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Monday, November 2, 2009

Values of Older Aircraft Unlikely to Recover Values of Newer Aircraft Expected To See Some Improvement by 2011

With the deepest point of the current recession for aircraft values expected to occur during the winter of 2009/2010, the focus of attention is now on which aircraft types will manage to stage a recovery – and when.

In terms of the economic recession, the worst seems to be over with some Asian economies registering double digit growth over the last quarter. While the recovery of the more major economies is less pronounced, the cyclic trough may have passed. House prices, a significant barometer in those economies that prize house ownership, have exhibited modest improvements in recent months though the potential for a double dip recession remains.

Passenger traffic and aircraft capacity levels may also be showing a slight improvement but this has to be seen in the context of nearly 1,000 aircraft still being delivered each year. Traffic today is inevitably being compared with the massive falls that started to be recorded from September 2008. For aviation, there exists a clear lag between an economic recovery and any improvement in values and lease rentals. The effect of actual redundancies and threat of further retrenchments as well as a reluctance to spend on non essential items such as air travel, makes for difficult times for airlines.

The low interest rates create problems for those more reliant on income from savings. Corporate profits also take time to recover, limiting the potential for a prompt return of high yielding traffic, so essential for the larger airlines with international networks. The winter is also a time when traffic traditionally drops forcing operators to offer aircraft for wet leases. Consequently, the aviation market will only start to see significant improvements in traffic during the second quarter of 2010. Even then, such improvements in traffic levels will be at the expense of yields. Passengers have become used to low fares but are increasingly concerned about the extra and obscure charges that are increasingly a feature of the low cost and to a lesser extent, the full service carriers. Operators having maintained high load factors during the recession in contrast to the mid 1990s when loads were fortunate to exceed 60 percent. Such high load factors during a recovery phase will quickly allow operators to improve yields and then necessitate the introduction of additional capacity. This is a new phenomenon for airlines and could see a quicker recovery than previously experienced.

Any improvement in values and lease rentals will lag behind rises in traffic. Only when the level of availability starts to diminish and profits return on a regular basis will values start to rise. At the ISTAT conference held in Dubrovnik, Croatia, in October there was consensus that the current downturn represented the worst recession for decades. The mood at the conference was subdued although there was a recognition that at least a recovery was in sight and that for the brave hearted, opportunity always knocked during the trough of the cycle.

Steven Udvar-Hazy, CEO of ILFC, highlighted the sustained production of new aircraft despite a desert awash with surplus equipment, citing a need on the part of manufacturers to continue producing aircraft to finance the development of other programs. Such sustained production rates are causing new aircraft to be used as replacement rather than growth capacity. With the manufacturers providing incentives for customers to accept earlier deliveries as others defer, older aircraft will be increasingly displaced, never to return to service. Just as the B727s and DC9s were sidelined during the 2003-2007 recovery period, so too will the B737-300s, -400s, -500s and early A320s find themselves at the fringes during the next recovery period. These aircraft have already experienced a recovery between 2003-2006. By 2012 Boeing is seeking to introduce an upgraded B737NG that will offer further efficiencies through a new engine variant and aerodynamic changes further differentiating the old and new. As the economic recovery takes hold, the price of fuel will inevitably increase once more. Values of older such aircraft are not expected to recover in such an environment. The B747-400, currently facing significant downward pressure, is likely to see improvement in the coming years as operators shy away from ordering the B747-8I and as Airbus faces difficulty in ramping up production of the A380 sufficiently quickly to meet demand. Most aircraft manage to register one period of recovery after production ends although such improvement usually lasts no more than three years.

As it becomes evident that the large number of aircraft sitting idle in the desert will not return to service in any meaningful manner, values will start to rise such that by 2011 there will be a discernible improvement. Even during the peak of the market in 2006-2007 there were still a large number of aircraft in desert storage. There is now an appreciation that many of those laying idle will only be candidates for the junkyard. The likely launch and service entry of more capable aircraft in the coming years will limit any such rise but then the same was said of the B767-300ER in 2005-2007 as development of the B787 progressed only for values to rise by 50 percent and for lease rentals to double.

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