Premium #237 – Hawaiian and the A380

This recent Bloomberg story has set tongues wagging. Hawaiian Airlines is apparently interested the A380? Seriously? Let’s look at why this might be the case and some of the factors that could drive a decision in that direction. Can a micro-fleet work? For an airline like Hawaiian, A380s would almost certainly be a micro-fleet. Let's look at the global A380 fleet as of 2Q16. Let's define a micro-fleet as six or less aircraft. There are a number of airlines that are currently operating A380s fleets like this. Among these, Malaysia Airlines is clearly a weak operator and the aircraft does fit with its business. The airline has announced it is looking for a ways of disposing of the fleet - even offering wet leases. The case for a micro-fleet is not strong. But at the right capital cost, could this aircraft be made to work? After all, an A380 comes with significant risk given its size. Airlines like China Southern, Etihad and Qatar can make this work because they have deep pockets and can plug into thick routes. We do see how Hawaiian could operate even six A380s. But let's look at more data. New vs Used A first step for such a fleet decision has to be the cost of used aircraft. Hawaiian is not looking at new A380s. They can only entertain this idea because pre-owned A380s are coming to market. The market is following these used A380s and there are issues playing out with the availability of pre-owned A380s. Its new territory for this aircraft, and because of this, there is no clear path. But you can be certain the market players seriously looking at these used aircraft are less than a dozen. As mentioned, the Malaysian A380s are also looking for a new home in addition to the Singapore Airlines aircraft being returned to its lessor. Could the Thai A380s be far behind? The pre-owned A380 coming from Singapore Airlines is ten years old. It has been maintained to standards set out in its leasing agreement. Since the MRO work was done by the airline, you can be sure this was done to high quality and, perhaps, exceeded return conditions. Singapore Airlines has a very good reputation. If you were to buy a used aircraft, Singapore Airlines would be one of the carriers that you would feel totally comfortable with taking a plane from. The owners of the Singapore aircraft are Doric Leasing and the Dr. Peters Group – both based in Germany. When they bought the A380 ten years ago, the market was hot. Many analysts thought the A380 was going to see orders for more than 500 aircraft. That has not happened due to a combination of market forces, including widebody market overcapacity, route dispersion, and A380 performance deficit in a few areas. Given current market conditions, and a dearth of A380 demand, we are certain that this asset is not coming back to its owners at the residual value they planned. The early production A380s, like this aircraft, were overweight and each one had to be re-wired by hand. Each of the initial batch of aircraft are, essentially, unique. This means any cabin refurbishment is going to be complicated, which translates to expensive. The owners of the aircraft don’t want to sit on it - they need it in the market generating lease payments. The owners don’t have a lot of leverage in a market with low demand. We expect they are going to take a deeper write down in value than they had planned. The fair market value for these aircraft may fall to under $100 million, perhaps $75 to $90 million range in today’s market. The aircraft sold for $200 million ten years ago. Refurbishment will likely cost between $15m to $20m. The Singapore A380 could be re-marketed below $100m. Under normal circumstance, for a 550 seater that would provide good value, and would certainly fall within a price range that Hawaiian, and a number of other airlines, could afford to take a risk on. The supply-demand balance for the A380 is tilted heavily in favor of supply. Airbus has cut production to one aircraft per month, and new orders have been hard to come by. It seems only Emirates knows how to effectively make money with this aircraft. The soon to be ex-Singapore aircraft can easily handle 12 hour legs at full payload, even if less efficient than the new models being delivered. At low capital costs and bearable operating costs, this aircraft in Hawaiian’s hands could be used to fend off a potential competitor. There is the other shoe that has yet to be dropped. Is Singapore also going to dispatch the other four A380s coming up to the end of their ten-year lease terms? Anyone taking the first A380 will want first refusal on these. Once the first A380 finds a home, the remaining four could see a jump in residual value because there would obviously be a market. Airbus wants this; the German owners Dr. Peters and Doric especially want this. We understand that Singapore decided to not renew the lease on the first aircraft because they and its owners disagree on aircraft value and lease rates. This is no surprise. An outlier like Hawaiian could offer everyone a way forward. If Singapore gets rid of all five aircraft as their leases come up, it can replace them with five it has on order. It would obtain newer and more efficient aircraft. Airbus is happy to sell another five. Rolls-Royce is in the same winning boat. The German owners get to ensure their assets keep performing – even if they take an unplanned asset value haircut on the first, perhaps to recover some of this on the other four. Disruption at Hawaiian? Why would Hawaiian need an A380? Hawaiian will be competing with ANA in the Tokyo to Honolulu market. Our cost analysis suggests that a ten-year-old A380 (priced at $100m, refurbished) could generate around $10m per year in operating savings over a new A380 (priced at $232m) or $4m per year in savings over two A330-200s. Our analyses indicate that the costs are very close, and aircraft pricing will be a key factor in determining whether sufficient savings exist to offset the risk of adding the A380 to its fleet. But no airline wants a single A380. Even ANA is taking two as an initial trial. But it’s the ANA move that is pushing Hawaiian. ANA is going to serve Hawaii with these aircraft, and that will change both pricing in the market and likely impact passenger preference. Passengers love the A380. Airbus likes to say that “the only way to compete with an A380 is with another A380.” Boeing disagrees, and points out that their smaller aircraft offer similar seat-mile economics with lower risk. As the largest 787 operator in the world, ANA understands Boeing's argument very well. Since both Tokyo Narita and Haneda are slot constrained, they are good A380 territory. Honolulu has adequate traffic to handle the A380 or ANA would not consider this route. According to Hawaii visitor statistics, in 2014 there were about 2.4 million Japanese visitors to Hawaii. This was roughly 6,600 people per day. Using a 550-seat A380, it would take a dozen A380s to move this traffic at 100% load factor, or 15 at 80% load factor. There is apparently sufficient traffic, especially when adding Americans traveling to Japan in the other direction. This traffic tends to be low yield and leisure, rather than business oriented. This actually supports the case for the A380 as it offers low costs per flight. Emirates operates the A380 in low cost seat configuration to India successfully. Importantly a used A380 might prove itself as tool to ensure Hawaiian fends off ANA. Of course, Hawaiian needs more than one. So where else might it use this aircraft, since focusing on Japan may not be optimal? Sydney, New York, and even London, which is only 12:40 hours away, are possibilities. There might be a case for looking at Hawaii's location the way we do with Dubai. If Honolulu were used as a hub, where might thick routes exist in a 12-hour radius? This is an idea worth pondering. Conclusions The possibility of interest in the used A380 highlights a number of questions: How might Hawaiian position an A380? If it comes to fruition, what impact would it have on the market perception of the A380 as an aircraft asset? Would this strengthen the pre-owned A380 market and its potential on highly competitive routes? Will it generate potential demand for new A380s among other airlines? The disruptive effect of Hawaiian (or another airline) taking on a used A380 should not be scoffed at. This Singapore Airlines A380 retirement is just the first half of what will likely be two transactions. The second half will determine the outcome of the game for the A380.

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