis does not expect much change in aftermarkets, except for the 767, and that has been expected for six years. Boeing 777 stocks should improve slightly. Airbus A330 prospects are uncertain, but stocks for them are ample. Parts for 737 classics, A310s and A300 will be written off for lack of markets.

Ian Malin, treasurer and chief investment officer of AJW Group, expects some older aircraft will stay in service longer to help meet strong traffic demand, supplementing but not reducing new aircraft orders. But AJW has not struggled to find aircraft for tear-down, still one of its main sources for used parts. AJW still bids for used jets based on parts values.

Used aircraft prices seem steady at present, Malin says, but they might rise: “People are starting to think differently about aircraft that have life left in them. Now they can keep them flying a little longer.” He notes that low fuel prices boost disposable income and travel as well as improving economics of older models. And extending aircraft lives back toward the traditional 25 years is a tactical solution to increased demand, not a long-term one.

Malin says used-part prices dropped during the massive decommissioning of 2013 and 2014 and have not yet recovered. AJW is not counting on a rise in part prices yet, but as a major holder of part stocks, he would be very pleased if it occurred. The company has evaluated leasing out whole aircraft, which would give it the option of flying or parting out its acquisitions, but AJW has no immediate plans to get into that business.

Henri de Belizal, vice president of asset management at Air France Industries KLM Engineering & Maintenance, sources parts from tear-down specialists, the aftermarket and within his company’s network. Buying bulk packages after tear-down can save up to 20-25% over smaller purchases, Belizal says, so he tracks and forecasts tear-down markets carefully.

Belizal predicts narrowbody tear-downs will increase steadily over the next 10 years due to the huge volumes of new aircraft—MAXs, NEOs and larger regional jets—due for delivery. He estimates 200-300 aircraft of all sizes will be available for disassembly annually.

The AFI KLM E&M executive says used-part prices have decreased, most sharply for larger parts and a bit less for smaller parts valued at less than $5,000. Continuing decreases in part prices plus more competition for retiring aircraft may trim tear-down margins, Belizal notes.

Some aircraft have reached a plateau in disassembly and others, primarily widebodies, are simply uneconomic to tear down, says Carl Glover, vice president of engine-part trading company AAR. Younger A320s and 737NGs are flying more and headed for part-out less frequently. Glover expects this shift to continue as long as fuel and maintenance costs stay reasonable.

Glover sees some used inventories continuing to increase as fleets mature and operators transition to new technologies. But used-part markets are highly volatile: Some prices will decrease, while others increase.

Fly Leasing CEO Colm Barrington sees resilience in the value of used aircraft, partly due to low interest rates. But he expects carriers will still seek NEOs and MAXs for their new technology and as a hedge against higher fuel prices. “There may be a trend to keep older aircraft a little longer as a result of current fuel prices, for example at Delta Air Lines,” Barrington notes.

The overall picture therefore includes strong demand for both new and mature aircraft, which mainly reflects continued economic growth. Lower fuel prices help boost both traffic and the attractiveness of older jets. There is no near-term probability of the kind of large interest-rate rise that could kill demand; indeed, central bankers are mostly trying to keep GDP growth limping along.

In brief, parts markets will not be flooded with more tear-downs, but normal retirements should keep stocks ample enough to moderate prices. 

Hide comments

Comments

  • Allowed HTML tags: <em> <strong> <blockquote> <br> <p>

Plain text

  • No HTML tags allowed.
  • Web page addresses and e-mail addresses turn into links automatically.
  • Lines and paragraphs break automatically.
Publish