Global air travel traffic (measured in revenue per kilometers (RPKs)) begins 2024 in line with pre-COVID highs. Certain markets, such as US domestic and intra-European have already surpassed pre-COVID levels and despite some lingering headwinds there are real causes for optimism globally that air travel passenger demand is back and new heights will be reached in the coming year.
However, the main issue facing the aviation industry this year is not on the demand side but on the supply side. The post-COVID airline ramp-up looks set to be hindered (or at least slowed down) by an under-supply of current and new technology aircraft.
Initially, COVID caused production lines at Boeing and Airbus to come to a halt, causing a backlog of aircraft that will never get built. On top of that, the supply-chain and outsourcing issues faced by original equipment manufacturers (OEMs) have been well-documented but just as Boeing and Airbus looked to have made progress with their delivery schedules, microscopic contaminants were found in a metal used in part of the engine core of Pratt & Whitney’s Geared Turbofan (GTF) engines powering Airbus A320neo aircraft. The inspection and repairs involved in addressing these contaminants involve taking the engine out of service for up to 300 days.
The Airbus A320 is one of the most popular aircraft types in the world and typically powered by either the Pratt & Whitney GTF PW1000 engine or the CFM Leap engine.
The issues with the GTF have increased demand for competing aircraft types and engines resulting in what some commentators have described as an upcoming “chronic undersupply” of certain aircraft models. Disappointingly, this undersupply of new technology may result in airlines slowing down their fleet renewal programs to replace older, less fuel efficient technology with newer equipment.
The pendulum has also shifted quite rapidly in the lessor-lessee negotiating dynamics for leased aircraft as airlines struggle to get their hands on the aircraft needed to power their rebound. Anecdotally, lease rates on narrowbody aircraft have seen an uplift of 20-30% in a short space of time and lessors are back in a position of negotiating strength with certain airlines when it comes to term lengths, cash security deposits and maintenance reserve payments. This improvement in lease rates and the consequential impact on lessors’ cashflows will increase the financing options available to lessors and lift equity returns — both of which suffered due to rapid interest rate hikes in 2022.
Lessors with expiring leases are in a great position right now and have been able to agree improved terms with their airline lessees as part of lease extensions but those looking to acquire aircraft and increase their scale (at least organically) have faced headwinds.
Rapid and material interest rate increases should have had an effect of diminishing the buying power of parties dependent on financing and reducing their maximum potential bids for aircraft but the undersupply of aircraft and the several-year waiting list for new-ordered aircraft have resulted in bid levels remaining very high (even accounting for the recent increase in lease rates).
Some lessors have taken advantage of this environment and sold aircraft to other lessors on the secondary market (locking in returns) but with leasing conditions improving so quickly and interest rate rises likely to be at or near their end, it must be tempting to simply hold inventory for now, so secondary trading levels remain quite low, albeit improving toward the end of 2023.
With inter-lessor trading depressed and order books not a viable option for short-term growth, some lessors have looked to consolidation to achieve scale quickly. In the two years since AerCap closed its acquisition of GECAS, Goshawk Aviation, AMCK, Seraph Aviation Management, Voyager Aviation Management and Falko have all been acquired by existing leasing platforms. 2023 also saw a new entrant to the sector (AviLease) using M&A to propel itself into a top 25 lessor through its acquisition of Standard Chartered’s aircraft leasing business that includes over 100 aircraft.
The attractiveness of M&A in the current environment is obvious. Almost overnight, a leasing company can materially increase its portfolio and often inherit new relationships with airlines, banks and others. Depending on the buyer, the fact that employees will typically travel with the portfolio may also be a positive (depending on the acquiring company).
While aircraft leasing platforms are very asset-heavy entities, the usual issues applicable to corporate acquisitions will still apply and there are a myriad of employment law, tax, antitrust and practical considerations to be addressed when acquiring a platform.
The M&A bidding processes of 2023 proved to be competitive and attracted a number of motivated participants. As the annual aviation conference in Dublin approaches, there are a number of ongoing processes and potential for more to come in 2024. With the current undersupply issues expected to last for some time, we anticipate small and mid-size aircraft leasing platforms (particularly those featuring portfolios with short remaining lease terms) to remain particularly attractive if buyer and seller pricing expectations can be aligned.
