Industry review and outlook: DVB Bert van Leeuwen

Extracted from Airfinance Annual • 2016/2017 Industry review and outlook: DVB

Industry review and outlook

Bert van Leeuwen, managing director, aviation research, DVB, says that, although the industry is still enjoying growth, there is concern about how, and when, the boom will end.

he golden age of commercial revision of the 2017 global growth their customers. According to the Taviation continued during the projection. The IMF also noted some International Air Transport Association first half of 2016. While geopolitical pick-up in Chinese infrastructure (IATA), the trade association and economic events caused investments and higher oil prices. representing some 265 airlines or significant uncertainty in many On 23 June, after the UK voted in 83% of total air traffic, average return parts of the world, passenger traffic favour of leaving the European Union, fares (before surcharges and taxes) continued on its growth path. Despite things changed and an important in constant (2015) US dollars will drop slowly increasing fuel prices, airline downside risk for the world economy from $407 in 2015 to $366 in 2016. profitability on an aggregated level is materialised. Also the financial While average fares have been still at very comfortable levels. markets were caught by surprise. falling for decades, it has been the After an almost unprecedented Because of the expectation that the lower fuel price that enabled airlines period of relative prosperity in the uncertainty resulting from Brexit to lower ticket prices by such a huge industry, questions are being asked will take its toll on confidence, in amount. The projected total spend about the longevity of this boom, general, and in financial conditions, in of air transport in 2016 is anticipated especially by those observers that particular, the IMF adjusted its World to be about $740 billion, 1.3% lower had seen how the almost 10-year long Economic Outlook (WEO) in July compared with the $750 billion from boom in the shipping industry ended. downward by 0.1 percentage point 2015. In real volume terms, both the In the early months of 2016, some compared with its April forecast. The revenue passenger kilometres (RPK), aviation industry leaders, mainly from European economies are expected to as well as the number of passenger the original equipment manufacturers be impacted most, with only modest departures, are projected to increase. (OEMs), as well as North American effects on the US and China. In its The RPK volume will rise from 6.679 airlines, dismissed concerns that the July WEO, the IMF projected a 3.1% billion in 2015 to an estimated 7.093 aviation business cycle was on the increase in the world output for 2016, billion this year, a 6.2% increase. The cusp of a downturn. increasing to 3.4% for 2017. number of passenger departures Airbus’s chief operating officer Another interesting and highly will increase by about 6% to 3.783 customers, John Leahy, was quoted relevant change in the IMF billion. The airline industry is offering as saying “aircraft manufacturing is projections is the assumed oil price. its customers an increasing range no longer a cyclical business”, and For 2016, the average projected oil of direct connections. Over the past American Airlines chief executive price was increased from $34.75 a 20 years, connectivity has doubled officer Doug Parker as “… it is highly barrel (bbl) to $42.90/bbl and for the and today the world’s airlines offer unlikely you are going to see losses year 2017 from $40.99 to $50/bbl. connections between more than again in this business”, later explained In its July report, the IMF concluded 18,000 unique city-pairs. by the airline that he “was not trying that from a macroeconomic The impact of terrorist actions on to say that no one will ever lose perspective, Brexit substantially global travel and tourism in 2015 money again in the airline business” increased economic, political and 2016 seems to be relatively but rather that “down-cycles won’t and institutional uncertainty, with modest, compared with the impact of look like they did in the past”. projected negative consequences, similar kinds of atrocities in the past. At the opposite end of the especially in European economies. Despite the apparently increasing spectrum, reputable analysts Given those economic frequency and high-profile nature of could be found, including Avitas’s uncertainties, plus the high level of these atrocities, it seems the impact Adam Pilarski, who questioned the terrorist activities and political unrest on travel and tourism is mainly felt assumption that “we are entering the (such as in Turkey), it is almost a locally. The World Travel & Tourism magical world of no aviation cycles”. miracle that passenger traffic has Council (WTTC) expects that for 2016, More on this later. continued its solid growth path. Over the direct gross demestic product During the first months of 2016, the the first half of 2016, global revenue (GDP) contribution of the sector will global economy evolved in line with passenger kilometres increased by still grow by 3.1%. the International Monetary Fund’s 6%. According to WTTC, only three (IMF) expectations, and improvements The growth in air transport can countries have seen their outlook in a few large emerging markets partly be explained by the lower ticket deteriorate during the first months of suggested a potential modest upward prices, which the airlines are charging 2016. Despite the Olympic Games,

6 Airfinance Annual • 2016/2017 Industry review and outlook: DVB

higher load factors and more income Airline industry – results per region from ancillary services. Traditionally, when airline profitability went up, the new order 30.00 [US$ bn] [US$ ] volume for commercial aircraft also

25.34 increased. This link has been broken 25 25.0025 22.90 in the past year. While the industry

20 20.0020 profit doubled between 2014 and

2015, the number of new aircraft

15 15.0015 orders dropped to 2,400 from about

3,600 (new orders for western-built

10 10.0010 jets, all commercial operations, 7.80 7.83 7.50 7.83 including type swaps). This trend 5.94 5 5.00 5 seems to have continued in the first

1.60 eight months of 2016, with about 1,100 0.10 0.38 0 0.00 0 orders versus almost 1,400 during the

-0.50 same period in 2015.

-5 Both the Boeing 737 and the -5.64 Airbus A320 booked decent order Africa Asia-Pacific Middle East Latin America North America Europe -10.00 volumes over this period. Airbus sold Projected 2016 net post-tax profit in US$ billion Projected 2016 net post-tax profit per passenger in US$

Source: IATA "Economic Performance of the Airline Industry, mid 2016" about 300 Neos and 130 Ceos but there was a significant number of type swaps included in this number. held in Rio, Brazil, turmoil and weak 5.9% to 9.3%, and for 2016 a further Boeing sold about 210 Maxs and 110 macroeconomics have caused increase to 9.8% is projected. NGs. Bombardier finally seemed to growth to deteriorate from -0.9% It should be noted that the main have hit the jackpot with 130 orders to -1.6%. Turkey will see the direct source of profitability is the North for the CSeries. Widebody aircraft contribution of travel and tourism to American market. It is interesting sales were particularly hit in 2016, the GDP deteriorate from an initially to compare the absolute post-tax with only 125 orders in the first eight anticipated -0.2% to -3.2%. Obviously, profit per region with the profit per months. in the case of Turkey, many factors passenger. By both criteria, North It has been suggested that the play a role: a spate of terrorist attacks, America stands out. Apart from the relatively low fuel price has taken the failed military coup, changes benefit of lower fuel costs, the North away a major incentive for airlines to in the internal political climate, the American result can be explained order fuel-efficient new-technology conflict with Russia and the war in by the increased market power of aircraft. It is difficult to find convincing nearby Syria. the major airlines after a wave of proof for this. Jet fuel (US Gulf Coast, The third country to suffer is France. consolidation. This has enabled FOB) reached a low in January While still in positive territory, the improved pricing power, as well as 2016 at just over $0.80 a gallon but growth in the contribution of travel and tourism to the French GDP will be reduced to 1.1% from 2.9% because of Crude oil and jet fuel price development the various terrorist acts in the country, including the atrocities in Nice in July. [US$ ] [ ] From a financial perspective, the 300 300 airlines are at a completely different level compared with years ago. While 250 250 during the first decade of this century (2000-09) significant losses were booked, this changed dramatically 200 200 after 2010 when, according to International Civil Aviation 150 150 Organisation figures, global airlines booked a net income of $17.3 billion. 100 100 In 2015, partly as a result of the low oil prices, net income doubled from 50 50 the previous year to $35.3 billion. For 2016, preliminary IATA figures indicate 0 0 a potential net post-tax profit of $39.4 Dec 13 Mar 14 Jun 14 Sep 14 Sep 14 Dec 14 Mar 15 Jun 15 Sep 15 Dec 15 Mar 16 Jun 16 billion. Between 2014 and 2015, the US Gulf Coast Jet Fuel Spot (US¢ per gallon) WTI Spot (US¢ per gallon) return on invested capital jumped US Gulf Coast Jet Fuel Spot (euro cent per gallon) WTI Spot (euro cent per gallon) Source: Energy Information Agency and European Central Bank from an already unusually positive

8 Airfinance Annual • 2016/2017 Industry review and outlook: DVB

subsequently showed a steady climb the German export credit agency, lower pace compared with 2015. to reach $1.45 in June. Since then, the Euler Hermes, halted all guarantees According to IATA, total revenue price has fluctuated between about and export support for Airbus passenger kilometres increased by $1.20 and 1.40 a gallon. aircraft. Reported “inaccuracies” 6.5% year on year for the full-year Apart from the price of jet fuel, it in applications for export credit 2015, slowing down to 6% during the seems the new order volume is held financing relating to information first six months of 2016. International back by the record backlog already provided in respect to consultants traffic – representing 63.6% of total on order and the resulting significant and other third parties were the traffic – grew by 6.2% compared with lead times for the delivery of the more reason for this suspension of support. 6.5% in 2015, while domestic traffic popular jet types. Overall, the backlog In July, Airbus reported that a process – representing 36.4% of total traffic – for commercial jets is equal to about for the re-establishment of ECA managed only 5.6% against 6.3% last nine times the production volume of financing had been agreed and was year. The 2016 numbers are broadly 2015. Another stimulating factor that ongoing, and that it was targeting in line with the 10-year average rates, was absent in 2015 and the first half ECA financing to resume in the fourth which is not too bad given the weak of 2016 was the launch of a significant quarter of 2016. situation of the global economy. new aircraft type. Only a few new The timing of these two incidents Predictably, the Middle East carriers variants, including a minor stretch could not have been better. Boeing (representing 9.4% of world RPKs in of the 737 Max 7, were announced. reported that the percentage of 2015) showed the strongest growth Airbus and Boeing were rumoured deliveries supported by Exim reached in international traffic, with an 11% to be contemplating new aircraft, 30% during the global financial increase in RPKs. Like in previous such as an A350-2000, a 777-10X, an crisis between 2009 and 2012. In years, load factors stayed behind as all-new middle-of-the-market aircraft the period 2012-15, this percentage the international airline capacity in the or a 737 Max 10, but effectively none had come down to a 10-year low of Middle East continued to expand by of these have been confirmed. Most 11%, probably partly as a result of the an ambitious 14.7%. During the first developments that were announced 2011 Aircraft Sector Understanding half of 2016, the big three, Emirates, focused on high-density interiors, that increased the cost of export Qatar and Etihad, took delivery of no by applying slimline seats, more financing for most borrowers and fewer than 33 large twin-aisle aircraft compact galleys and lavatories and made commercial funding more – including nine 777-300ERs and reconfigured emergency exits. attractive. For 2016, Boeing predicts 12 A380s – leaving little doubt their The stagnant order intake certainly that only 11% of all global commercial expansion plans are still very much is not caused by a lack of commercial jet deliveries will involve export credit, alive. funding. Both debt funding, as well down from 13% in 2015. Surprisingly, the runner-up in terms as equity, is abundantly available of international traffic growth was at historically low cost by a broad Air transport market – first-half Africa, the continent that carried range of lenders and investors. The 2016 the red lantern in 2015. Africa is a only source that could not easily be The good times for the global air relatively small market with a 2.2% tapped was government export credit transport market continued during the share in world RPKs in 2015. African financing. Both the US Export-Import first half of 2016, albeit at a slightly carriers saw their international traffic Bank and the European export credit agencies (ECAs) had their problems. While US Eximbank’s charter was IATA passenger market data reauthorised for five years at the end of 2015, the US Senate did [RPK growth and pax yield, %] [PLF, %] not nominate three new board 20 82 members for the export credit agency, 14.9 80.5 15 essentially taking away the bank’s 79.7 79.8 80 ability to approve big ticket $10 79.3 8.9 9.5 10 8.0 8.3 8.0 78.4 million-plus transactions. Reportedly, 6.9 6.6 7.5 6.5 6.3 5.7 6.0 in July, an amendment as part of 78.6 5.3 78 5 77.0 the appropriations bill that funds the 2.8 1.7 2.4 1.0 76.1 State Department and other related 0 76 agencies was approved, effectively 76.0 76.0 -1.2 -1.4 -2.5 allowing the bank board to approve -5 74.9 -3.9 transactions with a quorum of only 73.5 74 two members. For the legislation to -10 become law, both the Senate and -11.7 72 House of Representatives have to -15 -13.7 approve the legislation. -20 70 In Europe, the problems are of an 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 entirely different nature. In April, UK Source: IATA RPK growth Pax yield PLF Export Finance, Coface of France and

www.airfinancejournal.com 9 Industry review and outlook: DVB

increase by 9.6% during the first half markets in 2015, and this boom realise the global fleet of maindeck of 2016, driven by a 10% increase continued in 2016 with an RPK commercial jet freighters (including in available seat kilometres (ASK) volume growth of 23.3%, ahead of a combis and convertibles) is about capacity, which is mainly the long- 22.8% production increase. The load one-eighth of the size of the haul network expansion of Ethiopian factor in the Indian domestic market passenger fleet. Unfortunately, the Airlines. African carriers paid the reached a record 84.4%, apparently airfreight market is not sharing in the price of rapid capacity expansion in justifying the huge fleet purchases of good times of the passenger market. the form of a lower load factor, with Indian carriers in recent years. For the first half of 2016, global air 65.9% the lowest of all regions. The assumed economic slowdown cargo volumes, expressed in freight The third-highest international RPK in China did not impact the domestic tonne kilometres (FTKs) remained growth percentage was recorded air transport market. Demand grew in stagnant, with just a 0.5% increase. by airlines in the large Asia-Pacific line with production, 9.8% and 9.9%, In 2015, the airfreight operators region, responsible for 31.5% of respectively. The big US domestic benefited from additional demand world traffic. Asian-Pacific carriers’ market showed a reasonable traffic in the early months of the year as traffic grew by 8.2%. ASK production increase of 4.6% (more than double a result of the US west coast port increased more modestly with 7.7%. the pace of US international traffic), strikes. Latin America carriers, good for 5.4% which is about in line with the 4.9% It seems to be generally accepted of global traffic, came fourth with a ASK expansion. The relatively that, over the past years, the air 7.5% growth in demand (RPK) and small Australian domestic market cargo market has undergone a 6.3% in production (ASK). The gap achieved a 2.8% growth, with 0.4% fundamental change as a result of, between the growth pace in Latin increase in production. Russia’s what seems, a structural weakness in America and number five, Europe, domestic demand stagnated at global production and trade growth. is significant. Europe takes 26.7% of 0.3% but the troubled Russian Compared to the years before the world traffic. European international airlines produced 5.9% fewer ASKs, financial crisis, global production traffic increased by 3.9% (RPK) and boosting their load factor to 75.1%. and trade now follow a much lower ASK production by a 4.3% increase. Despite the preparations for the growth path and even seem to be European carriers still achieved summer Olympics, the domestic weakening in recent months. the highest load factor, 80.6%. It is Brazilian market could not escape Air cargo operators are not the only expected that the wave of terrorist the country’s political and economic ones suffering. Maritime container acts in Europe will impact traffic crisis. Troubled Brazilian carriers carriers are confronted with the same growth negatively. WTTC already has produced 6% fewer ASKs but problem. The word “deglobalisation” indicated a slowdown in spending on demand came down by 6.8%, so load has been mentioned. Danish shipping tourism and travel. The full impact of factors stayed more or less at the conglomerate AP Møller Mærsk has these events is not totally clear. same level. voiced concerns over how a potential North American carriers – Moving on from the passenger shift in global policy in favour of more accounting for 24.7% of world traffic market to the airfreight sector (air protectionism threatens to reduce – seem to have given up their bad cargo officially includes airfreight and global trade. Tariff barriers, Brexit and habits of the past and focused on express/mail, but we use the terms the potential political shift in the US profitability rather than volume. This interchangeably), it is important to are examples of this. Others refer to once more highly profitable region saw an increase in international traffic of only 2%. During the first half of Global production and global trade (YOY changes) 2016, North American international production growth outstripped [%] demand with a 2.4% ASK increase, 25.0% 25 but load factors of 80% on average 20.0% 20 are not bad. 15.0% 15 While much smaller overall, compared with international traffic 10.0% 10 flows, domestic markets often 5.0% 5

0.0% reveal interesting developments 0 and, during the first half of 2016, -5.0% showed certainly more extremes. -5 -10.0% Although the domestic US market -10 -15.0% has 15.4% of world traffic and China -15 -20.0% 8.4%, the other domestic markets for -20 which IATA releases monthly figures -25.0% -25 (Australia, Brazil, India, Japan and Russia) represent between only 1% 1m01 1m07 20 1 20 1 2001m01 2001m07 2002m01 2002m07 2003m01 2003m07 2004m01 2004m07 2005m01 2005m07 2006m01 2006m07 2007m01 2007m07 2008m01 2008m07 2009m01 2009m07 2010m01 2010m07 2012m01 2012m07 2013m01 2013m07 2014m01 2014m07 2015m01 2015m07 2016m01 and 2% of world traffic each. India World trade Production weighted, seasonally and working day adjusted surged to the top of the domestic Source: CPB Netherlands – World Trade Monitor

10 Airfinance Annual • 2016/2017 Industry review and outlook: DVB

of 1.1% in AFTKs, Asia-Pacific was up IATA cargo market data 3.9%, North America 5.1% but Africa added a staggering 22.4%. Given the above figures, it is no surprise that [%] the already low load factors in the 25 air cargo business (partly explained 19.4 20 by trade imbalances, forcing nearly empty return flights) deteriorated 14.4 15 11.6 even further by 2.3% to 42.5%. Africa’s freight load factor dropped to 10 7.0 6.3 5.6 24.9% in the first half of 2016. 3.9 4.4 4.7 5.0 5 Returning to the passenger market 2.3 0.8 2.2 0.5 0.4 0.6 and looking at the relationship 0 between traffic growth and capacity -0.7 -0.9 -2.0 -5 expansion, the large orderbook -4.2 -4.9 confirms the continuing expansion -10 -8.8 strategy of Middle Eastern airlines despite the decreasing load factor -15 -15.2 over the first half of 2016. As of -20 -18.0 August, the orderbook for passenger 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 jets was 85% of its fleet size. Airlines can attract more passengers Source: IATA FTK growth Changes in cargo yield by offering more capacity in the form of more (direct) connections, as well as Globalisation 2.0, which is the growth but with a modest 6.4% increase in increasing frequency of service. The in trade of intangibles, services, rather FTKs, which was achieved because of alternative is lowering ticket prices. than tangible manufactured goods a capacity production of 10.6% AFTKs. Over the past four years, it can be (Globalisation 1.0). European carriers came second with argued that this has happened on a Whatever the cause, stagnant 3.7% growth in demand, achieved global scale, but in 2015, the lower airfreight markets are a problem, with a 6,2% increase in production. fuel cost allowed airlines to lower because production (in available North America (-0.9%), Africa (-1%), prices significantly, resulting in an freight tonne kilometres) continues Asia-Pacific (-2.2%) and Latin America 11.7% lower passenger yield. With fuel to exceed demand by a significant (-5%) lost freight volume in the first prices showing upward tendencies, margin. While in the maritime industry six months of 2016. It is interesting traffic stimulation by lower ticket prices this is caused by the huge orderbook to note that in all four regions, may not be a viable option for much for new container vessels, in aviation production increased significantly. longer, at least not if airlines want to the increase in capacity is partly Latin America produced an increase maintain current profitability levels. a by-product of the growth in the widebody passenger fleet. Modern twin-aisle passenger aircraft have Traffic growth and capacity on order huge cargo capacity in the belly of the aircraft. Against the 0.5% demand [Year-on-year traffic growth and production, %] [Backlog, %] growth during the first half of 2016 20 %18 90 % stood a 6% growth in production. 85.4 Not only belly-freight can be blamed, 18 %16 80 %

though. During the first half of 2016, 16 % 14 14.6 70 %

12 new widebody freighters were 66.9 14 % delivered (mainly 767-300ERFs to 12 60 % 58.8 12 % 54.0 55.2 FedEx and 777-200LRFs to Middle 10 10.6 50 50 % 10.0 East carriers), plus eight passenger- 10 % 8 8.4 8.6 8.6 8.4 40.9 40 % to-freighter cargo conversions (mainly 7.8 8 % 6.7 767-300ERs). During the same 6 6.5 6.2 6.0 30 % 6 % 5.1 period, only 13 widebody freighters 4 4.3 4.0 20 15.8 3.8 3.6 3.7 3.7 20 % were retired (mainly MD-11Fs and 4 % 2.9 2.9 2 Fedex A310Fs). The 24 converted 10 % 2 % narrowbody freighters, in particular 0 0 0 % 0 % the 737-400 and 757-200, are Africa Asia-Pacific Europe Latin Middle East North Global mainly destined for express freight America and America operations in the US and China. Caribbean Middle East carriers also lead the Traffic growth 2015 (YoY) Traffic growth H1 2016 (YoY) Source: IATA Ascend Fleets Production (ASK) H1 2016 Backlog as % pax fleet way in the air cargo sector, market,

www.airfinancejournal.com 11 Industry review and outlook: DVB

demand for air transport, a more Worldwide airline profitability bottom-line focused airline policy in general and the consolidation of [US$ bn] the North American airlines were other contributing factors. It will be 45.045 39.4 interesting to see what the next 35.3 35.035 chapter will bring.

The outlook for 2016 is still 25.025 positive, although there seems 14.7 17.3 15 13.7 to be an upward trend in fuel 15.0 10.7 8.3 9.2 cost. Traditionally, when airlines 5.0 5.05 make money, a number of other

stakeholders start to exercise -5.0-5 pressure to get a bigger piece of -5.6 -4.1 -4.6 the pie. Already we see labour -15.0-15 costs becoming the largest biggest

-25.0-25 expense for the airlines, a position

-26.1 that was previously taken by fuel. -35.0-35 Especially in North America, airlines

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015E 2016F have had to agree to significant pay Net airline profit E = estimate; F = forecast rises, partly responding to the aim of Source: IATA "Economic Performance of the Airline Industry (Jun 2016) the pilots’ unions to restore salaries to pre-Chapter 11 levels. American The softness of the air cargo be for the global airlines. In 2015, reportedly reached an agreement markets is vividly illustrated by the commercial airlines booked a record with the pilots’ union about a 42% fact that even an 18% decrease profit. The net result by far exceeded salary raise over a period of five in cargo yield hardly resulted in a anything that the industry had seen years. Rival United and its pilots’ significant increase in demand. The before. The latest numbers published union agreed a two-year contract latest monthly cargo figures (June by IATA indicates profit of $35.3 with a 13% raise in 2016, followed 2016) looks slightly better compared billion, a 9.3% return on invested by a 3% increase in 2017 and a 2% with earlier months, but not enough capital and, probably for the first time rise in 2018. At the time of writing, realistically to expect a turning point in aviation history, a percentage that Delta, Hawaiian and Southwest in the market. exceeds the weighted cost of capital. were negotiating but it looks like As we are only halfway through Clearly, the unexpected fall in fuel the outcome will be a double-digit the year, it is not yet clear what the cost was the main reason for this pay rise over a number of years. The final financial results over 2016 will profit boom, but a robust growth in risk with this structural increase may

Airline net profit (post tax) by IATA region

[US$ bn]

45 39.4 40

35

30 22.9 25

20

15 7.8 10 7.5

5 1.6 0.1 0 -0.5 -5 Africa Latin America Middle East Europe Asia/Pacific North America Global

E = estimate; F = forecast Net profit 2012 Net profit 2013 Net profit 2014 Net profit 2015(E) Net profit 2016(F) Source: IATA

12 Airfinance Annual • 2016/2017 Industry review and outlook: DVB

manifest itself should fuel cost move up again. This may cause a significant IATA – net airline profit – (post tax) per region increase in the airlines’ costs and the trigger another round of Chapter 11 [US$ bn] 45.00 reorganisations. 39.40 IATA estimates that $22.9 billion 40.00 – 58% of the net global airline profit 35.00 30.00 in 2015 – was generated by airlines 22.90 25.34 from North America. Asia-Pacific and 25.00 Europe each took about 20% of the 20.00 15.00 10.42 global result, with $7.8 billion and $7.5 7.83 7.50 7.83 7.80 10.00 billion, respectively. The expanding 5.94 5.00 1.60 Middle East carriers generated $1.6 0.10 0.38 0.00 billion, while Latin American carriers -0.50 -5.00 scored a marginal $100 million net -5.64 -10.00 profit. Africa once more ended in the Africa Latin America Middle East Europe Asia-Pacific North America Global F = forecast red with a consolidated loss of $500 Source: IATA Net profit 2016(F) Net profit per passenger 2016(F) million. On a per passenger basis, the result of North America is even more spectacular. With a realized net profit IATA estimates – net post tax profit H1 2015 and of $25.34, this continent is more than H1 2016 three times as profitable as the joint Preliminary estimates based on sample of 22 airlines runners-up Europe and Middle East 1000010,000 with $7.83 per passenger.

Based on a sample of 22 airlines, 8,0008000 IATA has published some very early Q1 Q2 results for 2016. While overall profit 6,0006000 was up about 12% for the first quarter, the result was 15% lower for the 4,0004000 second quarter, resulting in a 2016 first-half profit about 7% lower than 2,0002000 the same period last year.

Of course, the sample is too small 00 to draw any conclusions, but it looks like airline profitability this year will -2000-2,000 not be much higher than that for 2015. 2015 2016 2015 2016 2015 2016 2015 2016 2015 2016 Source: IATA North America Asia-Pacific Europe Latin America Sample total Equipment market After several years of increasing sales volumes, the commercial jet order Commercial jet orders intake slowed down in 2015, and this (western-built, all civil operators, type swap) trend seems to have continued into 2016. According to the latest figures [Number, %] 4,0004,000 from Ascend, which provides advisory and valuations services to the aviation 3,555 3,577 3,5003,500 industry, western-built jet sales (all civil operation, including type swaps) 3,0003,000 collapsed by about one-third between 2,630

2,441 2,356 2,366 2014 and 2015. At the time of writing, 2,5002,500 and after the Farnborough air show, (extrapolated based on 1,900 orders per 1/9) 2,0002,000 2016 sales are down another 24%.

A simple mechanical extrapolation 1,434 1,354 1,396 1,5001,500 of the sales total (as reflected in our 1,067 database) of 1,067 at 1 September 1,0001,000 would result in sales of about 1,900 652 over full-year 2016. Obviously, a 500 few mega-orders can change this dramatically (at the time of writing, the 0 big AirAsia order for 100 A321neos 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2016 2016 Source: Ascend Fleets (P) 1/1–1/9 1/1–1/9 was not yet officially confirmed). Low-

14 Airfinance Annual • 2016/2017 Industry review and outlook: DVB

cost carriers speculating on large- scale sale and leasebacks in the near Orders placed by all civil operators (1 Jan–1 Sept 2016) future can gain confidence from the Western single aisles New Swaps Western regional jets New continuing favourable climate in the 737MAX-200 100 E170/175 30 airfinance and investment markets. 737MAX-8 56 E190 E2/195 E2 5 737MAX BBJ 3 E190/195 5 Over the first eight months of 737MAX TBD 48 CRJ900 21 2016, a total of 1,135 commercial 737-700 65 CS100 75 737-800 44 CS300 52 aircraft were sold, of which 26 were A320ceo 30 9 ERJ-135 1 for eastern aircraft (including 10 A321ceo 69 25 MRJ 90 10 A319neo ACJ 1 9 Subtotal 199 Sukhoi Superjet 100s) and 42 were A320neo 160 10 SSJ 100 - 95 10 for western turboprops According to A321neo 36 78 Total 209 Total 612 131 Ascend. The remaining 1,067 aircraft Western turboprops are western-built jets. This number Western twin aisles Do-228 4 747-8 4 Q400 15 includes 131 type swaps, in this case 767-300ERF 7 DHC-6 Twin Otter 3 mainly changes in the versions that 777-200F 2 ATR72-600 20 777-300ER 10 Total 42 were ordered within the A320 family. 787-9 23 Out of the remaining 936 new orders, A330-200 11 Eastern aircraft A330-300 17 An-178 10 western regional jets took 199, single A330-900neo 14 L-410 4 aisles 612 and twin aisles 125. The split A350-1000XWB 8 Y-12 2 A350-900XWB 27 Total 16 of aircraft types is shown in the table. A380 2 Total 125 While the already full orderbook, Source: Ascend as well as the low fuel price, can be used to explain the softening of the new equipment market, the fact Rumours persist about a few new In terms of sales successes, while that during 2015, as well as 2016, no versions of existing aircraft types, but the A320neo (and Ceo) family, as new aircraft types were announced neither an A350-2000XWB, nor an well as the 737 Max (and NG) booked did not help. Generally, new aircraft A380neo, a 737 Max 10, a 777-10X or decent order volumes, the only introductions significantly stimulate a CS500 were announced. manufacturer that had real reason sales volumes. Obviously, Boeing The much-debated Boeing middle- to celebrate was Bombardier. With announced a stretched version of of-the-market aircraft also remains orders from Air Canada and, maybe the 737 Max 7 (sometimes dubbed a long-term project. The dilemma even more important, Delta Air Lines, the Max 7½), but this effectively is a seems to be that on the one hand, the Canadian manufacturer regained redefinition of the Max 7, so not an this aircraft should be Boeing’s some much needed sales momentum. additional version. Airbus announced successor to the 757 and an answer The biggest order this year (as of the ultra long range version of its to the success of the A321neo; on the 1 September) was placed by VietJet A350-900XWB in October 2015, other hand, it would be positioned Air for 100 of the high-density interior but also that is only a minor variant, in the market niche below the 787-8, 737 Max 200 aircraft, almost half of featuring a higher capacity fuel where once the not very successful the total 737 Max orders. Malaysia system within the existing fuel tanks. 767-200 and A310 could be found. Airlines Berhad, slowly emerging

Commercial aircraft orders 2016 YtD (all civil operators, as of 1 Sept, incl. 131 type swaps in A320 family)

350

294 300

250 207 200

133 150 127 109 100

35 35 50 28 23 21 20 14 10 10 10 15 7 5 4 2 2 1 4 3 0

Source: Ascend

www.airfinancejournal.com 15 Industry review and outlook: DVB

from the ashes of Malaysian Airline Embraer’s largest order came from Lease for one A350-900XWB brought System Berhad, was the second- the Pacific Northwest as Horizon Air this type to the top of the twin-aisle largest customer with 25 new 737 signed up for 30 Embraer E175s. The table. Virgin Atlantic compensated its Max orders. Eastern Air Lines, Tui remaining new E-Jet orders came from loss of interest in the A380 by placing Travel, Arik, Norwegian and Okay J-Air (one) and Nordic Aviation (four) an order for eight of the stretched were the other customers for the 737 for the E190 model. Only five E2s were A350-1000XWB aircraft. Excluding Max. All orders where the version of sold, when Indonesia’s Kalstar Aviation the military MRTT, Airbus sold the aircraft was announced went to signed up for five E190-E2s. seven A330-200s to unannounced the Max 8 and its high-density variant Embraer’s competitors, MRJ from customers, plus 17 A330-300s to, the Max 200. Surprisingly, the good Japan and the Italo/Russian Superjet among others, IAG (two) and Cebu old 737NG received another 109 100, each booked 10 orders from Pacific (two). Garuda placed an order orders, including 40 for the shorter US leasing company Aerolease for 14 A330-900neos. -700 version from United. The other and Russian flag carrier Aeroflot, The dry spell continued for the customers were for the -800 and respectively. Sukhoi also revealed A380, although a small order for two included Xiamen and Pegasus. plans for a stretched 120-seat version of these big quads from Emirates The second-largest single order of the SSJ100. The new version would (apparently taking cancelled aircraft) came from Delta Air Lines when be able to use the existing PowerJet saved the honour. Mixed messages it ordered 75 CS100 aircraft from SaM-146 engines, but would need a reached the market, but it seems the Bombardier. Air Canada preceded new wing design. revamped A380neo is still far away it with an order for 45 CS300s, the ATR received the biggest turboprop from a launch announcement. same version airBaltic had ordered in order as the changes in the political Boeing’s remaining quad, the a smaller-sized transaction – seven climate allowed Iranian airlines to 747-8, only appealed to Russian aircraft. As Bombardier announced buy western aircraft, under certain cargo operator Volga-Dnepr Airlines, an onerous contract provision of conditions. Iran Air seized the which confirmed its intention to take about $500 million shortly after the opportunity and ordered 20 ATR72- 20 freighters. The announcement Delta order, many industry observers 600s. Bombardier added 15 orders for resulted in four additional firm orders. started speculation about heavy the Q400 model, nine from WestJet Boeing’s bestseller, however, was discounting that must have been a Encore, three from Porter Airlines, the 787-9 with a total of 23 orders: condition to get the two big orders. plus two from Air Tanzania and one six from Riuli Airlines, one each from One of Bombardier’s older types, the from Ilyushin Finance Company. The Thomson and Air Lease and 15 from CRJ900, could add orders from lessor Viking/DHC-6 Twin Otter is the aircraft unannounced customers. The 787-9 Falko (four), Canada’s Jazz (five) and that reportedly has shown the best has completely overshadowed the unannounced customers (12). residual value performance over the 787-8. Hardly any additional orders The third-largest single order past decades. Tara Air ordered three have been booked for this shorter went to Airbus when Avianca Brazil of these sturdy little props. version of the Dreamliner for some ordered 62 A320neos, despite the Meanwhile, 2016 has not been a time and it looks like this type will stellar year for the twin-aisle segment, follow the scenario of the 767- political and economical crisis in the with only 125 orders over the first 200ER, which was also eclipsed by South American country. Germania eight months. its bigger sister, the -300ER. This is a ordered 25 A320neos and Spirit Orders from China Eastern for unexpected development for such a ordered 10. The order total for 20, Philippine Airlines for six and Air revolutionary new aircraft design. A320neos came out at 170. While Boeing kept struggling to book Max 9 orders, Airbus continues Cumulative orders for regional jets to be successful selling its largest Incl. type swaps (1 = year of 1st order; recorded on date of original order) single-aisle aircraft. The order total came to 114 A321neos, including 30 400 from Norwegian, 15 from JetBlue and 350 12 from Avianca. Lessors AerCap, Air Lease, Alafco and ACG also placed 300 additional orders, underlining their 250 confidence in the A321neo. Avianca also ordered nine of the less popular 200

A319neo. The older A320 scored 150 orders for another 133, of which 94 were for the A321. Delta ordered 100

37 of the type, JetBlue 15 and 50 several lessors and airlines placed 0 single-digit orders. Allegiant Air and 0 1 2 3 4 5 6 7 8 9 10 11 12 13

Awas ordered 12 and 15 A320s, MRJ Cseries E-Jets E2 E175E2 E190E2 E195E2 Superjet 100 respectively. Source: Ascend Fleets

16 Airfinance Annual • 2016/2017 Industry review and outlook: DVB

A reasonably encouraging start that Cumulative orders for single-aisle jets stagnated after about four years Incl. type swaps (1 = year of 1st order; recorded on date of original order) had many observers doubting the viability of the type. As the graph 5,0005000 shows, the 2016 orders brought

the Canadian aircraft back on track, 4,0004000 albeit reportedly at the expense of

significant discounting.

3,0003000 In the mainstream market of single-

aisle aircraft, the battle between the

2,0002000 A320neo and the 737 Max continued.

Potential competition may come

from the East, as China’s Comac and 1,0001000

Russia’s Irkut continue to develop the

C919 and MS-21, respectively. In the 0 0 0 1 2 3 4 5 6 7 West, Airbus seems to have taken a lead over Boeing in sales volume, 737MAX Family 737MAX-7 737MAX-8/-8-200 737MAX-9 737MAX TBD

A320neo Family A319neo A320neo A321neo Source: Ascend Fleets even adjusting for the fact that the 737 Max was launched about eight months after its European competitor. The stretched -10 version did not in terms of market acceptance for the Short term, the A320neo is struggling find any new customers either, but different new programmes. with deliveries and performance. as the youngest member of the 787 In the regional market segment, the Unfortunately, the all-new Pratt & family, there should be plenty of sales contrast between the order patterns Whitney PW1100G-JM engines are potential in years to come. of the Sukhoi Superjet and the suffering some technical problems. The order total for Boeing’s new Embraer E2 family is striking. While The manufacturer is working 777X did not change, because only the Superjet has been struggling to on solutions, both software and orders for the current versions of the get some order momentum for about hardware related. 777 were announced: two for the five years since its launch customers Both families are struggling to sell -200 Freighter model from FedEx committed, the E2 order volume took their smaller versions, the A319neo and six from Air China (plus four off like a rocket, but (temporarily) and the now slightly stretched unannounced) for the -300ER version. slowed down after about two years’ 737 Max 7. The sweet spots of the FedEx also added an order for seven progress. It is interesting to note families are the A320neo and the 767-300ERFs to its book. An exotic that the current E175 (not in the slightly larger 737 Max 8. The Airbus order came from Silk Way Airbus for chart) maintained sales momentum. product also seems to be outselling 10 Russian Antonov An-178 freighters. There are questions about whether its American rival. Adding the high- The smaller Lockheed LM-100J the new E175-E2 will meet the all- density Max 200 version to the Max freighter did not book any firm orders important scope clause criteria in the 8’s order tally and assuming most but signed a commitment with Bravo US market. Scope clauses limit the of the orders where the version Industries for 10 of these rugged number and capacity, as well as the is undecided will go to the Max 8 machines. Bravo is a logistics and maximum take-off weight (MTOW), version, the sales gap between two defence group in Brazil. Overall, the of aircraft that can be operated by rivals is not that significant anymore. first months of 2016 did not bring commuter airlines on contracts with As has been widely debated in too much spectacular news from the the US major operators. These scope the industry, the main difference is commercial jet market, at least not clauses are negotiated between between the larger versions of the in terms of new orders. Some of the the US major airlines and the pilots’ two families, with the A321neo clearly aircraft that were announced a few unions. With the Embraer E2 series overshadowing the Max 9, unless all years ago with a lot of fanfare did now flight-testing, it should be well undecided versions would eventually not book to many sales successes positioned for a second wave of turn out to be Max 9s, which is beyond the original group of launch orders. unlikely. customers. The Mitsubishi MRJ took about Given the physical limitations In the regional market, effectively three years to gain a decent order of the 737 Max airframe, it seems only the CSeries could break through volume, but could not maintain this challenging (albeit not impossible) the 300 orders glass ceiling that momentum and recent sales progress for Boeing to further stretch the seemed to have existed for several has been slow. At the end of 2015, Max 9 to a Max 10. To do this, while years in this segment. the Japanese manufacturer had to maintaining almost full commonality Looking beyond the most recent announce a one-year delay in its with the other members of the Max (lack of) sales successes, how are the delivery schedule because it had to family, seems virtually impossible. various programmes progressing? strengthen the airframe and upgrade Maybe, eventually, the solution will The cumulative order charts give a the software of the aircraft’s systems. be in the form of an all-new middle- good indication of what is going on The CSeries is an interesting story. of-the-market aircraft, often referred

www.airfinancejournal.com 17 Industry review and outlook: DVB

to as the “new 757”, but this will require careful positioning, because Cumulative orders for medium/large twin-aisle jets a standalone design between the Incl. type swaps (1 = year of 1st order; recorded on date of original order) Max 9 and the 787-8 twin aisle seems difficult to justify. Given the age of the 1,4001400

Max design and the huge orderbook, 1,2001200 it is unlikely that Boeing will launch an all-new single-aisle aircraft anytime 1,0001000 soon. Moving to the twin aisles, also here 800 the A350XWB and the 787 seem 600 to maintain equilibrium. Both types have family problems, as well. While 400 Boeing had to cancel its Japanese domestic version, the -3, at an early 200 stage, Airbus had to do the same 0 for the -800XWB, which eventually 0 1 2 3 4 5 6 7 8 9 10 11 12 13 was replaced by the A330neo. In the 787 787-8 787-9 787-10 A350XWB A350 range, the stretched A350- A350-800XWB A350-900XWB A350-1000XWB A330NEO Source: Ascend Fleets 1000XWB is not booking spectacular sales successes either. Boeing’s not reporting financial results that are are struggling to find new orders. 787-10 made a strong start, but sales too encouraging? The Boeing product survives for the volume thereafter remained fairly The A330-900 is doing better time being on a few orders for the stagnant. The -10 design is still young and enjoyed a very strong start. The -8F freighter version, but Boeing and volume can still pick up. Clearly, current orderbook is made up of announced that 747 production will the A350-900XWB is by far the most 176 orders from three lessors (total be reduced to half an aircraft a month important version of the A350 for 55 orders) and five airlines (total 121 from the current one a month, and Airbus, in terms of sales volume. orders), of which Delta, with 25 orders, even admitted it was reasonably This is less clear in the case of the is the most prestigious. But AirAsia X’s possible that it could end production 787. Initially, the 787-8 was selling order is by far the largest, a whopping of the 747. like hot cakes, but it seems that 66 of these twin aisles. Arkia, Garuda Airbus announced it would reduce momentum for this version is lost. and TAP are the other A330-900 A380 deliveries from 27 last year to Apart from a few reworked early customers. During its ownership 12 in 2018 to prevent a glut of unsold aircraft (dubbed “terrible teenagers” change, TAP replaced its original order aircraft. A revamped version, dubbed after their line numbers), no more new for A350s with A330neos. Iran Air has the A380neo, increasingly seems a -8s have been sold during the past signed a letter of intent for 18 aircraft. long-term project if launched at all. An two to three years. In a number of In the top segment of very large improved version of the superjumbo cases, the customers even converted aircraft Boeing has two contenders, is needed to remain competitive, existing orders from the -8 to the the 747-8 and the new 777X. Airbus in terms of cost per ASM, against -9 and, in the remaining backlog puts the mighty A380 against this the large twin-engined competition, of about 111 aircraft, it can only be duo. Both the 747-8I and the A380 especially the 777-9X. speculated whether Aeroflot (18) and Delta (18, former Northwest order) will maintain their orders. Cumulative orders for (very) large twin-aisle jets The future of the -8 does not look Incl. type swaps (1 = year of 1st order; recorded on date of original order) too bright. Recent problems with

Rolls-Royce Trent 1000 B and C 350 engines in Japan do not help the 787. The 787-9 has effectively overtaken 300 the -8 as the main model in the 787 250 range. With the A330neo, Airbus launched 200 a second new type into the medium/ large twin-aisle segment. The shorter 150

-800 version is not setting the world 100 on fire, with just two customers for a total of 10 aircraft. Does it really 50 make sense to build an aircraft for 0 effectively one strong customer 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

(Hawaiian) and a customer that Source: Ascend Fleets 777X 777-8X 777-9X 747-8 A380 already suffers overcapacity and is

18 Airfinance Annual • 2016/2017 Industry review and outlook: DVB

has sold 243 units plus 50 options Aircraft on order, option and LoI as well as in to the same Middle Eastern carriers, as well as Cathay Pacific, All Nippon storage as % of fleet Airways, Lufthansa and unannounced

[%] customers. The 787-8 has been compared to the 767-200ER, but the 100 % 777-8X seems to resemble the 777- 90 % 84.7% 200LR ultra-long-haul niche aircraft. 80 % Boeing once more dominates 70 % the top end of the market with 60 % the 777-9X, although that could 57.3% 50 % change if Airbus decides to launch the stretched A350-2000. Such 40 % an aircraft would partly undermine 30 % the current A380, which makes this 20 % a tough decision for the Toulouse 10 % 8.8% based manufacturer. 0 % Despite the disappointing sales 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 1/9 volumes in the first months of Orders as % of in-service fleet Stored aircraft as % of total fleet Orders, option and LoI's as % of in-service fleet 2016, the manufacturers do not have to worry too much because the global fleet is still growing fast. While several customers have 8.3 a month to seven next year and Stepping back and looking at the reduced or cancelled their orders for 5.5 in 2018 and 2019. This will be a big picture, the rise of Airbus has the current A380, Emirates is eager mix of 777-300ER and 777-200LRF been spectacular and it would be to see production continue. Airbus models. Today, 777 production is interesting to know whether 25 years seems to be focusing on increasing believed to be suffering because of from now a major Russian or – more the seat density of the current A380 a combination of supplier issues and likely – Chinese manufacturer will and improve its efficiency based on a teething troubles in the new robotic be in a similar position. Shorter term, higher seat count. Boeing’s large twin, production line called fuselage Airbus, Boeing, Embraer, Bombardier the 777, is not immune to the trouble automated upright build (FAUB). This and the other original equipment in the large aircraft market either. Its FAUB is seen as critical technology manufacturers can enjoy a backlog current best seller, the 777-300ER, will to produce the upcoming 777X. Like equal to 8.8 years of deliveries at be succeeded by the 777-9 towards other aircraft families, the shorter 2015 production levels. the end of the decade and this is version (777-8X) is not selling too well. As mentioned before, the limits affecting demand. With orders from Emirates, Etihad in production capacity can be seen Reportedly, Boeing will reduce and Qatar for a total of 53 aircraft, it as the saving grace for the aviation 777 production from the current is staying far behind the -9X, which industry and one of the main

Western-built, in-service commerial jets and turboprops by manufacturer

3000030,000

2500025,000

2000020,000

1500015,000

AIRBUS 1000010,000 BOEING McD.D..

5,0005000 BOEING

0 0 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015

Boeing Boeing McDonnell Douglas Airbus Bombardier Embraer ATR Fokker BAe Systems Lockheed Fairchild/F.Dornier SAAB Others Source: Ascend Fleets

www.airfinancejournal.com 19 Industry review and outlook: DVB

months of the year, Ascend recorded Commercial jet backlog development 991 deliveries, slightly down on the 996 over the same period last year. [Backlog, %] % Much of this seems to be because of 16,00016,000 1,0001000% 887 delays in A320 and A350 deliveries. 881 900900% 14,00014,000 820 Statements from Airbus indicate that

800 746 800% 721 the company expects to “catch up” on 12,00012,000 672 673 738 700700% deliveries during the rest of the year.

10,00010,000 While not everything is good 557 542 624 600600%

500 news in 2016, the bad news is fairly 482 8,0008,000 455 500500% 419 414 limited in terms of order deferrals 390 393 363 360 358 400400% 6,0006,000 344 and cancellations, which seems to

353 338 338 344 300300% indicate fundamentally the equipment

4,0004,000 market is still healthy. 200200%

Obviously, there is not complete 2,0002,000 100100% transparency regarding order

0 0 00% deferrals and cancellations, and it is unlikely all agreements to cancel or End-of-year order backlog Deliveries during the year Backlog as multiple of deliveries during the year defer are included in the published Source: Ascend Fleets industry statistics. In the past, orders from, for example, defaulted carriers Annual deliveries of western-built commercial jets such as Kingfisher Airleines stayed (all civil operators) on the orderbooks for a long time, probably for legal reasons. Based 1,8001800 on available data, the number of

1,6001600 cancellations fell from 481 in 2014 to

1,4001400 250 in 2015. With still four months

1,2001200 to go, the 2016 tally is less than half

1,0001000 the 2015 number, with 116 reported

800 cancellations. These include: Ilyushin

600 Finance for 12 CSeries aircraft;

400 Eastern Air Lines and Malaysia

200 Airlines, each for 10 737-800s; and

0 Philippine Airlines and TransAsia for A321s. In several cases, the cancellations of A320s or 737NGs Source: Ascend Fleets Passenger Freight/cargo Others All were compensated by orders for new-generation single aisle models. differentiators from a shipping market a substantial lower order volume While the number of cancellations that still is in crisis. The shipping in 2015, the book-to-bill ratio was was relatively low, the number of crisis seems not so much caused by still more than 1.5. In 2016, up to 1 deferrals increased from 56 for the falling cargo volumes, but more by September, the book-to-bill ratio had full-year 2015 to 117 for the first eight unlimited shipping tonnage ordered come down to 1.07, the lowest level months of 2016. Main contributors by the shipping lines and pushed into in many years. For the first eight were reportedly Southwest for 66 the market by dozens of (subsidised) shipyards, eager to maintain jobs and keep their production going. Cancellations and deferrals commercial jets At the end of 2015, the commercial (Western-built, all civil operators) jet backlog stood at 59.3% of the 500 in-service fleet; as of September, this number has come down slightly to 400 56.7%. Whatever the cause – huge 300 backlogs, low fuel prices, over- ordering or economic headwinds 200 – there are now strong indications 100 that the new equipment market has passed its peak. This is not dramatic 0 and had to happen one day. For the 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 1/1–1/9 time being, deliveries have far from Asia-Pacific Europe North America Latin America Africa International Middle East Deferrals (all regions) kept pace with new orders. Despite

20 Airfinance Annual • 2016/2017 Industry review and outlook: DVB

not take into account the value effect Commercial jets – storage and retirements of the physical ageing of an aircraft. (Western built, all civil operators) As airline-to-airline transactions with naked aircraft seem to have 3,0003000 become a minority of the transactions 2,610 2,557 2,540 2,438 2,428 2,507 2,476 involving commercial jets, a debate 2,500 2500 2,348 2,271 2,282 has started about the relevance of

appraised values that do not reflect 2,0002000 the value of the attached lease. It

1,5001500 seems that especially aircraft lessors,

investors and traders are eager to see 1000 1,000 736 appraised value, including the value 671 580 631 624 498 504 518 487 of the lease and even the contractual 500 500 239 return conditions.

As the market has become 0 0 2008 2009 2010 2011 2012 2013 2014 2015 2015 2016 more competitive, it is important to 1/1–1/9 1/1–1/9 Source: Ascend Fleets Retirements In storage recognise every dollar of value in a transaction. It is, however, challenging to appraise an aircraft with lease Max 8s, American for 34 A350-900s aircraft, aircraft with a solid longer- attached, without including all and Thai Airways for A350s and 787s. term lease currently command a relevant details of the contract and Flybe deferred some E-Jets. premium. The potential buyers group applying an adjustment factor for For mid-life and ageing aircraft, for these income-generating assets the potential risk that an airline or the solid demand and low fuel cost is significantly larger compared with lessee is not willing or able to meet limited the number of retirements the number of potential buyers for off- all its contractual obligations. As an from 624 in 2014 to 487 in 2015 and lease aircraft. Off-lease aircraft sales example, a 10-year lease contract probably further down this year: at may be targeted at airlines that are with Lufthansa clearly has more value 1 September, the retirements had looking for short-term fleet expansion compared with a similar contract with totalled only 239 commercial jets. The or sophisticated lessors and traders, a carrier on the verge of bankruptcy. same trend is reflected in the storage which have the capability to arrange a Given the various forms of number of 2,277 aircraft, which is new lease for the aircraft. transactions, it is difficult to quantify about the same level as a year ago. To analyse used equipment the size of the used equipment prices, we have compared Ascend’s market. It seems simple airline- Used equipment market published current market value to-airline metal transactions are a For investors and financiers, it is estimates for the mid-year points minority now. In the lessor/investor important to analyse what the impact in 2013, 2014, 2015 and 2016. In market, individual aircraft with lease of the ongoing generation change is the graphs, we have used constant attached are traded, but also control – or will be – on the used equipment age values for hypothetical over the asset-owning entity (eg, a market and, in particular, on aircraft aircraft of an age that can be seen special purpose company) can be values. If a new aircraft design offers as representative for the type. transferred, leaving the legal owner better fuel burn and/or maintenance Consequently, the value dynamics do unchanged. Next to individual aircraft, cost levels, the only way the older technology aircraft can remain competitive is by lower capital costs Market value dynamics – single aisles – ie, lower purchase prices or lower Aircraft of hypothetical constant age, changes in mid-year CMV’s lease rates. [%]

When it comes to new aircraft 15 % pricing, there is no public domain data 10 %

3.8 with respect to, for instance, average 5 % 0.8 net transaction price levels. As a 0.3 N.A. 0 % proxy, we use independent appraiser -1.3 -5 % -3.5 -5.4 data for zero-year-old aircraft, in this -5.5 -6.2 case from Ascend. We have reflected -10 % the difference between estimated -15 % mid-year market values. In the used -20 % equipment market, it seems an -25 % increasing gap is developing between -30 % aircraft with leases attached and -35 % A319-100 A320-200 A320-200 A321-200 B737-300 B737-800 B757-200 CRJ200 Embraer naked aircraft. (10 yr) (0 yr) (10 yr) (10 yr) (15 yr) (10 yr) (15 yr) (15 yr) 170 (5 yr) With significant appetite among Source: Ascend 2013 2014 2015 2016 financial investors for commercial

www.airfinancejournal.com 21 Industry review and outlook: DVB

portfolios consisting of multiple aircraft are traded among lessors and Market lease rate dynamics – single aisles investors and, finally, entire leasing Aircraft of hypothetical constant age, changes in mid-year CMV’s companies are traded. Just focusing on the simple metal [%] market, it seems that over the past 20 % few months, the market for modern single aisles has been strong. 15 % Current-technology aircraft such 10 % as the 737-800 and A320 can remain 3.8 competitive versus the 737 Max 5 % and A320neo longer than originally 0.0 0.0 N.A. 0.0 anticipated because of the lower fuel 0 % -1.5 -1.9 cost. -5 % -4.1 While again difficult to quantify, the -6.3 impression is that lease contracts for -10 % A319-100 A320-200 A320-200 A321-200 B737-300 B737-800 B757-200 CRJ200 Embraer NGs and Ceos are more frequently (10 yr) (0 yr) (10 yr) (10 yr) (15 yr) (10 yr) (15 yr) (15 yr) 170 (5 yr) extended, giving the airlines the Source: Ascend 2013 2014 2015 2016 combined benefit of lower lease rates/capital cost and modest fuel cost. The flip side of this is that operators that did not commit to Market value dynamics – twin aisles Neos or Maxs in the years of high fuel Aircraft of hypothetical constant age, changes in mid-year CMV’s prices can now probably negotiate a [%] much lower lease-rate premium for the new-technology aircraft. In terms 10 % of storage numbers, it is interesting 5 % N.A. N.A. 0.3 to note that over the past two years, 0 % we have not seen a dramatic increase -5 % -6.1 in stored (in-production) single aisles. -10 % -9.2 -7.7

Obviously, the number of stored -15 % aircraft can diminish because aircraft -12.9 -20 % are broken up, as well as return to -25 % service. The only single aisles that -23.8 have seen a significant increase in -30 % stored fleets between 1 September -35 % -36.6 2014 and 2016 are the 757 and -40 % A330-200 A330-200 A340-600 B747-400SF B767-300ER B777-200ER A330-330 A330-300HGW B777-300ER regionals, in particular CRJs and ERJs, (0 yr) (15 yr) (10 yr) (20 yr) (15 yr) (10 yr) (20 yr) (5 yr) (5 yr) as well as E190s and E170s. The latter Source: Ascend 2013 2014 2015 2016 two types may, however, return to service in the short to medium term. The twin-aisle market seems to be much more challenging, with Market lease rates dynamics – twin aisles potentially significant changes in the Aircraft of hypothetical constant age, changes in mid-year CMV’s perception of some popular types. A few years ago, it was obvious [%] that aircraft such as the 747-400 20 % and A340 were falling out of favour. Despite some A340-600s finding new 10 % 2.7 homes in Iran, values went down, N.A. N.A. or rather it became more widely 0 % -2.4 recognised at what very low levels -10 % these aircraft were trading. -12.0

Passenger 747-400s are rapidly -20 % disappearing from the skies but even -20.5 -20.0 the freighter version is in surplus. The -30 % -30.7 747-400SF, as a converted freighter, -34.5 -40 % does not offer the benefits of the A330-200 A330-200 A340-600 B747-400SF B767-300ER B777-200ER A330-300 A330-300HGW B777-300ER nose-cargo door that a factory- (0 yr) (15 yr) (10 yr) (20 yr) (15 yr) (10 yr) (20 yr) (5 yr) (5 yr) built freighter brings, and both the Source: Ascend 2013 2014 2015 2016

22 Airfinance Annual • 2016/2017 Industry review and outlook: DVB

Boeing-converted BCFs and the help residual values of feedstock Finance environment IAI-converted BDSFs were parked in aircraft. During the same Boeing Capital large numbers as a result of the crisis Over the past year or so, the 777- conferences, the majority of voters in the air cargo market. A recovery for 200ER was probably the aircraft that believed there was too much capital this type seems unlikely. was hit hardest. Between September available for aircraft financing. Some For younger 747-400(ER)Fs, the 2014 and 2016, the number of stored 46% of voters agreed with this in longer-term outlook may be more 777-200ERs increased from five to New York, 56% in London and 60% positive. Should Boeing decide to 40 unit, one of the biggest increases in Tokyo. Only 4% to 6% of voters discontinue 747 production, -400(ER) in absolute terms. The type, very believed there was a shortage of Fs and 8Fs are the only remaining popular with the financial community capital. This strong – some would say western-built nose-loaders. Demand only a few years ago, really fell off “overheated” – aircraft finance market for this feature in the outsized cargo the cliff, in particular the Rolls-Royce- ensures that aircraft with decent market is likely to continue for many powered aircraft. While for an aircraft leases attached continued trading at years. such as the 777-200ER, it is mainly very high levels. The most interesting – and the airlines that will have to find an As mentioned before, this is a relevant – twin-aisle families for the end-of-life remarketing solution – for completely different market from the financial community are Airbus’s example, by operating the type for metal market, where naked aircraft A330 and Boeing’s 777. Both types longer – for the 777-300ERs, many are bought and sold. Referring to have enjoyed significant popularity lessors and/or financial investors Boeing’s benchmark traffic-light with lessors, investors and bankers. will be confronted with the task of chart for the aircraft finance market, The share of operating lessors in the remarketing. it seems that the good times are A330-200 fleet, currently at 46%, It cannot be excluded that some continuing, except for export credit. of these aircraft will not find homes is almost at single-aisle level. This Airframe and engine manufacturers anymore. At Boeing Capital Corp percentage is lower for the A330- are also yellow, which probably conferences earlier this year, the 300HGW, but still a respectable 39%. indicates that there is no real desire audience (aircraft financiers, lessors, The 777-300ER comes close with a from the manufacturers to step in. In investors, etc) saw widebody lessor share of 31%, while the 777- several cases, however, the original remarketing as the most important 200ER fleet is predominantly owned equipment manufacturers were challenge for lessors in the years forced to help carriers where ECA/ by the airlines: the lessor managed 2016-17. In London, 50% of the voters Exim finance was not forthcoming percentage is just about 22%. picked this option, in New York 45% or delayed. For the commercial Within the A330 family both older and in Tokyo 32%. banks, these situations also offered and newer vintages still underwent a In line with this perception, lease opportunities for bridge facilities, downward value correction of about rates seem to have come down faster awaiting the opening up of Exim/ECA 10%. Newer A330-300s have seen compared to aircraft values. The again. The uncertainty about ECA/ slightly less negative development A330 and 777-200ER models fell by Exim take-out financing also has an over the past year. The number of an estimated 20% or more. The 777- impact on pre-delivery payment (PDP) A330-200s in storage increased from 300ER has not suffered as much yet, financing. The attractiveness of this 16 to 37 between 2014 and 2016. but this is also a type that needs to be type of facility for financiers generally The A330-300 went from nine to 26. watched in the coming years. is based on the fact that the asset It remains to be seen how values for these two twin-aisle families will develop in the coming years, with a Financing forecast for global commercial airplane significant number of lease-returns deliveries in 2016 scheduled until the end of the decade. [US$ bn]

Larger twin-aisle jets have 200 proven to be challenging in terms 172 180 of remarketing potential, partly because top-tier airlines generally 160 140 127 prefer new equipment and partly 122 because of the high transition cost. 120 New interior parts are expensive and 100 with interior manufacturers not even 80 62 capable of delivering interior parts 60 for new aircraft in time, reconfiguring 40 a used twin aisle may be very time 20 consuming. For the A330-300, cargo 0 conversion may be a realistic option, 2010 2015 2016F 2020F F = forecast Total Tax equity Cash Capital markets Bank debt Export credit although history has shown that cargo Source: Boeing Capital Corp. conversion programmes do not really

www.airfinancejournal.com 23 Industry review and outlook: DVB

will be in a relative safe jurisdiction before delivery (France, Germany, Lessors’ share in global fleet of western-built jets the US, etc) and that, in most cases, there is a reasonable probability [%] that there will be take-out financing 70 % at the time of delivery. Apart from 60 several legal issues, the main risks 60 %

Stored aircraft materialise if the original customer 50 50 % 45% defaults before the delivery date. The OEMs tend to set the assignable 40 40 % 39% purchase price (the purchase price for 30 In-service fleet which the PDP financier can take over 30 %

the asset in case of a default by the 20 20 % original customer) often at absurdly 18% high levels, compared to the agreed 10 Fleet on order 10 % real purchase price. While this policy stems from a concern that financiers 0 0 % should not benefit from a default of the original customer, it means that, in many cases, the airline customer has Lessors' share of in-service fleet Lessors' share of fleet on order Lessors' share of stored fleet to inject significant amounts of equity Source: Ascend Fleets into the deal. While for strategic aircraft types, the OEMs are likely to help out the PDP financier, but this survey indicated that industry insiders for growth in aircraft leasing. may not always be the case. Under expect operating lessors to be the In all three financial centres there such a scenario, reconfiguration largest source of aircraft financing seems to be an agreement that next costs could be an unexpected and in three years’ time. The percentage to leasing, the capital markets will unwelcome additional cost element. ranges from 46% in the New York fulfil 23% to 25% of the finance need, Overall, however, there certainly is survey, 51% in Tokyo and 56% in with the remaining difference largely no more funding gap in the aviation London. Currently lessors manage made up by commercial bank debt. industry. In the Boeing chart, leasing 39% of the commercial jet fleet It should be taken into account that companies, capital markets, private (western-built, all civil operations), lessors rely largely on capital markets equity/hedge funds and commercial 45% of the aircraft in storage and only (53%) and internally generated banks could be printed in the 18% of the jets on order. Based on the cash (26%). Bank funding has been brightest green available. A Boeing survey, there still apparently is room reduced to 16% of lessor funding.

Lessor / Manager In-service Stored On order Total 1 GECAS 1,254 175 249 1,678 2 AerCap 1,163 35 404 1,602 3 Air Lease Corporation 273 4 374 651 4 SMBC Aviation Capital 395 3 202 600 5 BOC Aviation 274 2 210 486 6 CIT Aerospace 323 11 132 466 7 Avolon Aerospace Leasing Limited 278 8 133 419 8 BBAM LLC 399 1 0 400 9 Aviation Capital Group 253 8 103 364 10 ICBC Leasing Co 285 7 60 352 11 AWAS 254 3 15 272 12 Boeing Capital Corp 190 47 0 237 13 Macquarie AirFinance 190 3 40 233 14 Aircastle Advisor LLC 179 5 25 209 15 ALAFCO 59 3 125 187 16 CDB Leasing Company 155 0 26 181 17 China Aircraft Leasing Limited 72 1 100 173 18 ORIX Aviation 161 10 0 171 19 Nordic Aviation Capital 110 10 20 140 20 Jackson Square Aviation 118 0 0 118 21 BoCom Leasing 114 0 1 115 22 Standard Chartered Aviation Finance 94 5 2 101 23 Undisclosed bank / broker / lessor 53 42 0 95 24 Apollo Aviation Group 90 3 0 93 25 Castlelake 82 8 0 90 Total fleet size all lessors 9,188 1,025 2,455 12,668

Source: Ascend Fleets

24 Airfinance Annual • 2016/2017 Industry review and outlook: DVB

Airlines indicate they get extremely Global aircraft bank debt markets for airplane competitive offers for sale and deliveries (2016 forecast) leaseback transactions, from less experienced entities that apparently have huge risk appetite and/or are Other counting on bullish residual value 16% assumptions. As indicated, probably China 29% the fundamental economics of these transactions are less important than USA the protection they offer against 5% exchange rate risks and other monetary risks. Middle East Japanese investors, North 6% American private equity firms and pension funds also make significant investments in aircraft portfolios. Australia These latter categories, in many 7% cases, transfer the risk to others, including private investors and Japan employees who expect to benefit France 15% from pension schemes in future 9% years. For the fund managers, it is very difficult to find any meaningful Germany Source: Boeing Capital Corp. 13% investments that generate acceptable yields to fulfil pension obligations or offer competitive investment returns. For the survey period, export credit CIT Group for an estimated $3 billion Hopefully, investors have taken into is seen at an insignificant 1% to 2% to $4 billion. Should HNA win – which account that – contrary to stocks of total market funding (airlines and at the time of writing seemed very and bonds – aircraft are subject to lessors). The latter implicitly reflects likely – the combined HKAC/Avolon/ technological risks. the optimism in the industry. Export CIT fleet will move up to third spot Low fuel costs are extending the credit agencies had to come to the in the lessors ranking, immediately lives of midlife and older-generation rescue during the 2008-10 crisis behind mega-lessors Gecas and aircraft, but should fuel return to to prevent airlines falling into the AerCap. In terms of fleet size, Gecas previous levels, the old-generation funding gap. A repeat of this scenario still takes top spot; however, based on aircraft will be rapidly replaced is apparently not expected. estimated fleet value, AerCap should by more efficient new-technology Again, according to the benchmark be number one, according to Ascend, equipment. The fact that lessors and Boeing figures, the industry will need with an estimated fleet value of $31.6 financial investors own a significant an estimated $127 billion to pay for billion compared with $30.9 billion share of the world fleet may facilitate the 2016 commercial jet deliveries. for Gecas. Even if the Avolon and CIT a relatively quick transition, as airlines While this is a staggering amount, fleets are combined, this entity would will not have to deal with book losses it now looks like this will not be a be in third position, but with just over on these leased aircraft. problem. Asian investors, in particular half the fleet size and half the fleet While much of the investment from China, have indicated they are value of the number two. funds are aimed at (near) new eager to invest billions of dollars each It seems there are hardly any limits equipment, significant investments into commercial aircraft financing. to the appetite of Chinese investors are now also aimed at what once Chinese insurance company Ping An to acquire commercial aircraft. They was a niche market: mid-life and reportedly has indicated it is planning are eager to invest outside their own end-of-life aircraft. Anticipating to invest up to $10 billion in aircraft country and into dollar-denominated bonus income from lease extensions, financing and leasing. Bohai Leasing, and dollar-earning assets. Aircraft monetary return compensation for part of HNA Group, does not shy are expected to offer protection below-agreed aircraft condition and away from investing a few billion against currency movements and are anticipated proceeds from aircraft in commercial aircraft either. After expected to offer acceptable yields in and engine part-out, should result in having set up Hong Kong Aviation a world where interest rates have hit above-average returns. Capital, the Chinese travel, tourism rock bottom and, in some cases, even With reported asset-backed and logistics company acquired turned negative. securities transactions for mid-life Avolon for a reported $2.5 billion. Will this new gold rush come to and older aircraft from Awas/Kahala Recent reports indicate that HNA a happy end? Experienced aircraft (average age 16.4 years), Apollo (14.2 Group, as well as Ping An Leasing, traders complain that aircraft years), Element/BBAM (6.6 years), were among the prime candidates to transactions now take place at Och-Ziff/BOC Aviation (4.6 years), take over the aircraft leasing arm of unrealistically high price levels. Castlelake (15 years) and last but not

www.airfinancejournal.com 25 Industry review and outlook: DVB

least KKR/DVB (5.6 years), this can no the superheavy category, it seems the public and employees. The fuel price longer be called a niche market. relatively young 747-8 and A380 are remains unpredictable, but assuming The volume of enhanced already past their prime and both face another fuel spike, it seems very equipment trust certificate (EETC) an uncertain future. Overall, it can be likely that the world’s airlines could transactions reported reached $6.7 concluded that we are about halfway dive into the red again. Let us face billion during 2015, with the majority through the generation change, or, it, if you cannot make money today of paper coming from US majors halfway through the technology cycle. as an airline (and several airlines still American, Delta and United, plus The flipside of all the new aircraft cannot) when will you? Spirit. Air Canada and Latam also introductions is the fact that older- Finally, aircraft values and the had access to EETCs. An interesting generation aircraft will reach the used equipment market. During the exception was Turkish Airlines. After last-of-the-line stage soon. Based boom days of the 1980s, we used to the political and military turmoil in on historical experience, this group say, “if my garden shed had wings, I Turkey, it seems unlikely such a of late-production aircraft generally could sell it for a million”. While the transaction can be repeated. loses value much faster compared decisions justifying the flow of billions So, commercial banks have to with early- and mid-production aircraft from North American pension funds compete against a wider and deeper of the same type. Anybody investing and private equity firms, as well as group of alternative funding sources, in these last-of-the-line aircraft should Asian investors, are taken by smart with the emphasis on Asia. take this risk into consideration. people, somehow this gives many Things are changing as well in the There are three elements that observers an uneasy feeling. commercial banking world. Decades may be in favour of this group. First, Historic examples that spring ago, when aircraft financing was demand for air travel is still growing to mind include Tulip Mania in the still in its infancy, the big US banks at a solid pace. Second, low fuel mid-1600s, the dotcom bubble in the dominated the market. Later, the prices extend the viability of these – late 1990s, the sub-prime mortgage centre of gravity moved to Europe, relatively less efficient – aircraft for crisis of 2007 and the still ongoing followed by Japan. According to the time being. Third, low inflation crisis in the shipping business after Boeing Capital estimates, China will should result in modest delivery price a synchronised boom that ended in be the major source of bank debt for increases as the result of contractual 2008. commercial aircraft deliveries in 2016, escalation clauses. Although the While near term there are very few with 29% of the market. Japan will cost index for the labour element signs of an aviation crisis, the adage still be a respectable second (15%), is still increasing, material costs “the higher they climb the harder they followed by Germany (13%), France show negative index developments. fall” has to be kept in mind. Already (9%), Australia (7%), the Middle East Logically, delivery prices for last-of- we see clear signs of weakness and USA (both 6%). the-line aircraft should not increase as in the twin-aisle market where the fast as originally feared. technology change is taking place. Outlook Staying with the metal, it is obvious Airlines and investors are already So, with all of the above in mind, can that we are already in a downward confronted with disappointing we now answer this simple question: phase with respect to sales volumes, residual values for their expensive “where are we in the cycle?” Yes and whatever the explanation for this. twin-aisle aircraft. So, for twin aisles no. The complicating factor is that in Given the huge backlog, it is easy to we already seem to be on the way our industry there are many cycles. agree with statements from Airbus down. Single aisles still have some To start with the simplest cycle, (and implicitly Boeing) that “aircraft time to go, but already we see some the technology cycle, it seems we manufacturing is no longer a cyclical of the smart money trading out of are right in the middle of the fleet- business”. Even in case of a mild their older asset. wide generation change. Arbitrarily downturn, the OEMs seem to have Geopolitical, macroeconomic and allocating new-technology aircraft enough of a backlog to keep the energy-political factors will drive the types, in the regional jet market, factories going for a few years, under major changes but, unfortunately, the Superjet 100 is now a small but the conditions that (i) there will still the timing for these remains established aircraft. CSeries also has be funding available to pay for the unpredictable. entered into service but is still at an delivery of all these shiny new aircraft To end on a more positive note: early stage. The E2 and MRJ are still and (ii) the market share battle will not liquid, new-generation aircraft, such to enter service. result in further short-term increases as the 787-9, A350-900, A320neo In the single-aisle market, the in production rates. After all, and 737 Max appear to be great A320neo has entered service, but the production discipline in commercial investments for many years to come 737 Max has not. Looking East, the aviation is the only thing standing and will almost certainly survive the Russian MS21 and Chinese C919 will between us and chaos (such as a next downcycle(s). For those that also take a few years before service shipping-type crisis). really have the stomach for a bit of entry. In the twin-aisle market, the 787 Moving away from the metal, it risk, why not try a 747-400 nose- and A350XWB are in service and can seems airline profitability is close loader? n be spotted at an increasing number to peak levels. Fuel cost savings of airports. The A330neo and 777X are slowly distributed to other are still in the pre-prototype phase. In stakeholders, including the travelling

26 Airfinance Annual • 2016/2017 Imprint

DVB Bank SE G. (Bert) van Leeuwen Managing Director Head of Aviation Research Phone +31 88 399 7986 [email protected]

WTC Schiphol Tower F 6th Floor Schiphol Boulevard 255 1118 BH Schiphol The Netherlands www.dvbbank.com

Photos on the front and back cover: ©Bert van Leeuwen