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Friday, October 23, 2020

The Price Is Right: Commercial Aircraft Market Offers Bargains For The Bold

Covid has decimated the demand for travel, resulting in more than 25 airline restructurings and bankruptcies, according to data I’ve compiled. Looking more closely, we can see a divergence across the industry between Covid’s effects on international and domestic flights, with the former getting more severely hit than the latter. 

This turmoil has also created divergent views in the valuation community. Some have viewed this more as a temporary effect on aircraft values, while others see it as having a deeper ingrained impact with other ramifications. This paves the way for a natural experiment in pandemic exogenous shocks on the pricing for commercial aircraft. Aircraft leasing is a simple business but with many complications that only the most experienced players understand and can overcome given its opaque nature.

The mission, should one chose to accept it, is to discover the offering prices of available aircraft in the market in the absence of evidence from completed transactions.

In addition to second-hand trading of aircraft, airlines and lessors are still taking delivery of new orders at a much lower rate than previously. Many airlines and lessors have deferred deliveries, a trend that was underscored by the fact that there were no widebody aircraft deliveries in July by Airbus.  

Even before Covid, aircraft values and methodology had changed very little, and during these times of unprecedented market turmoil, more opportunities are created for the profession and the industry to move forward. Like other markets, the bid-ask spread usually widens during periods of turmoil like what we’ve been experiencing. The event that triggers the turmoil, like other financial shocks, causes less efficient markets and a decrease in transactions. 

While there is a consensus within the valuation community that the value of assets has decreased, the difficulty is in assessing the degree of such a decrease. Comparatively, new generation technology has performed better than older technology aircraft, while narrowbodies have performed better than widebodies. 

New technology narrowbodies performed the best with only a small roughly 4% to 8% decrease in value for Airbus A320NEO aircraft. Boeing 737MAXs are still a special case. Trade in the yet to be re-certified aircraft has been sparse, but with the hope that the aircraft will soon be flying, market expectations are still strong. New technology widebodies, like A350s and 787s, have seen their values relatively hold up relatively well under the conditions, losing only about 5% to 8%. 

Older technology aircraft have not been as lucky, with much larger markdowns. 737-800s had a temporary bounce up with the MAX groundings, but are now back to original levels. Wide-bodied aircraft are most affected as they tend to be the work horse of international travel and suffered the biggest drop in traffic because of international travel bans. In addition to larger quantum, they are more difficult and costlier to transition to another airline. Those costs can be in the millions.

Used A330-300 aircraft are being offered at between 40% to 50% of their pre-Covid appraised values. Similarly, 777s are also plentiful in terms of availability, which was apparent before Covid with large numbers of aircraft being redelivered after coming to the end of their first lease term.

These were popular assets with a large user base, but the market appears oversupplied with a large overhang effect on anything coming off lease. Covid may be a convenient explanation to investors but the issues predate the crisis. 

Aircraft transactions can involve all sorts of parties including investors, leasing companies; ABS players, OEMs and the banks. Why the banks? As the senior financiers, they are ultimately in a position to resolve things if there is further deterioration. At present, with many airlines benefitting from rent deferrals or holidays, many have been working with clients to reschedule loan facilities.

While not all of the outstanding liquidity has been exhausted, nobody seems in a hurry to call in any of the security guarantees or issue default notices. This would result in the repossession of the assets and nobody wants that headache including storage and maintenance costs if one can even take possession as there are travel restrictions and many governments are not operating as normal. 

The majority of the transactions done during Covid times are ones that were agreed before the pandemic and too far along the process to be jettisoned or postponed. Also, many say they are buyers, but many of the transactions announced early in the crisis appear to be linked to rescheduling and cancellations of orders with manufacturers, although this is difficult to prove with definitive links. 

Lessors are putting a brave face on matters. Current offerings are sparse and basically at pre-Covid levels and few. Few are transacting for fear that the bid-ask spread will throw book values into disarray and actual pricing will require the need to mark-to-market and have a knock-on effect on remaining inventory. Portfolios in the market pre-crisis that did not sell are still being offered. Recall that an arm’s length transaction by definition involves a willing buyer and seller at a market clearing price. 

With over 25 bankruptcies and filings, I can only wonder as to how many airlines (or soon leasing companies) will be in business to meet those deferred obligations going forward or whether they will still be obliged after any Chapter 11 type filings. What is clear is that many are borrowing to keep the ship afloat and with rating agencies having put on watch and trimmed the ratings of ABSs, it is a matter of time before they look at the leasing community.

Those most highly ranked will exit this crisis stronger (look at ALC’s recent earnings report) but those whose rating fall below investment grade will probably have to shed assets and downsize; especially if they have substantial new aircraft commitments. The aviation leasing industry attracted billions in investment, there will be more pain for some. The faster the pain is felt, the faster values can be reset resulting in more opportunities for the bold.

David Yu is the author of the upcoming book: “Aircraft Valuation: Airplane Investments as an Asset Class” published by Palgrave Macmillan.

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