Airbus Contemplates Entry into Passenger-to-Freighter Market

While the airfreight industry and the market for large freighters has been in a recession over the last few years, a bright spot for the air cargo sector has been the surge in order for passenger to freight (P2F) conversions for narrow-body aircraft, in particular the Boeing 737 Classics. We expect nearly 50 conversions to be delivered this year, a level not seen since FedEx converted a large fleet of Boeing 727s two decades ago. The P2F conversion market is currently in an upswing, the opposite of the moribund market for long-haul freight. Today, the narrow-body freighter market is dominated by Boeing products, including the 727, 737 Classics and the 757. 737 Classics are being converted to replace aging 727s in the cargo fleet. The following chart shows the fleet breakdown of light freighters at year-end 2013. With the exception of a few BAe 146 and Russian-built aircraft, the light freighter market is virtually all Boeing. There is currently no P2F conversion program for the A320 family with a certified STC. Conversions for the Boeing 737 Classic Three cargo converters perform P2F conversions on the Boeing 737 Classic. PEMCO is the market share leader among 737 Classic converters, and has a backlog of 40 orders through 2015. PEMCO also converts the Boeing 757-200 into freighters. Aeronautical Engineers Inc. (AEI) offers cargo conversion programs for the 737-300, 737-400, MD-80, and has announced the first conversion program for the 737-800NG, to be available in beginning in 2017. Israeli Aircraft Industries-Bedek Division (IAI-Bedek) has been converting Boeing aircraft from passenger to freight since the 707, and currently converts 737-300, 737-400, 767-200, 767-300, and 747-400 models. Their conversions have logged more than 2 million flight hours. Conversions for the Boeing 757 The Boeing 757 is also converted by three major players. PEMCO focuses on combi conversions after acquiring a 757 STC. ST Aerospace converts the Boeing 757-200, with a 14.5 pallet capacity, won a major contract with FedEx, converted 5 aircraft in 2013, and has delivered more than 60 conversions. Precision Converters has a 15 pallet version of the 757 of and has converted 41 Boeing 757s. Once a cargo aircraft begins to age beyond 25-30 years, replacement demand increases for that type. Today we are seeing a replacement bubble for 727s, which are predominately over 26 years of age. The following chart illustrates the average age of the light freighter fleet as of year-end 2013. It is notable that within the next 5 years, a significant number of 737 and 757 aircraft in freighter service will reach the age at which replacement often occurs, potentially beginning another replacement cycle. AEI has already announced a program for the 737-800NG, which could be a replacement for the oldest early 737 models in freighter service. But to date, there is no viable replacement for the 757, nor any competition from Airbus in this space. We spoke with Airbus and Boeing regarding their perspectives on the market and their respective strategies in the P2F marketplace. The Boeing Perspective Boeing believes that the market between 2014-2033 will be for 960 narrow-body freighters, all through P2F conversions. This is an average of 48 per year, as projected in their 2014 Current Market Outlook. While currently enjoying a unique position, they anticipate that there is room for another competitor in the P2F segment, which will be driven by both market demand and whether their competitor chooses to enter the market. Currently Boeing has a licensing agreement with third party narrow-body passenger to freight converters for the 737 Classics, 757-200, and MD-80s. “While Boeing currently does not own any STC for narrow body P2F, we are talking with customers and studying the business case for a 737-800 Boeing Converted Freighter. The 737-800 is the first Next-Generation 737 to be studied in detail because of the large quantity of existing feedstock candidates and the airplane’s superior payload/range performance relative to the other Next-Generation 737 models.” While this might come as news to AEI, who already announced intentions for a 737-800 STC, it indicates that the next generation of conversions has not yet been settled, by any means. The Airbus Perspective Airbus is not currently in the P2F market, but is examining current market trends and residual values for its aircraft to determine whether it is time to enter that market. Airbus had a joint venture project for an A320 P2F conversion several years ago with Irkut, but that project was cancelled due to both market and technical issues. At that time, there simply wasn’t enough feedstock at a reasonable price to move forward with the program and the economic equation didn’t add up. The pricing delta at the on-ramp price between A320 and its 737 Classic competition was too big to make a good value proposition. In addition, a cargo door behind the wing on the A320 was not viewed as optimal by several industry observers. There is a good news/bad news proposition for Airbus in looking at the market. The good news is that A320 residuals are higher than those for 737 Classics of similar vintage. The bad news is those higher values mean higher feedstock prices, which result in higher prices for a segment that is driven by low capital investment. Airbus would prefer sustained residual values for its passenger aircraft rather than having attractive candidates for P2F conversion, even if it leaves them absent from the P2F conversion market. After all, the volume in the P2F segment is dwarfed by sales to airlines of new and pre-owned A320s. While the freighter business has never been core for Airbus, they believe that an STC solution for A320 and especially A321 could emerge. With 221 Boeing 757 freighters in service but aging, the A321 is an area of interest for Airbus, as it is the only aircraft offering similar capacity. But such a conversion program is likely several years away. P2F Lead Times for STC Development Historically, P2F conversions require a 3-4 year time frame to reach the market, with conversion of a prototype requiring 12-14 months. While that time frame can be shortened, the focus of most conversion houses is on feedstock cost. Accelerating the time frame can be expensive, and could negatively impact the price to be charged for a conversion, which would likely limit conversions in a competitive market. Given a 3-4 year lead time, it is likely that an A320 conversion would compete against the 737-800, and the A321 against a potential 737-900ER conversion. The -900ER does not look like a strong P2F option according to industry feedback, given its runway performance limitations. The A321 has recently experienced a market spike in popularity, with the result that there are few aircraft available to provide affordable feedstock today. The high residual values for the airplane is representative of its value proposition, and current unique position in the market. Perhaps indicative of that unique value is that the US Airways A321 fleet has been moved into to American’s fleet before any other type. Operators of the 757 like the A321s operating economics, especially after being fitted with sharklets. Currently, one Boeing converter, AEI, has announced intentions for a 737-800 P2F program. At Airbus, the major converters and a new entrant have approached the company to discuss an A320 STC program, but none have yet signed with Airbus for the data required to complete an STC. Airbus expects that A320 or A321 P2F STCs will be pursued in the next round of development by the major players, in the same 3 to 4 year time frame that 737NG models begin to be converted. The Bottom Line Could Airbus be competitive in the P2F market today? With some very early A320 models being parted out, there would be an opportunity for A320 freighters to compete with the 737 Classic today. But by the time a program could be developed, in 3 to 4 years, the replacement bubble for 727s with 737 Classics will be nearly complete. While the A320 has better operating economics than the 737 Classic, it also has higher residuals for aircraft of comparable vintage, reflecting that advantage. But the heart of the market will be the opportunity for the A321, likely in 5-8 years when residuals fall and candidates for freighter conversion begin to come off leases. As 757 freighters begin to be retired, A321 is the logical replacement candidate. But having missed the current replacement wave, there’s no reason to rush into production as long as residual values remain high. The decision for Airbus is whether to pursue a factory-engineered STC conversion and license it, or provide data licensing for conversion firms to develop their own STCs. We believe the former might provide the most cost-effective approach for Airbus, and eliminate the disappointment left when the A320 joint venture conversion with Irkut was curtailed. Airframe manufacturers have been increasing their participation in the aftermarket. Were Airbus to sponsor an A320/A321 conversion, it is likely that Boeing would sponsor a 737NG conversion program of its own, and begin to change the nature of the conversion aftermarket. It will be interesting to watch this space over the next couple of years as key decisions are made in Toulouse and Seattle.

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