FOR CURRENT &
FUTURE AIRCRAFT VALUES

Residual Values of A380 Compromised by Premature End

March 4, 2019

Mid Term Program Cancellation Represents Less Than Desirable Outcome

The cancellation of any program which sees a premature ending of production with the delivery total falling well short can have a profound effect on values and the A380 is unlikely to be any exception.

Any reduction in current and future values of the A380 due to the cancellation of the program needs to be viewed in the context of the wider market and to a large extent it remains difficult to understand why the A380 is not a success either in terms of new aircraft sales or in the disposal of used aircraft. In either scenario, the aircraft should be in demand. Values should be strong and residuals even stronger. The demand for passenger traffic continues to be above trend and manufacturers are seemingly struggling to meet this demand; the major airports around the world are faced with ever greater congestion which by necessity requires the use of larger aircraft; the B747-400 is being retired in ever greater numbers and replacements are needed; the positive passenger perceptions regarding the A380 make it one of the few aircraft that even economy passengers look forward to a long flight; the marketing opportunities afforded by its size made it much sought after by Asian and Middle Eastern carriers, the efficiency of the aircraft in terms of seat mile costs could hardly be matched, and even the cost of the aircraft, when compared to the B777-9, is relatively favorable. Population growth and urbanization also seemed certain to ensure that the operation of the A380 was more of a necessity rather than a desirability. For a time the A380 was expected to be stretched and it was this A380-900 that would offer the degree of efficiencies that would make it a success. Reconfiguring the existing -800 provided a cost effective alternative. Re-engining was also a consideration that failed to materialize.

The market has therefore not developed as logic suggested. In the 1990s Airbus and Boeing engaged in a joint study regarding VLAs – Very Large Aircraft. Eventually there was a parting of the ways as Airbus, anxious to continue to offer a competitor to the B747-400, forecast considerable demand for the VLA while Boeing saw much lesser need preferring instead to indicate that the demand would be on the larger twins. The A380, seen by some as a vanity project, nonetheless represented just as much of a gamble as when the B747 was initially launched by Boeing in the 1960s. Airbus secured state launch aid for the A380 which was to be repaid with each aircraft delivered. There will have been an agreement as to the expected number of deliveries and therefore the amount to be paid on each delivery. If Airbus managed to argue that deliveries would be in excess of 250 – possibly 400 or more – this means that those governments that provided state aid could be set to make substantial losses.

Indeed, as the years progressed the imperatives for the use of the A380 would see to increase rather than diminished but the time of the A380 always seemed to be tomorrow rather than today and operators placed orders for twins instead. The delay to the service entry of the A380 was itself a problem. If the A380 had entered service on schedule it would have done so at a time when the market was at its strongest. As it was, 2007 was just before the financial crisis and airlines quickly re-evaluated their capital spending. The very size of the A380 and four engined configuration has therefore proved to be the cause of its initial “success” and its current demise. The size of the A380 means that it is suited to the densest of routes. Every seat does not need to be filled on every flight but what is needed is for the mix of passengers to favor the higher yielding. As with most long haul flights the highest yielding 20 percent of passengers generate 80 percent of the revenue – and profit. There is little point therefore in seeking to carry as many economy passengers as possible. While the size of the A380 makes it possible to carry more high yielding traffic, these seats need to be filled and all too often this was achieved by discounting fares. The higher yielding traffic also has a preference for more point to point service and frequency rather than flying to hub airports. Much of the A380 sales campaigns focused on the ability to replace two B777 flights with a single A380 service and while initially a compelling argument as operators sought to cut costs, in a more buoyant market frequency becomes a higher priority. The A380 has also caused problems with respect to pilot pay scales and in shifting passengers to alternative flights in the event of a cancellation. While demand for aircraft is high, the overall demand for widebodies is perhaps more fragile with production failing to advance as quickly as narrowbodies. The orders for the B777-9 have been virtually static for some years.

There will now be only some 20 aircraft delivered in the next two years as Emirates has cuts its orders and Amedeo has reached an agreement with Airbus on its 20 long standing orders. The eventual number of deliveries will therefore number some 250 over the course of 14 years – of which some are already being scrapped. The cessation of A380 production in 2021 has now been announced as Emirates switches its orders. This is obviously a major negative not least because the production run at some 250 will be less than the number considered reasonable (although there were only 442 B747-400s produced). The experience of operators with some of the engines in particular has not helped.

In terms of current and residual value calculations there now needs to be a re-assessment. It is not appropriate to consider that existing values should remain unchanged. Indeed, the last two years which has seen the scrapping of early aircraft and the lack luster appetite for others, has already had an impact on values. The argument that the focus of values should now switch from the traditional ISTAT assumption of a willing seller, willing buyer to one which sees the value being based on the value to the existing operator seems to be based on financial engineering rather than the realities of the market. Nonetheless, there is an expectation that the majority of A380s will remain with their initial customers for many more years as the B747-400 did. However, such retention needs to be seen in the context of many financing arrangements which sees many 10-12 year financings. Qatar has already indicated that it will dispose of its A380 after ten years when current financing arrangements expire. While Emirates will continue to operate the A380 well into the 2030s, this does not preclude those delivered in the early years from coming onto the market in the near future. Singapore Airlines has not been known for operating old aircraft. Therefore, availability on the used market is an issue going forward and as such estimating the market value remains the most appropriate means of calculating values.

However, one of the major concerns in terms of values when a program is cancelled lies with continued product support. This is not expected to be an issue with Airbus, the engine makers and component manufacturers all likely to continue to support the program. The effect of the cancellation of the A380 therefore more needs to focus on the number of operators and the size of the fleet. As has already been proven, remarketing the A380 is not easy with HiFly being the only second tier user to acquire the aircraft despite speculation that British Airways would acquire used units. There are only some 15 operators of the A380 even including HiFly. Of these, Emirates operates nearly half the fleet. Nearly every one of these operators will have secured considerable discounts not least because they ordered multiple units from the manufacturer and as such none are likely to be willing to pay appraised value figures which are always based on single units. Remarketing the A380 has already proved extremely difficult and will remain so into the future. The lessors have traditionally shied away from becoming involved in the larger widebodies because of the potential difficulties associated with remarketing. The cost of reconfiguring the aircraft has also proved to be an issue with more than $10 million being cited although the down time needed to make the changes is also a major cost element. The financial institutions that have taken a stake in the A380 have perhaps always had a realistic view of the secondary market and as such the initial 10-12 term of the lease, accompanied by an end of lease compensation payment or maintenance reserve fund, will likely equate to a full payout leaving some opportunity for further profit from the sale of spares or a lease to a second tier operator at low rentals or via a power by the hour arrangement.

If the experience of other types in the lead up to even an orderly program cessation is examined, then values of the last of the line fall sharply in the last two to three years of production. The most relevant type would perhaps be the A340-600 which saw the value of a new aircraft fall from $127 million three years before the last one was delivered to some $100m – this was also the case for the B777-200ER and the B747-400. If a similar 25 percent discount is applied to the value of a new 510 tonne A380 as of 2021 then this suggests that the value of a new A380 in 2021 will be some $160 million. Some recent financings of new A380s have sought values of nearer $300 million. The book value of A380s indicated by some airlines will therefore be considerably askew from market values. The value of a 2018 B747-8 which also has effectively ceased production, is only $140 million, less than a new B747-400 15 years ago. The B747-8I has an advantage over the A380 in that conversion to freighter is a possibility, something which is not expected to be offered for the A380 even if the feedstock value falls to less than $40 million. Of seven appraisers, the average value attributed to a new A380 amounted to $210 million with the highest being $245 million and the lowest just over $190 million (the assumed MTOW is not known – this ranges between 510 tonnes to 575 tonnes). There is an argument that the limited production run will result in a restricted market place such that the lack of used aircraft will force operators to seek used aircraft – this may be the case to a very limited extent but any interested buyer will be seeking to pay a much lesser price.

If again the experience of other aircraft, is considered the deterioration in used A380 values will be significant partly because of the fall in the value of a new A380. To a large extent, there has already been some readjustment to residual values because of the slowdown in production and continued speculation as to the future of the A380 although there was a hope that re-engining would revitalize the program. At present AVAC (www.aircraftvalues.net) is anticipating that the value of a 2018 vintage A380 will be $170 million in 2021 representing a 25 percent decline from today. Instead, with the cessation of production, as of 2021 the values of used A380s will likely have declined by some 40 percent – instead of $170m the value will be less than $130m. This still compares favorably with the B747-8I which has a value of $110 million in 2021. The values of the oldest A380s will also decline such that instead of $60 million for a 2007 vintage aircraft as of 2021, this will be less than $40 million. There has been much speculation that the proceeds from the scrapping of the first two A380s will generate some $80 million but this represents the exception rather than norm as such revenue is being generated by the lease of the engines, something which cannot be relied upon in the future. The issue of value convergence will also be a major concern in the coming years as the values of the youngest converge on the oldest. This is because of the perception that operators are not willing to pay a sizeable premium for a younger aircraft that has the same economics, reliability and maintenance costs of an older example. The greater value attributed to the year of build loses its significance once production ceases.

Because of the reduction in order tally and the limited number that will be in service as of production cessation, the imposition of a sizeable discount needs to be immediate. In terms of the values of both new and used aircraft then it would now be prudent to start using lower current market values for those aircraft yet to be delivered. For a 569 tonne A380, if the value of the last to be delivered example was expected to be $220 million but is now forecast to be $165 million based on a 25 percent reduction, then the value of a new A380 delivered this year should be under $205 million, $185 million for a 2020 delivered aircraft and $170 million in 2021. For an A380 built in 2018, the residual value as of 2030 was expected to be around $80 million but this may likely be less than $50 million illustrating the difficulty in placing the aircraft after the theoretical initial 12 year lease term. There will also inevitably be an adverse effect on the Aircraft Rating.

In producing values, it is recognized that the appraiser should be reflecting the market rather than seeking to influence it. In reducing the values of the A380 in the absence of market data this suggests that the appraisers are indeed leading the market. But to assume that there should be no change to values seeks to ignore a material change in one of the core determinants when calculating values – that the aircraft is expected to remain in production and that there would be at least 400 produced and delivered to more than 20 customers. Mere retention by existing operators is no guarantee of residual value strength. The experience of other widebodies in the past all too clearly illustrates the dangers of such an assumption. There were only a few operators of the DC10-10 for some years and in the absence of market data, values were assumed to be high but when the aircraft were sold, the price equated to virtual scrap levels; the experience of the A340-600 and A340-500 in recent years shows how quickly prices can fall with figures of $10 million now being suggested for aircraft that only some 12 years ago were attracting values of more than $100 million. By comparison a forecast of $50 million in 12 years seems generous for a 2018 A380. The experience of the larger widebodies may see the values of the B777-300ER fall at a more rapid rate sooner rather than later.

THE SEARCH FOR AIRCRAFT VALUATIONS
A one-of-a-kind database filled with aircraft valuation data, including information on leasing, valuations and vital statistics, as well as Aircraft Assessment Reports.
Search an Aircraft Valuator
Error Demonstration

Live chat by BoldChat