Transitioning Product Line Impacts Values of Outgoing Models

November 12, 2018

Demand Insufficient to Hide Vulnerability of Types Coming to End of Production

Demand for aircraft, as evidenced by higher than trend traffic and an extensive – record – backlog, would seem to suggest that values for nearly all types should be rising but the process of replacement is taking its toll on the fortunes of those aircraft coming to the end of production.

The market is at its zenith – and has seemingly been so for some time. In similar market conditions of the late 1980s and even the mid 2000’s, values were rising. Resulting from greater economic freedom and a collapse in oil prices, the late 1980s saw rapid growth in international air travel and the demand for widebody capacity could not be met from the manufacturers with both the B747-400 and MD11 being delayed at the same time as production of the B747-200/300 and DC10 had all but ceased. The values of used DC10-30s nearly doubled from less than $20 million to nearly $40 million in only a few short years. Even the Lockheed L1011 was viewed with a modicum of enthusiasm. In such a growth period, financial institutions inevitably vied with one another even as the infant lessors shied away from such investments – for good reason. For a time future values forecasts from the then engineering dominated appraisal community could only see further rises in values although some concerns started to be voiced as to how widebody values would react in a downturn. The early 1990s resulted in a sharp reminder of how fragile aviation could be. The values of DC10-30 – and all other widebodies – plummeted and investors quickly exited aircraft financing registering significant losses after having invested at the peak and selling at the trough.

The prevailing market conditions – strong traffic, record backlogs, and delays in the delivery of new aircraft – would seem to suggest that values should be rising. They are not. Even values of aircraft new to market are fortunate to be rising by one to two percent per annum. The models that are in the process of being replaced are the most vulnerable to the process of replacement and static new pricing. On average, values of aircraft in production and mature, fall by some eight percent per annum. The rate of decline is higher for those no longer in production or nearing the end of production and lower for types that have only recently entered service; a strong market may reduce the rate of decline for most types and conversely, weak market conditions will be accelerate the fall. Todays market can be characterized as strong but not sufficient as to markedly warrant a deviation from the average decline of eight percent for a mature type in production. The decline is values is to a large extent, also dependent on how lease rentals are performing. Lease rentals of even new A320neos are perhaps fortunate to exceed $350,000 per month. Leases that see a rental of $380,000 per month may involve a full life end of lease arrangement that equates to perhaps $50,000 per month thus indicating that the real lease rental for a new A320neo is only $330,000 per month. When compared to a value of $49 million, the low lease rentals caused by intense competition among lessors and low cost of funds, provides for very limited opportunities for values of even new aircraft to rise by more than 1-2 percent. With lease rentals of only $350,000 for a new A320neo, this suggests that lease rentals of very young A320ceos are perhaps less than $300,000. Lessors are facing the problem of lease rental convergence – at the end of production, lessees are loath to pay a premium for younger aircraft that essentially do the same work as a 10-15 year old aircraft which is available at much lower rentals. As the product life cycle of a type draws to an end – the A320ceo and B737NG – then the lease rentals and values of the youngest converge on the oldest and this is all too evident in todays market.

This decade has seen and is seeing a seismic change in the product line. Production of the passenger B767 has ceased; the A320ceo and B737NG families are coming to a close; the B777-200ER is no more and the backlog of the -300ER is tumbling; the A330ceo backlog is falling; the B737MAX, B747-8, B787, B777-9, A220 (CSeries), A320neo, A330neo, A350 have all been, or are due to be, introduced into service. Only the A380 will effectively have been in production at the start and at the end of the decade. The values of the A320ceo and B737NG families as well as the B777-300ER are therefore exposed and to expect a negligible decline of only 3-4 percent this year is perhaps failing to appreciate market realities in terms of relative attraction. In the last six months the values of the A320ceo and the B737NG have fallen by more than five percent, with the expectation that over the twelve months between April 2018 and April 2019 they will have declined by more than ten percent, albeit dependent on the relative age and specification of the aircraft. Moreover, the values of the, the B777-300ER for example and A330ceos, have fallen by a greater margin. The values of a 2006 A330-300 have fallen by some six percent in the last six months and a similar vintage B777-300ER by eight percent. As more newer widebodies are delivered, there will be a greater tendency to use these aircraft as replacement rather than growth capacity. To some extent, the market for widebodies has been temporarily buoyed by the need of operators to lease in capacity to compensate for the dozens of B787s grounded due to the Rolls-Royce Trent issues. This all too temporary demand for older aircraft may have inadvertently masked the vulnerability of such types and caused some to consider that values should remain unaltered. The failure to accurately reflect the weakness of outgoing types could lead to a seemingly precipitous fall in values reminiscent of the DC10 experience 30 years ago.


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