Avolon: passenger traffic back at 2019 levels by June

Global passenger air traffic will reach 2019 levels already by June this year, driven by the strong recovery of Asia Pacific and, in particular, China. “Despite the implementation of testing requirements, reopening of the world’s second-largest aviation market will drive a rapid uptick in air travel”, lessor Avolon says in its 2023 outlook that was published on January 16. Avolon: passenger traffic back at 2019 levels by June. With this forecast, Avolon is slightly more optimistic than airline association IATA, which said in December that the industry will recover to 2019 levels by 2024, citing travel restrictions, fuel prices, depreciation of the US dollar, and the effects of a mild recession as factors that impact the recovery pace. But Avolon, the third biggest lessor by aircraft size, is expecting a strong recovery in Asia Pacific this year that will see traffic recover to pre-pandemic levels this summer. “While the US and Europe benefited from accelerated re-openings in 2021-22, economies in Asia Pacific look the strongest heading into 2023. Australia led the way in Asia Pacific last year showing how travel restrictions could be reduced and borders re-opened while managing through Omicron-induced exit waves, followed by Singapore and the rest of Southeast Asia. For every two seats of airline capacity added in the world today, one is in Asia. China’s reopening will unlock significant demand, driving rapid recovery in the region,” Avolon says. Asia has now taken over the growth lead from North America and Europe, says Avolon, with Latin America closely behind. Global domestic capacity is close to ninety percent of 2019, with international capacity at 75 percent but recovering swiftly. “The expected mild recession in the West should not impede the positive outlook for air travel, driving a return to operating profits for the airline sector in all regions”, the Dublin-based company says. Airline profits In IATA’s predictions, the airline industry is expected to generate some "razor thin" profits of $4.7 billion this year, up from a $-6.9 billion loss in 2022 and the record-high $-137.7 billion in the first Covid-year 2020. Avolon notes that airlines were largely covered by increasing costs by higher airfares. “With the global economy 15% larger today than in 2019, airline revenues remain $130 to $260 billion below their historical share of world GDP. This creates a buffer against weakening economies in 2023.” The lessor says that while some 100 start-ups took benefit from low-cost aircraft, crew, and slots during the pandemic, they will be faced now with competition from bigger airlines that have the benefits of larger scale and resources after deleveraging their balance sheets and shedding off debt. While new airlines emerged, not all will be successful in getting there, “but the ones who are will reshape the competitive forces in their markets, as airlines that have grown out of past crises have demonstrated.” The effect will be airline consolidation: “Start-ups without competitive niches will be forced to exit while incumbents are rapidly repaying government loans, enabling acquisitions again. Strong operating conditions mitigate credit concerns, but government support will be limited for airlines with unsustainable business models.” Cargo will see revenues return to a more normal twenty percent or lower in 2023 after two years of very high revenues (forty percent) and yields, but this normalization doesn’t mean that air cargo is past its sell-by date. The number of aircraft in storage has fallen to pre-pandemic levels, says Avolon. This is Teruel Airport in Spain. (Aeropuerto Teruel) Aircraft shortages And this is where predictions for the aircraft market – Avolon’s core business – come in. When it comes to cargo, a lot of capacity will be taken over by belly cargo. “However, the continued growth in e-commerce underpins the outlook for the medium widebody dedicated cargo fleet. Despite record freighter backlogs, the in-service fleet remains ripe for replacement with more than a third of dedicated widebody freighters over 25 years of age.” Keep in mind that Avolon has been the launch customer of the Airbus A330 passenger-to-freighter program with IAE Aerospace Industries back in October 2021, so it has every interest in a strong secondary market. When it comes to new aircraft, Avolon is concerned that there will be a shortage of new aircraft. This is the result of the much-spoken of supply chain issues and staff shortages that have become endemic. The days when Airbus and Boeing produced a combined 100 single-aisle aircraft and 32 widebodies per month are still a long way off at the current pace of the industry’s recovery. Avolon is most skeptical of Airbus's production target of 75 A320neo family aircraft by 2025: “To date, no programme has ever ramped up at a rate exceeding 4-5 monthly units per year. A monthly rate of 45 today is more likely to be 60 in three years’ time than the 75 Airbus is forecasting.” Instead, Avolon says: “Airbus and Boeing are currently targeting increasing production to a combined 140 single-aisle and 24 twin-aisle aircraft per month by 2025. These targets will be delayed a year as manufacturers focus on delivering to schedule and quality versus aspiration.” Used aircraft market Lower deliveries impact the used aircraft market. The number of stored aircraft has fallen back to pre-pandemic levels and the retirements and part-outs are artificially low at some 300 in the past two years compared to 600 per year before 2019. With a short supply of new aircraft, competition for new aircraft deals is strong and often has led to cut-and-throat rivalry in which some lessors opted to back out from for example sale and leasebacks. Of all new aircraft deliveries, sixty percent were for lessors, which have grown their fleet by seventeen percent over the past three years. As the new fleet grows further – albeit at a reduced pace – Avolon expects competition to become softer. IBA presented this slide in its 2023 outlook, which shows the trends of aircraft base values. (IBA) As supply constraints continue, demand for used aircraft will remain strong. And that is driving lease rates. Rates for the A320neo family and Boeing MAX were up five to ten percent in 2022, says Avolon. This was also identified by IBA consultants in their 2023 outlook last week. IBA said that rates for the latest-generation single aisles will be up this year from 2022, notably for the A321neo. The same applies to base values of the A320neo-family and Boeing MAX, while the A350-900/-1000 and Boeing 787-10 are also doing better than last year. Rates and base values for older widebodies like the 777 and A330 dropped significantly over the past years, but both Avolon and IBA expect them to recover. Avolon says that lease rates for the A330ceo will go up by even 35 percent, which fits its A330P2F market projections very well. De-risking aircraft financing Avolon is seeing a significant shift in the way new aircraft are being financed. In the past year with low-interest rates, asset-based securities (ASB) or enhanced equipment trust certificates (EETC) were popular instruments, but Avolon notes that the market has become significantly risk-averse in 2022. “Lessors turned to cash, banks, and alternative lenders to meet their capital requirements. With interest rates set to be higher for longer, aviation markets are adjusting to the new cost of funds.” It adds: “Lessors with steeper near-term financing requirements will look to aircraft trading to bridge the funding gap. The volume of secondary market aircraft trades has declined in the last three years to two-thirds of pre-Covid levels. With the ABS market closed for now, and a heightened focus on underwriting risk, new-technology assets with top-tier credits are in the highest demand.” High inflation and a tight supply-demand environment will result in higher aircraft values, says Avolon. In this market, 2022 was a “bumper year” (IBA) for lessor mergers and acquisitions. Not just the acquisition of GECAS by AerCap, but also Carlyle taking over FLY leasing, SMBC acquiring Goshawk, and DAE taking over a portfolio of Sky Leasing. This trend could well continue in 2023, both Avolon and IBA say. At the same time, the market has seen new entrants like AviLease from Saudi Arabia and High Ridge. Sustainability Avolon also shares its view on sustainability and the emergence of new, net-zero aircraft concepts. While it applauds the commitment from airlines to become net zero in 2050, the lessor says that the industry needs to make greater progress in addressing concerns about how it addresses sustainability and the long-term environmental impact. The production of adequate levels of sustainable aviation fuels is key, although lifting total production to ten percent of global consumption in 2030 will require a massive $250 billion. Although Avolon itself has invested in the Advanced Air Mobility Market with an order fifty Vertical Aerospace VX-4s, the lessor isn’t fully convinced yet of the robustness of the eVTOL market. “While almost 700 electric aircraft projects have been launched, only a small number are on a pathway to deliver a commercial product to customers. Considering technical, commercialization and funding challenges, there are significant barriers to success.” The effect of the new all-electric vehicles on the sector’s sustainability will be rather limited, says Avolon: “Global aviation’s carbon emissions are unlikely to be materially dented by disruptive technologies for the next two decades. The initial short-range applications and the challenge of timescales in replacing 34.000 delivered passenger and freighter commercial aircraft means sustainability solutions must drop into today’s architectures.”

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