Quarterly Industry Review

Industry Update Q4 2024

• Special Topic – Aircraft Economic Life
• Macro-Economic Background
• Traffic and Aircraft Demand
• New Aircraft Supply
• Airline Industry Financial Performance
  Where are all the early retirements? Is it different this time?

Aircraft Economic Life

As we discuss in more detail below 2024 was another very weak year for new aircraft deliveries. The recent decline is unprecedented as the delivery trough was 723 aircraft, 45% of the prior peak of 1,619, but on this metric, it is not much more severe than the decline of the early 1990s where the trough was 385, 50% of the prior peak of 771 (these figures include McDonnell Douglas although it had not yet been acquired by Boeing).

It took until 1998 for deliveries to exceed the level achieved in 1991. We are now in 2025, which is also 7 years after peak deliveries, but we are probably still some years away from the level achieved in 2018. There is strong evidence of increased demand for used aircraft because of the shortfall in new capacity and as one would expect the average age of aircraft has increased (the charts below refer to passenger aircraft only – although some passenger aircraft have their lives extended by conversion to freighter and other uses the numbers are relatively small).
As one might expect a low level of new aircraft deliveries has led to an increase in average fleet age, which is now as high as it has ever been since 1990 for both single-aisle and twin-aisle aircraft (twin-aisle average aircraft age has gradually increased relative to single-aisle aircraft as the latter had a “head start” with entry into service 6 years before the first twin-aisle delivery).

This increase in fleet age suggests it’s worthwhile to look at trends in aircraft retirals as these should be related. This raises the question of what the most useful data is to look at. If one considers the number of aircraft retirals, both in absolute terms and as a percentage of the world fleet, the results do not show any particular trend after 2010 – the increase prior to 2010 is largely due to the maturing of the world fleet as hardly any aircraft had been retired prior to 1990 other than obsolete early technology types.

The impact on retiral age of reductions in new aircraft deliveries in the early 1990s and from 2019 has been very different. In the 1990s there was a sharp increase in age at retiral which one would expect given the drop in deliveries and increase in average fleet age. Although both these conditions have also prevailed since 2019 the long run drop in average age at retiral that started in 2008 has broadly continued.

We believe that the most important cause of this difference is the increased share of the fleet owned by lessors. As investors seeking to maximise the present value of their assets, lessors are typically reluctant to commit additional capital to redeploy an aircraft with a new airline operator once it reaches c. 18 years old because there is very little time in which to recoup this investment.

Lessors consistently retire aircraft at younger age than airlines as the redeployment cost issue does not arise for the latter.
The key factors affecting a lessor’s decision whether to reinvest are the break-up value of the aircraft and the cost of redeployment. Break-up values have been increasing relative to value in use for many years, mainly because the value of an aircraft’s principal components, its engines, have been increasing in relative terms. In 1998 engines accounted for c. 25% of the cost of a new aircraft whereas in 2024 the proportion was over 50%.

Macro-Economic Background

The IMF’s January 2025 update to its World Economic Outlook had very similar projections for global GDP growth as in October 2024. The chart below compares the 2024 forecast with its three most recent predecessors. The forecast horizon moves forward each year, so it is helpful to create indices that help visualise the rate of change – obviously steeper is better. The October 2024 forecast was notably more positive than the previous two years. The next full WEO will be published in April 2025, and it will be interesting to see if their view has changed given the threat of significant disruption of international trade.

Economic growth is a key driver of long-term growth of air travel. However, since early 2020 its impact has been overshadowed by the fall and recovery in traffic associated with the pandemic. In time the influence of overall economic conditions on air travel is likely to reassert itself, but industry forecasts published by Airbus, Boeing and IATA assume much higher rates of traffic growth than GDP growth over the rest of the 2020s as the former catches up to its long-term trend (see our Q1 2024 Industry Update for a more detailed discussion).

The US Dollar has recently surpassed its previous 2022 peak, creating pressure for airlines outside the US for dollar-denominated costs such as fuel, aircraft rents and aircraft spares. The price of jet fuel has remained volatile, but it has continued its gradual decrease from February 2024. This reduction has mainly been driven by a reduction in the “crack spread” from c.$30 to less than $17.

Another indicator that is potentially important to aircraft investors is the breakeven inflation rate on US Treasury Inflation-Protected Securities (TIPS). This indicator measures inflation expectations and it matters because used aircraft values are strongly influenced by the cost of new aircraft and over time this cost is linked to US Dollar inflation. In the short term this linkage is driven by escalation clauses in aircraft purchase contracts and in the long term by the general input cost environment for the aircraft manufacturers. The chart below compares the breakeven rate for 10-year and 5-year TIPS.

Although medium or long-term inflation expectations have never gone higher than 3.5%, actual inflation experience has been much higher in the last few years. This has led to higher appraised values for new aircraft. If tariffs are applied to aircraft and/or aircraft components this is likely to increase the cost of new aircraft.

Traffic and Aircraft Demand

The month of December 2024 was a bit weaker than expected (the IATA forecast referenced above was updated just weeks before the end of the year). However, growth improved significantly in January 2025, suggesting that December’s figures did not presage a persistent weakening trend.

Full recovery has yet to be achieved for twin-aisle aircraft, mainly due to weak traffic to and from, and within the Asia-Pacific region. The figures by region in the tables above are based on airline domicile, so weak Europe to Asia traffic reduces recorded international RPKs in other regions. Twin-aisle aircraft in service has shown a greater improvement relative to 2019 than ASKs which suggests that aircraft are being returned to service with lower utilisation in anticipation of continued recovery.

New Aircraft Supply

[1] The CFM56 is used by both the A320 Ceo and B737NG, whereas the V2500 is only used by the A320 Ceo.
[2] RPKs is the acronym for revenue passenger kilometres, which is the product of the number of paying passengers times distance flown.
[3] ASKs is the acronym for available seat kilometres, which is the product of the number of available seats flown times distance flown.

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Disclaimer

by Siriusavcap

Industry Update Q3 2024

• Special Topic – Aircraft Leasing Industry Financial Performance
• Macro-Economic Background
• Traffic and Aircraft Demand
• New Aircraft Supply
• Airline Industry Financial Performance
  Where are all the early retirements? Is it different this time?

Aircraft Leasing Industry Financial Performance

2023 saw a significant improvement in the profitability of the aircraft leasing industry. There were no major asset write-downs such as those incurred because of Covid, and the de facto expropriation of most aircraft leased to Russian airlines in 2022. In fact, several lessors were able to write back some of the latter charges as they received partial insurance settlements. Despite these unprecedented problems the aggregate performance of the industry has been relatively stable, particularly relative to the performance of the airline industry[1].

Asset impairments and write-backs have had a huge impact on aggregate industry results since 2020 as shown in the chart below. Insurance settlements in respect of aircraft expropriated by Russia are likely to have a positive impact on results in 2024 and beyond. Most amounts paid to lessors to date have been received from Russian insurers while litigation with western insurers continued. However, AerCap recently settled some of its claims with the latter which may presage more payments. It is a measure of the defensive financial strength of the industry that there has been very little financial distress in this period. Two lessors sought court protection, NAC and Voyager, which both had niche asset strategies based on regional and widebody aircraft respectively. None of the major lessors with more diverse aircraft fleets suffered a credit rating downgrade.

Before we discuss underlying financial performance it’s worth a detour to note some important changes to the industry background for aircraft lessors. First growth in terms of asset value has slowed down. This is mainly due to the disruption of new aircraft deliveries particularly at Boeing which is discussed in more detail below. There has also been some impact from cyclical changes in aircraft values although this has largely worked its way through the system (the chart below uses Avitas Market Values where available). This increases competition between lessors in the new aircraft market as most of them have targets for balance sheet growth although there are fewer deals available.

We believe net lease rental yield is a key measure of underlying performance. This ratio is the net rent earned by the lessor excluding maintenance rent etc. as a percentage of average aircraft book value and is analogous to rental yield in commercial property[2]. The chart below shows the range of yields achieved by the group of lessors we follow over the last ten years. This ratio has started to recover after a significant decline since 2019, but it is not a strong recovery as one would expect a higher yield if only because of fleet ageing.

The recovery in yield also needs to be considered in the light of changes in interest costs. Interest expense is a key part of aircraft lessors’ cost of sales - they seek to pass on any increases to their airline customers in higher rents and are likely to pass on decreases by way of lower rents due to competitive pressures. One should not expect changes in interest rates to immediately feed through into aircraft lease rates as the relationship between them is more than a little “sticky” and tends to be hard to identify separately from the impact of changes in aircraft supply and demand. Lessors typically have significant medium-term fixed-rate borrowings to hedge their fixed-rate leases, so their cost of debt is relatively stable. Despite these caveats it would be reasonable to expect a greater increase in rents to have occurred in 2023 given the rise in interest rates and the increased age of the fleet.

Macro-Economic Background

We have mentioned a few times recently that we want to shift the focus of our discussion of world GDP development from a look back to a look forward perspective. Looking back made a lot of sense in the last few years as this kind of data can be subject to major revisions and it was important to capture the overall impact of the pandemic from 2020 through 2024. Any revisions now are very small, so it is time to move on.

The chart below compares the IMF’s forecast for world GDP growth from its October 2024 World Economic Outlook with its three most recent predecessors. The forecast horizon moves forward each year, so it is helpful to create indices that help visualise the rate of change – obviously steeper is better. The 2024 forecast is notably more positive than the previous two years.

Economic growth is a key driver of long-term growth of air travel. However, since early 2022 its impact has been overshadowed by the fall and recovery in traffic associated with the pandemic. In time the influence of overall economic conditions on air travel is likely to reassert itself, but industry forecasts published by Airbus, Boeing and IATA assume much higher rates of traffic growth than GDP growth over the rest of the 2020s as the former catches up to its long-term trend (see our Q1 2024 Industry Update for a more detailed discussion).

The US Dollar has weakened since its recent peak in September 2022, providing relief for airlines outside the US for dollar-denominated costs such as fuel, aircraft rents and aircraft spares. The price of jet fuel has remained volatile, but it has moderated since February 2024. This reduction has mainly been driven by a reduction in the “crack spread” from c.$30 to c.$13.

Another indicator that is potentially important to aircraft investors is the breakeven inflation rate on US Treasury Inflation-Protected Securities (TIPS). This indicator measures inflation expectations and it matters because used aircraft values are strongly influenced by the cost of new aircraft and over time this cost is linked to US Dollar inflation. In the short term this linkage is driven by escalation clauses in aircraft purchase contracts and in the long term by the general input cost environment for the aircraft manufacturers. The chart below compares the breakeven rate for 10-year and 5-year TIPS.

Although medium or long-term inflation expectations have never gone higher than 3.5%, actual inflation experience has been much higher in the last few years. This has led to higher appraised values for new aircraft.

Traffic and Aircraft Demand

Full recovery has yet to be achieved for twin-aisle aircraft, mainly due to weak traffic to and from, and within the Asia-Pacific region. The figures by region in the tables above are based on airline domicile, so weak Europe to Asia traffic reduces recorded international RPKs in other regions. Twin-aisle aircraft in service has shown a greater improvement relative to 2019 than ASKs which suggests that aircraft are being returned to service with lower utilisation in anticipation of continued recovery.

New Aircraft Supply

Boeing suffered another disruption to its aircraft production activity when its machinists went on strike in September. There are reports that 737 Max production restarted in early December after the strike was resolved in November, although Boeing has not confirmed this. At the end of Q3 Boeing held an inventory of 60 B737-8 aircraft produced prior to 2023 compared to 175 at the start of the year, plus 35 -7 and -10 variants awaiting certification. B787 production has also been hit by the strike as well as supply chain problems and rework requirements. Inventory reduced from 50 at the start of the year to 30 at the end of Q3. The inventory reductions show that Boeing is struggling to deliver “new build” aircraft so far this year.

Boeing has stopped providing official production guidance. Its long-term target for B737 production is 56 per month but this is clearly several years away, and, in the meantime, production is capped at 38 a month by the FAA until it is happy that the manufacturer has resolved the quality control lapses that caused the door panel of an Alaska Airlines B737-9 to detach in flight last January. Several analysts have written that production will be at very low levels for some time. B787 production will also take time to build back towards Boeing’s target of 5 per month.

Boeing has also pushed back target entry into service dates for its new B777 models with B777-9 EIS now 2026, B777-8F 2028 and B777-8 2030.

The number of commercial jets delivered by OEMs other than Airbus and Boeing remains subdued. COMAC of China achieved a significant increase in ARJ 21 and C919 deliveries and slightly ahead of 2023.

[1] Sirius has created the time series of aggregate aircraft leasing industry returns by based on public financial information in respect of the following companies: AerCap, Aircastle, Air Lease Corp., ALAFCO, Aviation Capital Group, Avolon, AWAS, BOC Aviation, CDB Aviation, DAE Capital, Fly Leasing, GECAS, Genesis Lease, ILFC, Intrepid/Voyager, Nordic Aviation Capital and SMBC Aviation Capital. We have excluded NAC from our calculations for 2022 because their net income includes a $2.6 BN gain on restructuring of financial liabilities and some other large one-off items.
[2] For the purposes of calculating net rental yield we include assets such as maintenance rights and lease premiums in aircraft book value as both these items are allocations of amounts paid for used aircraft and their exclusion would inflate net lease yield compared to aircraft bought new. We have excluded ALAFCO and NAC from these calculations
- ALAFCO has been subject to an orderly wind-down in recent years and this has made this ratio very volatile due to the timing of aircraft sales.
- NAC’s bankruptcy involved very substantial aircraft impairments relative to its total aircraft book value which have distorted this ratio.
[3] RPKs is the acronym for revenue passenger kilometres, which is the product of the number of paying passengers times distance flown.
[4] ASKs is the acronym for available seat kilometres, which is the product of the number of available seats flown times distance flown.

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by Siriusavcap

Industry Update Q2 2024

• Special Topic – Aircraft Trading Update
• Macro-Economic Environment
• Traffic and Aircraft Demand
• New Aircraft Supply
• Airline Industry Financial Performance
  Where are all the early retirements? Is it different this time?

Aircraft Trading Update

It is a cliché to point out that there is no “ticker” in the aircraft market. A result of this lack of transparency relative to some other asset types is the temptation to fall back on anecdotal evidence of market activity, which obviously runs the risk of confirmation bias, groupthink and other distortions.

One source of real data is aircraft lessor financial statements which provides details of aircraft sales revenue and normally units sold as well. The chart below shows aircraft sales revenue for ten companies that could reasonably be classed as “new aircraft lessors”, which is to say that most of the aircraft they acquire are new or nearly new. The only significant exception is AerCap which has grown in part through the acquisition of competitors such as ILFC and GECAS, although these mature businesses were also built on the acquisition of new aircraft.

The chart shows the impact of the pandemic on trading activity. The sharp reduction aircraft sales revenues was driven by two key factors:

• A large proportion of the aircraft sold by these lessors are subject to lease and the sales process typically requires lessee (airline) co-operation. In 2020 and 2021 many airlines sought rent deferrals, and it would not have been practical for lessors to seek consent to an aircraft sale whilst simultaneously negotiating a rescheduling.
• Potential buyers of aircraft sought more attractive economics but there was little lessor appetite to sell at a loss, so the market largely failed to clear. None of the lessors featured in the chart suffered any material downgrade to their credit ratings because of the pandemic and they all had large liquidity buffers so they could afford to sit the market out.

The market has gradually recovered since 2020 although it has yet to return to pre-pandemic levels. There is some understatement of activity in 2023 as CDB and SMBC have yet to publish their financials, but this is offset by GECAS trading activity being included as part of AerCap and a large one-off asset sale by ALAFCO.

Given the limitations of this approach we thought it might be worth trying to use alternative data sources to get a better sense of the overall market. Our approach was to use data on the number of aircraft trades from Cirium Fleets Analyser combined with historical values from the Avitas Blue Book. There are a lot of reasons why this approach is not going to tie out too closely to the numbers from the financial statements, principally:

• It is challenging for data providers like Cirium to capture which aircraft are owned rather than managed by lessors as many aircraft are held in special-purpose companies which may or may not be owned by the lessor. We have assumed all aircraft managed by a lessor are also owned as we believe this is the “least bad” approach.
• The timing of a sale for accounting purposes may not coincide with the actual transfer of title and there may be delays in making the regulatory filings that allow data providers to identify a transaction.
• Avitas Blue Book values generally assume an aircraft is in a “half-life” maintenance condition whereas real world transactions reflect actual maintenance status and/or the impact of a lease in place.

The two charts below compare the “Actual” numbers in the financial statements with the numbers derived from our methodology which we refer to as the “Model” numbers. We have shown these numbers in the aggregate for all ten lessors and on this basis the two approaches tie out reasonably well, although there can be greater divergences at the level of the individual lessor. The relatively big shortfalls in the model vs actual figures by units and value in 2023 may reflect the impact of reporting delays as discussed above.

It seems reasonable to conclude that the Model approach is a reasonable basis for looking at the broader aircraft trading market although it’s probably best considered a guide to the direction of travel rather than an exact record.

The kind of aircraft trading discussed above is a subset of the larger overall aircraft trading market. Cirium classifies aircraft purchases as:

• Purchase (no lease involved)
• Sale and leaseback on delivery
• Sale and leaseback
• Purchase subject to lease
• Securitization

Most of the sales by large lessors consist of aircraft subject to lease or securitizations. We have filtered the securitisation transactions to eliminate those which are financings rather than transfers of economic ownership. This is mainly a function of whether E notes were issued along with senior debt, but we have also researched industry publications and pre-sale reports. We have also eliminated some non-commercial aircraft types and there are some gaps in the value data available, but we still capture c. 90% of transactions overall and our coverage improves to more than 90% over time.

The charts below show historic aircraft trades from 1990 by category, units and value.

It is also clear that the cyclicality in the trading activity of large lessors is also present in the overall market, although the reasons for lower trading activity in downturns may not be the same for other market participants.

Macro-Economic Environment

As we discussed in our Q1 2024 industry update we have changed our GDP focus from the retrospective amount of damage done by the pandemic to looking forwards. The IMF has gradually been taking a more optimistic view with its latest 2024 projection at 2.7% vs 2.4% only nine months ago.

Although medium or long-term inflation expectations have never gone higher than 3.5%, actual inflation experience has been much higher in the last few years. This has led to higher appraised values for new aircraft.

Traffic and Aircraft Demand

International traffic recovery still lags domestic and shows greater variation by region, with Asia-Pacific conspicuously weaker than in 2019 and North America much stronger. It is striking that North American international RPKs are 11.0% higher than in 2019 vs only a 1.5% increase for domestic US RPKs: domestic traffic across the Americas was the quickest major market to recover after 2020 so it is tempting to assume that all is well, but markets such as the US are relatively mature limiting long-term growth potential.

The key markets driving domestic traffic volumes growth are China and India which as emerging markets with very large populations are vital to the aviation industry long-run fortunes.

Although some short-haul aircraft serve international routes nearly all long-haul aircraft do so, and this is reflected in the relative demand for single-aisle (narrowbody) and twin-aisle (widebody) aircraft. Aircraft demand can be measured in terms of aircraft in service and ASKs, the standard measure of aircraft capacity deployed by airlines which indicates how intensively aircraft are being flown. Single aisle aircraft demand on both metrics is higher so far in 2024 than in 2019 whereas twin-aisle aircraft are marginally weaker by aircraft in service and lagging more in terms of ASKs. The difference between the two metrics may be down to the gradual move away from very large aircraft such as the B747 and A380 towards the smaller B787 and nA350, resulting in fewer ASKs per aircraft unit.

It is hard to see the TA 2024 data series because it is only very marginally lower than TA 2019.

New Aircraft Supply

The latest status of Boeing’s production plans is:

Airline Industry Financial Performance

There has been some recovery in airline share prices since the summer which is most reasonably explained by lower fuel prices.

GOL of Brazil files for US bankruptcy protection in January. This was not a major surprise as GOL’s major competitors Avianca and LATAM had already done so during the pandemic and GOL had engaged in significant financial restructuring in the same timeframe.

[1] RPKs is the acronym for revenue passenger kilometres, which is the product of the number of paying passengers and distance flown.
[2] ASKs is the acronym for available seat kilometres, which is the product of the number of available seats flown and distance flown.

Downloadable Version

Disclaimer

by Siriusavcap

Industry Update Q1 2024

• Special Topic - Traffic Growth Outlook
• Macro-Economic Background
• Traffic and Aircraft Demand
• New Aircraft Supply
• Airline Industry Financial Performance

Traffic Growth Outlook

As discussed below the industry has recovered, if we are happy to define recovery as traffic exceeding 2019 levels. However, this does beg the question of whether 2019 traffic is the appropriate benchmark for recovery.

When the pandemic hit both Airbus and Boeing made significant adjustments to their annual 20-year industry forecasts. In the chart below we compare Boeing’s forecast of global RPKs[1] in 2038 published in 2019 with our estimates of the comparable number for forecasts published in subsequent years (we estimate the figures for the following years by interpolating between Boeing’s 10 and 20 RPK forecasts). Boeing’s forecast effectively reduced by 10% after the onset of the pandemic and has stayed there since. Our analysis of the comparable Airbus forecasts suggest they did something very similar, but presenting this would require a lot more estimates on our part and we prefer not to go there.

A 10% reduction in long-term RPK growth is a lot more than would be justified by the 2.0-2.5% reduction in world GDP growth caused by the pandemic as the historic RPK/GDP growth multiple is less than 2X. One possible justification for a more conservative approach is that traffic growth was very strong in the latter years of the 2010s so that basing a forecast on cyclical high point would be biased upwards. However, this would not necessarily be correct if this high growth period was partly or wholly offsetting an earlier period of low growth.

A more systematic approach is to create a model of RPK growth which can compare actual with expected RPKs. An analysis of historic traffic data in “normal” times shows that world GDP growth and changes in the real cost of air travel, as measured by constant $ yield[2], provide a very strong explanation of growth in RPKs (a regression analysis on this data for the period 1970-2019 gives an adjusted R-squared of 0.998).

This analysis shows that RPKs were indeed above trend in the 2010s. This was not unprecedented as there was a similar phenomenon in the late 1990s, and it is also striking to note the prolonged period of weak growth in the 2000s.

Another way of looking at same data is to chart the ratio of actual to expected RPKs as in the chart below. This demonstrates that the strong traffic levels of the 2010s were in line with previous up-cycles. Based on this analysis the reduction in the OEMs RPK forecasts is reasonable. In 2019 actual RPKs were 4% above trend and there is a case for a 4-5% reduction based on “lost” GDP growth.

It’s also interesting to consider what this analysis suggests about where the market is right now. We have rolled the model forward to 2024 based on IATA’s traffic and yield forecasts and the IMF’s world GDP forecast.

Based on this approach actual 2024 RPKs will only be 85% of expected, compared to 93% in 2002 (in the aftermath of 9/11). Obviously, the world may have permanently changed, but based on history there is scope for significant further traffic recovery in 2025 and beyond.

One factor that may obstruct this is a shortage of new aircraft. This may also have been part of the weak traffic performance in the 2000s, when new passenger aircraft deliveries did not surpass their previous peak of 1,191 in 2001 until 2012. If this happens then pent-up demand may find an outlet in higher ticket prices.

Macro-Economic Background

Having said in our last market update that we would focus more on the outlook for GDP the IMF confounded this goal by publishing a significant revision to their numbers for 2020 and 2021. These changes mean that the “permanent” loss of GDP growth which we estimated at 2.5-3.0% should be revised down to 2.0-2.5%.

Economic growth is a key driver of long-term growth of air travel. However, since early 2022 its impact has been overshadowed by the fall and recovery in traffic associated with the pandemic. As recovery is largely complete the influence of overall economic conditions on air travel is likely to reassert itself.

The US Dollar has weakened since its recent peak in September 2022, providing relief for airlines outside the US for dollar-denominated costs such as fuel, aircraft rents and aircraft spares. The price of jet fuel has remained volatile, but it has moderated since February 2024. This reduction has mainly been driven by a $10 reduction in the “crack spread” from c.$30 to c.$20.

Another indicator that is potentially important to aircraft investors is the breakeven inflation rate on US Treasury Inflation-Protected Securities (TIPS). This indicator measures inflation expectations and it matters because used aircraft values are strongly influenced by the cost of new aircraft and over time this cost is linked to US Dollar inflation. In the short term this linkage is driven by escalation clauses in aircraft purchase contracts and in the long term by the general input cost environment for the aircraft manufacturers. The chart below compares the breakeven rate for 10-year and 5-year TIPS.

Although medium or long-term inflation expectations have never gone higher than 3.5%, actual inflation experience has been much higher in the last few years. This has led to higher appraised values for new aircraft.

Traffic and Aircraft Demand

Global Air Passengers, RPK Billions per Month

March 2024 RPKs were 0.1% higher than in March 2019, so recovery is official! Also, no region was more than 5% higher or lower than in 2019 so most of the extreme disparities in terms of recovery have worked their way out of the system.

International traffic recovery still lags domestic and shows greater variation by region, with Asia-Pacific conspicuously weaker than in 2019 and North America much stronger. It is striking that North American international RPKs are 11.0% higher than in 2019 vs only a 1.5% increase for domestic US RPKs: domestic traffic across the Americas was the quickest major market to recover after 2020 so it is tempting to assume that all is well, but markets such as the US are relatively mature limiting long-term growth potential.

The key markets driving domestic traffic volumes growth are China and India which as emerging markets with very large populations are vital to the aviation industry long-run fortunes.

Although some short-haul aircraft serve international routes nearly all long-haul aircraft do so, and this is reflected in the relative demand for single-aisle (narrowbody) and twin-aisle (widebody) aircraft. Aircraft demand can be measured in terms of aircraft in service and ASKs[3], the standard measure of aircraft capacity deployed by airlines which indicates how intensively aircraft are being flown. Single aisle aircraft demand on both metrics is higher so far in 2024 than in 2019 whereas twin-aisle aircraft are marginally weaker by aircraft in service and lagging more in terms of ASKs. The difference between the two metrics may be down to the gradual move away from very large aircraft such as the B747 and A380 towards the smaller B787 and nA350, resulting in fewer ASKs per aircraft unit.

It is hard to see the TA 2024 data series because it is only very marginally lower than TA 2019.

New Aircraft Supply

IN contrast to 2022 Airbus exceeded its delivery guidance of 720 aircraft in 2023. Management is guiding total deliveries of 800 aircraft for 2024 with most of the increase likely to come from the A320 family. The latest status of Airbus’s production plans is:

The only significant production target not captured in the table above is the objective to raise A320 family production to 75 per month by 2026.

The latest status of Boeing’s production plans is:

The Alaska Airlines B737-9 incident in January has once again created significant uncertainty around Boeing’s ability to increase production of the Max. The FAA is investigating Boeing’s quality control systems and other related matters and has announced that it will not approve any increases in production until it is satisfied with Boeing’s level of compliance. Boeing has also announced that it will not seek certification of the B737-7 and -10 variants until it has engineering solutions for the engine inlet overheating issue resulting from extended engine anti-Ice operation in dry air. There is no definite timeframe to resolve this issue.

B737 inventory decreased from 175 at the end of 2023 to 110 at the end of Q1 2024, including 70 B737-8 aircraft due to be delivered to Chinese airlines which must be approved and accepted by the Chinese aviation regulator the CAAC. The 110 number above only includes aircraft manufactured before the start of 2024, suggesting that nearly all the B737s delivered in Q1 2024 were from inventory as the reduction of 65 compares to 67 aircraft delivered in the quarter. (Currently, China's 13 domestic carriers operate 97 B737 MAX planes in their fleet. China Southern, Air China and Hainan Airlines have 24, 16 and 11 aircraft, respectively. Shanghai Airlines, Xiamen Airlines and Shandong Airlines are also B737 MAX operators.

As with the Max Boeing holds a significant inventory of undelivered B787 aircraft, c.40 at the end of Q1 vs c.50 at the end of 2023. Boeing has said it expects to deliver most of them in 2024. The inventory reduction of 10 aircraft compares with 13 total deliveries, suggesting that both B737 and B787 production is being severely disrupted. Boeing has not provided any delivery guidance for 2024.

COMAC of China achieved a significant increase in ARJ 21 deliveries and Embraer was in line with 2023.

Airline Industry Financial Performance
IATA released a new airline industry financial forecast in June 2024 as part of its semi-annual Global Outlook for Air Transport. The table below compares key forecast outputs for 2024 with IATA’s previous forecast published in December 2023.

The new forecast does not show a big change in RPKs or key costs such as jet fuel, but the yield, revenue and profitability outlook is significantly better.

One development with a potentially important impact on 2024 airline profits is a recovery in the price of business and first-class travel. Although Q1 2024 share of RPKs was in line with typical historic levels at around 7% share of revenues increased from a historically low 15% to a more “normal” 20%. This will help the bottom line of the network airlines rather than low-cost airlines with very limited, if any, premium cabin offering.

Since the start of 2024 airline share prices have shown persistent, albeit limited, downside volatility relative to the overall stock market.

NYSE Arca Global Airline Index vs S&P Global 1200 Index (Google Finance)

GOL of Brazil files for US bankruptcy protection in January. This was not a major surprise as GOL’s major competitors Aviance and LATAM had already done so during the pandemic and GOL had engaged in significant financial restructuring in the same timeframe.

The second largest airline by equipment value to fail is Lynx Air of Canada with a fleet including 9 X B373-8s. Lynx filed for bankruptcy protection in February, citing rising operating costs, high fuel prices, increasing airport charges, and a difficult economic and regulatory environment. Lynx was a low-cost airline that started operations in 2022 and some or all its problems are shared by most low-cost North American carriers up to and including Southwest Airlines, which have not benefitted from the strength of North American international traffic in the same way as the network airlines.

Sometimes airline financial distress comes in shades of grey rather than black and white. Although Pacific Airlines has ceased operations it has declared its intention to restart, and SpiceJet of India (43 aircraft) has suffered several adverse court judgments although it remains in business.

by Siriusavcap

Industry Update Q4 2023

• Macro-Economic Background
• Traffic and Aircraft Demand
• New Aircraft Supply
• Airline Industry Financial Performance
• SPECIAL TOPIC – Airline Industry Default History
  Where are all the early retirements? Is it different this time?

Macro-Economic Background

The IMF’s latest update to its World Economic Outlook shows a marginal improvement in its assessment of overall performance across the years affected by the pandemic. Our focus in presenting this data so far has been to see if there has been any “permanent” loss of output in this period. World GDP grew at 2.8% p.a. for the 30 years through 2019 and leading forecasters such as DRI expect a similar growth rate for the next 20 years. This implies that the pandemic has caused a long-term output loss of c. 0.7% p.a. for the years 2020-2023, or roughly 2.5-3.0% in total. In future updates we will focus more on the outlook for growth.

Economic growth is a key driver of long-term growth of air travel. However, since early 2022 its impact has been overshadowed by the fall and recovery in traffic associated with the pandemic. As recovery is largely complete the influence of overall economic conditions on air travel is likely to reassert itself

The US Dollar has weakened since its recent peak in September 2022, providing relief for airlines outside the US for dollar-denominated costs such as fuel, aircraft rents and aircraft spares. The price of jet fuel has remained volatile and has increased since the start of 2024. The IATA chart below shows that a key characteristic of current jet fuel market conditions remains the historically high level of the “crack spread”[1] at over $30 per barrel. Some of the issues that have contributed to this increase include the pace of traffic recovery, especially in Asia Pacific, and reported local refinery issues in the US and Europe. It seems reasonable to expect that the crack spread will reduce over time but with a lot of volatility around this trend.

Another indicator that is potentially important to aircraft investors is the breakeven inflation rate on US Treasury Inflation-Protected Securities (TIPS). This indicator measures inflation expectations and it matters because used aircraft values are strongly influenced by the cost of new aircraft and over time this cost is linked to US Dollar inflation. In the short term this linkage is driven by escalation clauses in aircraft purchase contracts and in the long term by the general input cost environment for the aircraft manufacturers. The chart below compares the breakeven rate for 10-year and 5-year TIPS.

The recent reduction in US inflation has not significantly impacted the TIPS market, implying that this was already captured in investor expectations.

Traffic and Aircraft Demand 

December 2023 air travel volumes were only 2.5% below December 2019, and full year comparison shows 2023 5.9% below 2019. Asia Pacific was the strongest performing regions as government restrictions (especially in China) were finally relaxed. As in 2022, there was a much bigger increase in international traffic vs domestic traffic, mainly because the former is still coming off a lower base.

Despite its strong year on year performance Asia Pacific remains the weakest region compared to 2019 with a significantly lower share of global traffic.

The chart below shows the changes in RPKs[2] and ASKs[3] by month. Since the start of 2023 the level of increase in RPKs has reduced because the year-on-year comparison is with a month in 2022 that was subject to a greater level of traffic recovery. Second the rate of increase in RPKs and ASKs has become more alike as the recovery in load factors is largely complete, so additional capacity needs to be deployed to support further traffic growth.

Although some short-haul aircraft serve international routes nearly all long-haul aircraft do so, and this is reflected in the relative demand for single-aisle (narrowbody) and twin-aisle (widebody) aircraft. Aircraft demand can be measured in terms of aircraft in service and ASKs, the standard measure of aircraft capacity deployed by airlines which indicates how intensively aircraft are being flown. Single aisle aircraft in service and ASK levels from Q2 2023 were ahead of the comparable period in 2019 reflecting the stronger recovery in domestic traffic. Full recovery has yet to be achieved for twin-aisle aircraft, mainly due to weak traffic to and from, and within the Asia-Pacific region. The figures by region in the tables above are based on airline domicile, so weak Europe to Asia traffic reduces recorded international RPKs in other regions.

New Aircraft Supply

IN contrast to 2022 Airbus exceeded its delivery guidance of 720 aircraft in 2023. Management is guiding total deliveries of 800 aircraft for 2024 with most of the increase likely to come from the A320 family. The latest status of Airbus’s production plans is:

The only significant production target not captured in the table above is the objective to raise A320 family production to 75 per month by 2026.

The latest status of Boeing’s production plans is:

Total B737 Max deliveries in 2023 were at the upper end of the revised guidance issued after Q3. The incident with the Alaska Airlines B737-9 in January has once again created significant uncertainty around Boeing’s ability to increase production of the Max although it has reached its short-term target of 38 aircraft per month. The FAA is investigating Boeing’s quality control systems and other related matters and has announced that it will not approve any increases in production until it is9 satisfied with Boeing’s level of compliance. Boeing has also announced that it will not seek certification of the B737-7 and -10 variants until it has engineering solutions for issues with their deicing systems and there is no definite timeframe to achieve this.

B737 inventory decreased from 250 at the end of 2022 to 175 at the end of 2023, consisting of:

• 80 B737-8 aircraft due to be delivered to Chinese airlines.
• 60 B737-8 aircraft due to be delivered to other airlines.
• 35 B737-7 and B737-10 aircraft which will be delivered once certification is achieved.

Boeing plans to deliver most of these aircraft in 2024 although it will need the Chinese government to sign off on the first tranche (all aircraft previously delivered to Chinese airlines are back in service) and type certification for the third tranche.

Q1 2023 saw the delivery of the last B747 which like the B767 had not seen any passenger variants sold for several years. That has also been the case recently for the B777, but this is likely to change with the entry into service of the B777-8 and B777-9 from 2025. Boeing has also had quality and production problems with the B787, its main passenger twin-aisle offering. It suspended deliveries in May 2021 and restarted in Q3 2022. Production levels are back at 5 aircraft per month going to 10 by 2025/2026. As with the Max Boeing holds a significant inventory of undelivered aircraft - 50 at the end of Q4 vs 100 at the end of 2022. Boeing has said it expects to deliver most of them in 2024.

The number of commercial jets delivered by OEMs other than Airbus and Boeing remains subdued. Although there is a gradual upward trend in deliveries from Chinese manufacturers (ARJ 21 and C919 models) these are likely to be confined to Chinese airlines for the foreseeable future.

by Siriusavcap

Industry Update Q3 2023

• Macro-Economic Background
• Traffic and Aircraft Demand
• New Aircraft Supply
• Airline Industry Financial Performance
• SPECIAL TOPIC – How tight is aircraft capacity?
  Where are all the early retirements? Is it different this time?

Macro-Economic Background

The IMF’s latest update to its World Economic Outlook (October 2023) shows a marginal improvement from their April update. The IMF’s discussion of the world economy centres on the impact of central banks’ efforts to control inflation which is causing moderately low growth by historical standards. This situation is expected to persist through 2024.

Global economic growth is a key driver of long-term growth of air travel. However, since early 2022 its impact has been overshadowed by the fall and recovery in traffic associated with the Covid 19 pandemic. As recovery is largely complete the influence of overall economic conditions on air travel is likely to reassert itself.

The US Dollar has weakened since its recent peak in September 2022, providing relief for airlines outside the US for dollar-denominated costs such as fuel, aircraft rents and aircraft spares.

The price of jet fuel has fallen back after a sharp increase through September. The IATA chart below shows that a key characteristic of current jet fuel market conditions is the historically high level of the “crack spread”[1]at over $30 per barrel. Some of the issues that have contributed to this increase include the pace of traffic recovery, especially in Asia Pacific, and reported local refinery issues in the US and Europe. It seems reasonable to expect that the crack spread will reduce over time but with a lot of volatility around this trend.

Full recovery has yet to be achieved for twin-aisle aircraft, mainly due to weak traffic to and from, and within the Asia-Pacific region. The figures by region in the tables above are based on airline domicile, so weak Europe to Asia traffic reduces recorded international RPKs in other regions. Twin-aisle aircraft in service has shown a greater improvement relative to 2019 than ASKs which suggests that aircraft are being returned to service with lower utilisation in anticipation of continued recovery.

New Aircraft Supply

The only significant production target not captured in the table above is the objective to raise A320 family production to 75 per month by 2026.

The latest status of Boeing’s production plans is:

Boeing has reduced its guidance for B737 Max deliveries in 2023 from between 400 and 450 to between 375 and 400. This is mainly due to manufacturing problems such as the requirement for rework of some fuselage sections manufactured by Spirit AeroSystems. B737 inventory increased from 220 to 250 in Q3 so it is back to where it was at the start of the year. Any significant further reduction is probably dependent on their ability to restart deliveries to Chinese airlines (85 of the aircraft in inventory are contracted for delivery to China). Boeing has also announced a medium-term production target of 50 aircraft per month by 2025/2026. The FAA deadline for certification of the Max 7 and Max 10 variants has been pushed back by new legislation and they are now planned to enter service in 2024 (Boeing had previously targeted EIS for the Max 7 in 2023).

Q1 2023 saw the delivery of the last B747 which like the B767 had not seen any passenger variants sold for several years. That has also been the case recently for the B777, but this is likely to change with the entry into service of the B777-8 and B777-9 from 2025. Boeing has also had quality and production problems with the B787, its main passenger twin-aisle offering. It suspended deliveries in May 2021 and restarted in Q3 2022. Production levels for are back at 3 aircraft per month going to 5 by the end of 2023 and 10 by 2025/2026. As with the Max Boeing holds a significant inventory of undelivered aircraft - 75 at the end of Q3 vs 100 at the end of 2022. Boeing has said it expects to deliver most of them within the next two years.

The number of commercial jets delivered by OEMs other than Airbus and Boeing remains subdued.

Airline Industry Financial Performance

Given there is no obvious shortage of twin-aisle capacity what might motivate airlines to extend leases? This discussion will be speculative as we do not have the detail of the leases that have been extended, but anyway…

Airlines may be sceptical about the ability of Airbus and Boeing to increase output in line with announced production plans. There has been the specific problem with B787 production in the last two years and there is the more general issue of the low level of current production rates by historic standards. After the onset of Covid 19 the manufacturers reduced production to levels where the market would inevitably rebalance at some point in the future. Increased production rates have been announced to levels that have readily been achieved in the past but require a rough doubling from current rates. This is a bigger proportional increase than for single-aisle aircraft types which some airlines may deem challenging.

Another possible motivation is to lock in rents in an airline-friendly market environment. Rising interest rates and supply/demand rebalancing are both likely to increase rents in the future.

[1] The crack spread is the difference between the price of crude oil and refined products such as jet fuel.
[2] RPKs is the acronym for revenue passenger kilometres, which is the product of the number of paying passengers times distance flown.
[3] ASKs is the acronym for available seat kilometres, which is the product of the number of available seats flown times distance flown.
[4] Airbus normally quotes its production rates based on an 11.5-month year for single-aisle aircraft.
[5] ACMI stands for Aircraft, Crew, Maintenance, and Insurance and is also known as wet leasing and/or damp leasing.
[6] Fleet numbers are as of December 31st, 2002.
[7] Our definition of single-aisle aircraft includes regional jets with more than 50 seats.

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by Siriusavcap

Industry Update Q2 2023

• Macro-Economic Background
• Traffic and Aircraft Demand
• New Aircraft Supply
• Airline Industry Financial Performance
• Special Topic - Aircraft Leasing Industry Financial Performance through 2022
  Where are all the early retirements? Is it different this time?

Macro-Economic Background

The IMF’s latest update to its World Economic Outlook (July2023) shows a marginal improvement from their April update. The IMF’s discussion of the world economy centres on the impact of central banks’ efforts to control inflation which is causing moderately low growth by historical standards. This situation is expected to persist through 2024.
Global economic growth is vital to the long-term growth of air travel. However, in the next few years the key drivers of traffic growth will likely be very specific to the airline industry, especially the recovery from the industry downturn caused by the Covid 19 pandemic.

The US Dollar has weakened since its recent peak in September 2022, providing relief for airlines outside the US for dollar-denominated costs such as fuel, aircraft rents and aircraft spares.

The price of jet fuel has increased sharply in the last three months and as the IATA chart below shows this is mainly due to an increase in the “crack spread”[1]. Some of the issues that have contributed to this increase include the pace of traffic recovery, especially in Asia Pacific, and reported local refinery issues in the US and Europe. The current level of the crack spread is high by historic standards, and it seems reasonable to expect that it will reduce over time.

Traffic and Aircraft Demand

Full recovery has yet to be achieved for twin-aisle aircraft, mainly due to weak traffic to and from, and within the Asia-Pacific region. The figures by region in the tables above are based on airline domicile, so weak Europe to Asia traffic reduces recorded international RPKs in other regions. Twin-aisle aircraft in service has shown a greater improvement relative to 2019 than ASKs which suggests that aircraft are being returned to service with lower utilisation in anticipation of continued recovery.

New Aircraft Supply

The only significant production target not captured in the table above is the objective to raise A320 family production to 75 per month by 2026.

The latest status of Boeing’s production plans is:

Boeing plans to deliver between 400 and 450 B737 Max aircraft in 2023, up from 387 in 2022. Part of this will be achieved by reducing aircraft in inventory, although this is a slow process due to rework requirements for these aircraft to enter service. B737 inventory fell from 250 to 225 in Q1 and 220 in Q2 a reduction of 5 per month. Boeing’s guidance for the full year is a reduction of 8 to 10 units per month, which is probably partly dependent on their ability to increase deliveries to Chinese airlines (85 of the aircraft in inventory in June 2023 are contracted for delivery to China). The other contributor to higher deliveries will be an increase in monthly production from 31 to 38. There remains significant uncertainty around Boeing’s ability to meet its targets due to supply chain problems such as the requirement for rework of some fuselage sections manufactured by Spirit AeroSystems. Boeing has also announced a medium-term production target of 50 aircraft per month by 2025/2026.

Despite this overall improvement the Max still faces challenges. The FAA deadline for certification of the Max 7 and Max 10 variants has been pushed back by new legislation and they are now planned to enter service in 2024 (Boeing had previously targeted EIS for the Max 7 in 2023).

Q1 2023 saw the delivery of the last B747 which like the B767 had not seen any passenger variants sold for several years. That has also been the case recently for the B777, but this is likely to change with the entry into service of the B777-8 and B777-9 from 2025. Boeing has also had quality and production problems with the B787, its main passenger twin-aisle offering. It suspended deliveries in May 2021 and restarted in Q3 2022. Production levels for are back at 3 aircraft per month going to 5 by the end of 2023 and 10 by 2025/2026. As with the Max Boeing holds a significant inventory of undelivered aircraft - 85 at the end of Q2 vs 100 at the end of 2022. Boeing has said it expects to deliver most of them within the next two years.
The number of commercial jets delivered by OEMs other than Airbus and Boeing remains subdued.

Airline Industry Financial Performance

The fleet percentage line shows that relative reductions in off-lease aircraft after a downturn are slow and steady, but it is reasonable to expect there will be continuing improvement in this metric in 2023 and beyond, particularly with the supply chain issues affecting new aircraft deliveries.
In addition to increases in off-lease aircraft there was unprecedented economic stress associated with those aircraft that remained on lease. Large numbers of leased aircraft entered storage and aircraft in service showed sharp reductions in utilisation, as shown in the charts below. The first shows off-lease and on-lease but stored aircraft relative to the total leased fleet and the second shows utilization by aircraft class for aircraft on lease and in service.

This kind of stress is clearly going to have an impact on rental income. This can arise in several ways in addition to rent deferrals which have already been discussed. When airlines are in bankruptcy protection leases can be restructured with lower rents (sometimes in return for a lease extension) and/or “power by the hour” arrangements where airlines only pay rent if the aircraft flies. From the lessor’s point of view such arrangements may be the best available option despite the concessions involved. Such arrangements may also arise if there is just the threat of bankruptcy rather than actual court proceedings.
In conclusion the aircraft leasing industry has once again demonstrated the defensive value of contracted lease income streams and a geographically diversified customer base in the most adverse of circumstances. Of the 3% reduction in net rental yield since 2019 we can account for 1% by the impact of lower debt costs and some of the rest by the impact of lease terminations and restructurings, although it is impossible to be definitive. One other factor which should be considered is the long-term impact of aggressive price competition from new entrants, particularly Chinese lessors. We expect that outcomes will vary quite significantly by lessor reflecting customer concentrations and equipment mix.

[1] The crack spread is the difference between the price of crude oil and refined products such as jet fuel.
[2] RPKs is the acronym for revenue passenger kilometres, which is the product of the number of paying passengers times distance flown.
[3] ASKs is the acronym for available seat kilometres, which is the product of the number of available seats flown times distance flown.
[4] Sirius has created the time series of aggregate aircraft leasing industry returns by based on public financial information in respect of the following companies: AerCap, Aircastle, Air Lease Corp., ALAFCO, Aviation Capital Group, Avolon, AWAS, BOC Aviation, CDB Aviation, DAE Capital, Fly Leasing, GECAS, Genesis Lease, ILFC, Intrepid/Voyager, Nordic Aviation Capital and SMBC Aviation Capital. We have excluded NAC from our calculations for 2022 because their net income includes a $2.6 BN gain on restructuring of financial liabilities and some other large one-off items.

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by Siriusavcap

Industry Update Q1 2023

• Macro-Economic Background
• Traffic and Aircraft Demand
• New Aircraft Supply
• Airline Industry Financial Performance
• Special Topic - Airline Industry Credit Outlook
  Where are all the early retirements? Is it different this time?

Macro-Economic Background

The IMF’s latest update to its World Economic Outlook (April 2023) shows a slight decline from their January update due to a combination of negative factors including the impact of Russia’s invasion of the Ukraine, supply chain disruption etc. with most of the drop occurring in the main developed economies.
Global economic growth is vital to the long-term growth of air travel. However, in the next few years the key drivers of growth will likely be very specific to the airline industry, especially the recovery from the industry downturn caused by the Covid 19 pandemic.

The US Dollar has weakened since its recent peak in September 2022, providing relief for airlines outside the US for dollar-denominated costs such as fuel, aircraft rents and aircraft spares. Jet fuel is also on a downwards trend, albeit with a lot of volatility.

The drop in the price of fuel has mainly been a function of a reduction in the “crack spread” which is the difference between the price of crude oil and refined products. Disruption of global supply caused this spread to reach very high levels by historical standards after Russia invaded Ukraine and to remain elevated for some time. Ultimately this has proved to be a temporary phenomenon as the iATA chart below shows.

Traffic and Aircraft Demand

New Aircraft Supply

The only significant production target not captured in the table above is the objective to raise A320 family production to 75 per month by 2026.

The latest status of Boeing’s production plans is:

Boeing plans to deliver between 400 and 450 B737 Max aircraft in 2023, up from 387 in 2022. Part of this will be achieved by reducing aircraft in inventory, although this is a slow process due to rework requirements for these aircraft to enter service. B737 inventory fell from 250 to 225 in Q1 and Boeing’s guidance for the full year is a reduction of 8 to 10 units per month. The other contributor to higher deliveries will be an increase in monthly production from 31 to 38. There remains significant uncertainty around Boeing’s ability to meet its targets due to supply chain problems such as the requirement for rework of some fittings manufactured by Spirit AeroSystems. Boeing has also announced a medium-term production target of 50 aircraft per month by 2025/2026.
Despite this overall improvement the Max still faces challenges. It has yet to be recertified by the Chinese authorities although this is expected to be resolved soon. The FAA deadline for certification of the Max 7 and Max 10 variants has been pushed back by new legislation and they are now planned to enter service in 2023 and 2024 respectively.
Q1 2023 saw the delivery of the last B747 which like the B767 had not seen any passenger variants sold for several years. That has also been the case recently for the B777, but this is likely to change with the entry into service of the B777-8 and B777-9 from 2025. Boeing has also had quality and production problems with the B787, its main passenger twin-aisle offering. It suspended deliveries in May 2021 and restarted in Q3 2022. Production levels for are back at 3 aircraft per month going to 5 by the end of 2023 and 10 by 2025/2026. As with the Max Boeing holds a significant inventory of undelivered aircraft - 95 at the end of Q1 vs 100 at the end of 2022. Boeing has said it expects to deliver most of them within the next two years.
The number of commercial jets delivered by OEMs other than Airbus and Boeing remains subdued.

Airline Industry Financial Performance

[1] RPKs is the acronym for revenue passenger kilometres, which is the product of the number of paying passengers times distance flown.
[2] ASKs is the acronym for available seat kilometres, which is the product of the number of available seats flown times distance flown.
[3] Airbus normally quotes its production rates based on an 11.5-month year for single-aisle aircraft.

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by Siriusavcap

Industry Update Q4 2022

• Macro-Economic Background
• Traffic and Aircraft Demand
• New Aircraft Supply
• Airline Industry Financial Performance
• Special Topic - Aircraft Economic Life
  Where are all the early retirements? Is it different this time?

Macro-Economic Background

The IMF’s latest update to its World Economic Outlook (January 2023) shows a significant improvement on its forecast in October 2022. In retrospect this forecast probably discounted significant economic disruption from Russia’s invasion of the Ukraine that ultimately did not happen. Overall, for the entire period from the start of 2019 to the end of 2023 overall growth is back where it was estimated to be in the middle of last year.
Global economic growth is vital to the long-term growth of air travel. However, in the next few years the key drivers of growth will likely be very specific to the airline industry, especially the recovery from the industry downturn caused by the Covid 19 pandemic.

The US Dollar has weakened since its recent peak in September 2022, providing relief for airlines outside the US for dollar-denominated costs such as fuel, aircraft rents and aircraft spares. Jet fuel is also on a downwards trend, albeit with a lot of volatility.

Another indicator that is potentially important to aircraft investors is the breakeven inflation rate on US Treasury Inflation-Protected Securities (TIPS). This indicator measures inflation expectations and it matters because used aircraft values are strongly influenced by the cost of new aircraft and over time this cost is linked to US Dollar inflation. In the short term this linkage is driven by escalation clauses in aircraft purchase contracts and in the long term by the general input cost environment for the aircraft manufacturers.
The chart below compares the breakeven rate for 10-year and 5-year TIPS to highlight the differences in expectations for the different time horizons. The shorter maturity has been more volatile, especially since the onset of the pandemic, but there is a strong overall correlation that suggests changed inflation expectations are not for a transitory “blip”.

Traffic and Aircraft Demand

The strong recovery in air travel from the start of 2022 has continued through Q4 although overall RPKs for the month of December remained 23.1% below the comparable figures for 2019. Europe and the Middle East are the strongest performing regions because their recovery has mainly occurred this year, whereas the Americas already achieved a significant recovery in 2021. Asia- Pacific remains the weakest region (see discussion below).

The main outlier in the pace of recovery has been the Asia-Pacific region due to a much slower relaxation of government restrictions on international travel and the impact of China’s zero-Covid policy on its domestic market. To illustrate this the chart below compares traffic in 2019 and 2022 for Asia-Pacific and ROW (Rest of the World). Although ROW international traffic has recovered more slowly than ROW domestic, this is mainly down to drop in flights from other regions to Asia- Pacific (IATA’s regional statistics are based on the airline’s domicile rather than traffic flows).

Although some short-haul aircraft serve international routes nearly all long-haul aircraft do so, and this is reflected in the relative demand for single-aisle (narrowbody) and twin-aisle (widebody) aircraft. Aircraft demand can be measured in terms aircraft in service and ASKs[1], the standard measure of aircraft capacity deployed by airlines which indicates how intensively aircraft are being flown. Single aisle aircraft in service levels are now very close to where they were in 2019 with a slightly weaker recovery in ASKs due to lower utilization. The comparable figures for twin aisle aircraft remain much weaker.

New Aircraft Supply

Airbus missed its delivery 2022 target significantly. Its final total of 661 aircraft compared with an initial target of 720, which was reduced to 700 around the beginning of Q4. The shortfall was caused by supply chain problems, particularly with engines.

The latest status of Airbus’s production plans is:

Airbus recently announced delays in planned production increases for the A320 family due to supply chain problems. The increase to 65 aircraft per month has slipped by about a year to late 2024 and the further increase to 75 has gone from mid-decade to late 2026. Some planned increases for twin- aisle aircraft were announced, with the A330 Neo going from 3 to 4 per month in 2024 and the A350 going from 5 to 6 per month later this year, and possibly going to 9 by the end of 2025.

The latest status of Boeing’s production plans is:

Boeing significantly increased B737 Max deliveries in 2022 and by year end had achieved the target monthly production rate of 31 that it announced when it resumed production in 2021. Boeing’s inventory of manufactured but undelivered B737 Max aircraft is dropping slowly, from 335 aircraft at the end of 2021 to 250 at the end of 2022 (our estimated actual monthly production rate nets off the inventory reduction of 85 from 387 total deliveries). Boeing has stretched out the period over which it expects to deliver these aircraft. Its most recent guidance is that it will reduce this inventory at a rate of 8-10 per month with some deliveries not occurring until 2025. Earlier discussion of an increase in production to 38 per month has been shelved due to supply chain problems.
Despite this overall success the B737 max still faces challenges. It has yet to be recertified by the Chinese authorities although this is expected to be resolved soon. The FAA deadline for certification of the B737 Max 7 and Max 10 variants has been pushed back by new legislation and they are now planned to enter service in 2023 and 2024 respectively.

Boeing has also had quality and production problems with the B787, its main passenger twin-aisle product (nearly all B747, B767 and B777 deliveries are freighters or tankers). It suspended deliveries in May 2021 and restarted in Q3 2022. Production levels for now remain “very low”, and 100 undelivered aircraft are in inventory. Boeing has said it expects to deliver most of them within the next two years.
The number of commercial jets delivered by OEMs other than Airbus and Boeing declined slightly in 2022 but outcomes varied significantly by manufacturer. There was a big reduction for the SSJ due to the impact of sanctions on Sukhoi, particularly the announcement by the SSJ’s engine supplier Powerjet that it is withdrawing from the Russian market. There were increases for Embraer and COMAC, and the latter delivered its first C919 which is a medium sized single-aisle aircraft that competes directly with the A320 and B737 aircraft families. This is a big step forward for Chinese aircraft manufacturing and the C919 will likely be the focus of much curiosity within the industry as to its performance in terms of operating economics and productivity.

Airline Industry Financial Performance

IATA’s December 2022 financial forecast shows the airline industry returning to near breakeven in 2022 and moving into profit in 2023. North America is by far the strongest performer followed by Europe and the Middle East. Asia-Pacific, Latin America and Africa remain loss-making through 2023. The differences in profitability are not very great apart from North America and Asia-Pacific, with 2023 EBIT margins for Africa, Europe, the Middle East and Latin America falling within a range of - 1.1% to +0.8%. The single biggest reason for North America’s outperformance is its lack of exposure to the impact of a historically strong US Dollar, and the biggest reason for Asia-Pacific’s underperformance is relatively high government travel restrictions.

Global airline share prices have improved since the end of 2022, outperforming the overall market. Despite macro headwinds robust travel demand is allowing for higher ticket prices and capacity is constrained by airline failures, a low level of airline start-ups and low new aircraft deliveries.

The chart below average fleet and retirement ages from 1990. Both are relatively stable, especially fleet age (the small increase from 2018 reflects the big drop in new aircraft deliveries discussed above).

There is more variability in retirement age, but the main changes here seem to be more secular than cyclical, and in particular there has been a marked drop in average retirement age since the financial crisis. There are some possible explanations that do not bear too much scrutiny:
• Aircraft supply and demand is an unlikely explanation given that the two peaks in retirement age coincide with the aftermath of 9/11 and the onset of the financial crisis; and
• Fuel prices probably do have an impact, but retirement age is much less cyclical.

Part of the answer is looking at who controls the aircraft[3] For the last 20 years lessors have consistently retired aircraft at a younger age than airlines and during this period their fleet share has increased from 25% to 48%.

Lessors obviously need a good reason to retire aircraft as this results in an opportunity loss of revenue. However, lessors have to make a commercial judgement which also takes account of the costs associated with obtaining this revenue and the break-up value of the aircraft. Costs may include both overhaul and reconfiguration expense if a new airline operator is being sought.
Break-up value is largely driven by engine values, which are in turn very dependent on the value of engine spare parts. The engine manufacturers have an effective monopoly on new spare parts and have historically enjoyed significant pricing power until c.10 years from when the relevant aircraft type ceases production. For many years engine spare parts prices have increased by 6-7% p.a. while new aircraft prices have increased by 1.0-1.5% p.a.

These trends have created a situation where stand-alone engine values can exceed an aircraft’s value including engines well before the point where the aircraft has reached its potential service life. Where an existing airline operator is happy to extend a lease, a lessor will have very little cost associated with extending its revenue stream and is likely to choose this option so not all aircraft will be broken up at the same age.
It should be borne in mind that not all engine types have the same level of marketability. The CFM56 and V2500 engine types associated with the A320 Ceo and B737 NG aircraft families are maintained by several different market participants who compete to buy used engines. Where engines are subject to a total care agreement with the engine OEM this is generally not the case as the engine OEM is the sole supplier of engine maintenance services.
One way to test the importance of break-up values is to look at what has happened with different members of the A320 Ceo and B737 NG families. Break-up values are very similar for all family members but the larger aircraft types command higher rents, so if break-up values matter, we should expect to see smaller types retired earlier and in greater numbers. The chart below shows how the different family members have performed through 2022. Smallest to largest aircraft types are presented left to right.

Based on the chart this approach helps to explain what is happening in the single-aisle aircraft market. However there has been a similar pattern of earlier retirement ages for small regional jets and twin-aisle aircraft where there is a much less robust engine market. It may well be that lessor decisions for these aircraft classes are driven by the same kind of economic analysis as for single- aisle aircraft, but the lessors have fewer and less attractive options.

[1] ASKs is the acronym for available seat kilometres, which is the product of the number of seats flown and distance flown.
[2] Airbus normally quotes its production rates based on an 11.5-month year for single-aisle aircraft.
[3] For the purposes of this discussion, we use the Cirium Fleets Analyser concept of aircraft Manager to denote control.

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by Siriusavcap

Industry Update Q3 2022

• Macro-Economic Background
• Traffic and Aircraft Demand
• New Aircraft Supply
• Airline Industry Financial Performance
• Special Topic - Interest Rates and Aircraft Leasing
  The most important economic event of 2022 has been the global increase in inflation and interest rates

Macro-Economic Background

The IMF’s latest World Economic Outlook (July 2022) shows modest decreases for forecast growth in 2022 and 2023, although looking over the entire period since the onset of the pandemic these reductions are entirely offset by upward revisions to 2020 and 2021.
Global economic growth is vital to the long-term growth of air travel. However, in the next few years the key drivers of growth will likely be very specific to the airline industry, especially the recovery from the industry downturn caused by the Covid 19 pandemic.

For airlines outside of the US the impact of the high cost of fuel has been compounded by a strengthening US Dollar. This is a very important factor in airline financial performance because so many airline costs are typically US Dollar-denominated – not just fuel, which may or may not be hedged, but also aircraft rents, debt service, aircraft, and spare parts.

Another indicator that is potentially important to aircraft investors is the breakeven inflation rate on US Treasury Inflation-Protected Securities (TIPS). This indicator measures inflation expectations and it matters because used aircraft values are strongly influenced by the cost of new aircraft and over time this cost is linked to US Dollar inflation. In the short term this linkage is driven by escalation clauses in aircraft purchase contracts and in the long term by the general input cost environment for the aircraft manufacturers.
The chart below compares the breakeven rate for 10-year and 5-year TIPS to highlight the differences in expectations for the different time horizons. The shorter maturity has been more volatile, especially since the onset of the pandemic, but there is a strong overall correlation that suggests changed inflation expectations are not for a transitory “blip”.

Traffic and Aircraft Demand

The strong recovery in air travel at the start of 2022 has continued through Q3 although overall RPKs for the month of September remained 26.2% below the comparable figures for 2019. Europe and the Middle East are the strongest performing regions because their recovery has mainly occurred this year, whereas the Americas already achieved a significant recovery in 2021. Traffic growth in Asia Pacific remains weak mainly due to the disruptive effect of lockdowns on domestic Chinese RPKs.

Although some short-haul aircraft serve international routes nearly all long-haul aircraft do so, and this is reflected in the relative demand for single-aisle (narrowbody) and twin-aisle (widebody) aircraft. Aircraft demand can be measured in terms aircraft in service and ASKs1, the standard measure of aircraft capacity deployed by airlines which indicates how intensively aircraft are being flown. Single aisle aircraft in service levels are now very close to where they were in 2019 with a slightly weaker recovery in ASKs due to lower utilization. The comparable figures for twin aisle aircraft remain much weaker.

New Aircraft Supply

The latest status of Airbus’s production plans is:

In its H1 2022 results presentation Airbus confirmed that it is aiming for an A320 production rate of 75 per month in 2025. However, due to supply chain problems it has put back the timing for its interim target of 65 per month from mid-2023 to early 2024. The A321 Neo XLR has had its target date for entry into service put back from 2023 to early 2024 and the timing for an increase in the A350 production rate has slipped from late 2022 to early 2023.

Airbus recently reduced its overall deliveries guidance for 2022 from 720 to 700.

The latest status of Boeing’s production plans is:

Boeing significantly increased B737 Max deliveries in the first nine months of 2022 and has achieved the target monthly rate of 31 that it announced when it resumed production in 2021. Boeing’s inventory of manufactured but undelivered B737 Max aircraft is dropping very slowly, from 335 aircraft at the end of 2021 to 290 at the end of June 2022 (we have not been able to identify an aggregate number for September 2022). Boeing has stretched out the period over which it expects to deliver these aircraft. Its most recent guidance is that it will reduce this inventory at a rate of 8-10 per month with some deliveries not occurring until 2025. Earlier discussion of an increase in production to 38 per month has been shelved due to supply chain problems.

Despite this overall success the B737 max still faces challenges. It has yet to be recertified by the Chinese authorities although this is expected to be resolved soon. Also, there is effective FAA certification deadline at the end of 2022 for the new B737 Max 7 and B737 Max 10 variants. If Boeing fails to meet this deadline these aircraft will have to be redesigned to add a new emergency alerting system, which would lead to delivery delays.

Boeing has also had quality and production problems with the B787, its main passenger twin-aisle product (nearly all B747, B767 and B777 deliveries are freighters or tankers). It suspended deliveries in May 2021 and restarted in Q3 2022. The inventory of undelivered B787 aircraft stands at 115 and Boeing has said it expects to deliver most of them within the next two years.

The number of commercial jets delivered by OEMs other than Airbus and Boeing through Q3 was slightly over 50% of the comparable figure for 2019. Modest declines for the CRJ and SSJ are due to the former ending production and the impact of sanctions on Sukhoi, in particular the announcement by the SSJ’s engine supplier Powerjet that it is withdrawing from the Russian market. The production decreases at COMAC and Embraer are more short term as the former has a strong backlog and the latter is guiding 60-70 deliveries for the full year.

Airline Industry Financial Performance

IATA’s June 2022 financial forecast shows the airline industry returning to near breakeven in 2022. North America is set to be the first region to move back into net profit and Europe is forecast to be the next best performer on an EBIT Margin basis. The forecast shows a general pattern of modest improvements compared to its predecessor in October 2021 except for a much-improved outlook for Europe and a much less favourable outlook for Asia-Pacific. Europe’s relative performance is much better than in 2021 due to positive impacts of its Covid passport scheme and the re-opening of North Atlantic travel, whereas Asia-Pacific is suffering from both lockdowns in China and more persistent government travel restrictions than in other regions.

So far in 2022 airline shares have slightly underperformed the overall market. Since 2020 airlines have not recovered in line with the overall market because of the need to issue new stock to repair their balance sheets. New equity issuers have included Air Asia, Air France-KLM, Air New Zealand, American Airlines, easyJet, El Al, Flyr, Garuda, Lufthansa and TUI.

In the early 2000s fuel prices took off after many years in the doldrums, and from the onset of the financial crisis in 2008 until 2015 there was a historically unusual combination of high fuel prices and low interest rates. This created a huge demand for more efficient aircraft which was expressed in a record backlog of aircraft orders.

Increased interest rates may modestly improve lessor margins in the short term as lessor interest costs reflect a mix of financings executed over a number of years and move quite slowly. The chart below shows the range of interest costs for up to 16 different lessors from 2007 compared to the yield on the 5 Year US Treasury Note. It demonstrates a wide range around the average cost across all lessors which is driven by differences in size, asset mix, credit rating and access to the capital markets. The changes in the average cost of debt tend to lag market developments as explained above, and a lag as rates increase should be a positive.

The impact of increased interest rates on aircraft trading is proving less positive. Lessors typically sell aircraft subject to an existing lease and buyers evaluate transactions based on a discounted cash flow analysis rather than just looking at the “metal value” of the asset. Most aircraft leases have a fixed monthly rent4 , and when rates increase the trading value of aircraft on a fixed-rate lease goes down, all other things being equal.
The table below shows an example of the effect on an increase in the discount rate on the trading value of a new aircraft. The residual value is based on a typical industry depreciation policy of writing down an aircraft over 25 years to a scrap value of 15% of purchase price. A 2% increase in the discount rate reduces the value of the aircraft by nearly 12%.

A significant change in trading values tends to disrupt market activity as sellers and buyers take time to recalibrate their expectations, and this has happened in 2022 according to informed market Intestest Expense/Average Debt or Yield
sources. However, if aircraft owners are hedged this should allow trading activity to increase in 2024.

This comment obviously begs a couple of questions

  • what does “being hedged” mean? ; and
• what are the mechanics of unwinding hedges to allow trades to proceed?

Lessors appear to take a number of different approaches to managing interest rate risk insofar as one can judge by studying annual reports. The strictest approach to hedging is to target the trading value of a lessor’s assets so that the average life of a lessor’s debt is slightly below its average lease term (aircraft are depreciating assets). Even this is by no means a perfect hedge as different aircraft buyers may not have the same approach to calculating their weighted average cost of capital at different levels of interest rates. The example above implicitly assumes 100% sensitivity to rising rates across the capital structure, whereas buyers often have a equity return target that does not track a particular interest rate benchmark.

Another approach is to focus more on minimising the sensitivity of earnings to changes in interest rates for a number of years without fully matching average lease term. Under both approaches the level of borrowings relative to aircraft also matters. If a lessor is fully matched on debt life vs. lease term this does not mean that it has hedged its trading values if its debt level is way below what would be considered a market level for potential buyers.

The chart above shows the maturity gap between average lease term and debt life for a number of major lessors. Both axes cover a range of five years and it is clear there is a lot more variability in the former than the latter. Average lease term variation is mainly a function of fleet age as leases on new aircraft have longer tenors than for used aircraft and fleet ages range from 3.9 to 10.2 years old for this group. There is less variation in business fundamentals on the liability side of the balance sheet as all these lessors have investment-grade credit ratings. The narrower range of outcomes on debt suggests that it is relatively inefficient in terms of cost to borrow more on a long-dated basis to increase the average life to over five years.

The chart does not include derivative positions because reading the detail of the company reports suggests that these are mostly used to match fixed rate lease income with floating rate debt and not to change the maturity structure of aggregate debt. Part of the reason for the lack of additional strategic derivative positions to reduce this mismatch is that these would be subject to regular mark- to-market calculations that would impact the income statement, as hedge accounting is generally only allowed for interest rate derivative positions that hedge floating rate debt into fixed rate debt. The figures show that across the industry there is a general robust level of hedging albeit not achieving a full match with average remaining lease term.

Also, it is important to re-emphasise that the level of debt relative to aircraft is just as important to hedging trading value as the maturity mismatch. The market level of debt for a leased aircraft is a subjective judgement, but it is very unlikely to be over 70% today, so the debt levels carried by these lessors also contribute to hedging trading value, in some cases to a very significant degree.

The debt levels discussed above are gross rather than net, and the latter are often much lower. Some lessors carry significant cash balances as part of their overall liquidity position alongside undrawn credit lines. Liquidity is a subject that merits detailed consideration in its own right, but in general lessors entered the pandemic with high levels that allowed them to ride out a short period of higher bond yields and afterwards achieve renewed access to the bank loan and debt capital markets.

The mechanics of monetising hedges to facilitate aircraft trades in the next few years may prove to be quite diverse. If one is unwinding a pay fixed interest rate swap allocable to an aircraft being sold the procedure including the accounting treatment is well-established and straightforward to execute. However since the financial crisis all of these lessors have obtained public credit ratings and have issued significant amounts of fixed-rate notes in the debt capital markets, and it is possible that future hedge unwinds may involve repurchase of debt at a discount as the yield on this debt has increased since it was issued. There is much less precedent for this type of transaction, and there is always the alternative of benefitting from below market interest costs for the remainder of the debt’s tenor rather than buying back, but it would not be a surprise to see this happening quite soon.

[1] ASKs is the acronym for available seat kilometres, which is the product of the number of seats flown and distance flown.
[2] Airbus normally quotes its production rates based on an 11.5-month year for single-aisle aircraft and an 11- month year for twin-aisle aircraft.
[3] Fleet totals are based on Cirium Fleets Analyser data as of November 2022
[4] Some aircraft are leased on a floating rate basis where the rent is adjusted periodically in line with short-term interest rates. The amount of the adjustment calculated to pass on the interest rate cost of the lessor’s debt associated with the aircraft

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by Siriusavcap