Blain’s Morning Porridge, Sept 15th 2023: Aero-Engine Problems and AirCraft As An Asset: Opportunity!
“Sometimes old is better than new”
This week’s “shock” announcement of a major aero-engine maintenance crisis with RTX engines on Airbus Neo Narrowbodies is reverberating round the aircraft market. It pushes up the value of older aircraft – and will impact many airlines.
As regular readers will know, I am a complete anorak when it comes to planes and airlines. Generally Airlines should be having a superb year – people remain desperate for holidays (a factor boosted by the dismal summer in the UK), and business folk remember nothing beats a face to face meeting. Despite the threat of recession, hard vs soft landing economic projections, and inflation effects on consumer spending, demand is robust. Prices are high. Business travel is back to about 85% of pre-Covid numbers.
But there are serious headwinds. The threat of a recession and tightening credit conditions has impacted the willingness of funders to finance planes, while the supply of new aircraft is seriously constrained by supply chain and technical issues, meaning many routes are unserved. There is an ongoing shortage of skilled staff, not just pilots, but critically aerospace engineers. Jet fuel prices are rising again.
However, this week a critical failure point in aviation metastasized into crisis.
US engine maker RTX (Raytheon in old money) announced it will have to ground hundreds of new Airbus Narrowbody jets using its Pratt and Whitney Geared Turbofan Engines for full-service checks and repairs. It comes at a terrible time for engine servicing capacity – such checks should take about 60 days, but because the volume required and the fact the shops are already full, its looking more like 300 days sitting idly, and uselessly on aircraft tarmacs. RTX reckon over 650 jets will sit idle in early 2024.
The problem is the new fuel-efficient engines the latest narrowbody aircraft use are some 20% more fuel efficient – but they burn hot. Very very hot. This is addressed by using complex powdered metal coatings on components, but it turns out these were vulnerable to micro-contamination, leading to engine cracks. It will be felt across the whole airline sector. European airline Wizz will see 10% of its fleet grounded. Indian airline SpiceGo cites the engine issues as the main reason for its collapse. Other airlines will have to cut flights.
My network of contacts within the OEMs (Original Equipment Manufacturers; Airbus and Boeing for planes, GE, P&W and Rolls Royce for engines) tell me the other popular new LEAP engine made by GE/Safran CFM is also having problems with coatings – but they have better infrastructure and spares in place to lessen service delays. All Boeing Max 737s are powered by CFM engines.
However, that bad news suits our current investment thesis in Aviation Assets rather well – that older aircraft offer greater value because of reliability and availability.
My day job is financing Alternative Assets – basically anything complex, real and not a listed stock or bond. Alternatives can cover anything from private equity to macro hedge funds. My main focus tends to be private credit deals – lending on real assets.
The concept of aircraft as an asset is simple. Many aircraft are not owned by the airlines that use them, but by Aircraft Leasing Companies. These specialists understand the risks inherent in the market: i) what an aircraft will earn them from being leased (rented) to an airline, ii) what the credit risk of the airline is (the chance it will default on the lease leaving a non-earning asset) and, iii) the value of the aircraft at all points through its life cycle. Different aircraft leasing companies specialise on specific parts of the market and fund themselves accordingly. Some focus primarily on new aircraft, some on older and some on specific types.
Like any market, knowledge is key. If you found yourself a despairing holder of bonds or equity linked to the lease of the Airbus 380 Superjumbos, you may just have been thrown a lifeline – rather than these behemoths of the sky being dumped when their current leases end, the main user of the type, Emirates, has decided to refurbish and extend leases on many of them. That’s because they have no alternative but to keep using them – the new aircraft they expected to replace them, new Airbus 350s, Boeing Dreamliners and that unicorn of the Skies, the B-777X are simply not available, and will not for decades.
As a result – older aircraft are worth more because new aircraft are not available. An older aircraft being refurbished and repainted is better than 2 sitting on Boeing or Airbus’ Order Books! I’ve written about this many times:
- Blain’s Morning Porridge – May 10th, 2023: Aviation – an asset class ripe with opportunity, and more than a few issues..
- Blain’s Morning Porridge 21stJune 2023: The Paris Air Show and the Outlook for Aviation – its “Dynamic”!
- Blain’s Morning Porridge – July 28th 2023: New Jet Engines are terribly efficient, but only when they work….
The aviation market anticipates demand in excess of 40,000 new aircraft over the next 40 years, but current deliveries are running at less than 1400 per annum because of ongoing supply chain breaks, a shortage of trained aeronautical engineers, and other factors. Banks like to finance new aircraft – its easy to get past credit committee and the new engines make them greener, but ask any engineer and they will tell you using older aircraft for longer is more sustainable in terms of life cycle costs.
The reality is the supply problems in new narrowbody aircraft today can be traced back to bad business decisions over the last 20 years. Everyone in aviation is acutely aware of how polluting Aircraft are. An average narrowbody consumes its own body weight in jet-fuel on a daily basis, making multiple flights pumping CO2 and other pollutants into the atmosphere. But, in terms of tech there is no alternative to jet engines burning carbon based fuel – it’s the only energy source dense enough to power a lump of metal into the air and keep it there. Forget anything you’ve been told about electric or hydrogen planes – they are decades away.
There are basically only three ways to design aircraft to make them more efficient and less polluting:
- Make them lighter – build them out of carbon fiber or nano-tubes, making them stronger and lighter.
- Make them more aerodynamic – using new production methods and materials to improve the flight and fuel-use characteristics.
- Make more efficient engines that produce more power with lower fuel consumption.
(There is also a fourth option, making aircraft and airlift vehicles slower – like airships, and a fifth – simply not flying.)
But everything in life is a compromise. Boeing brought the airline industry into a new modern age over a decade ago when it introduced the B-787 Dreamliner – using new light-weight composite material technology with massively improved aerodynamics to give an improved customer experience. But it cost some $32 bln to develop the initial programme, a further $5 bln fixing subsequent faults and billions in compensation costs to airlines for slow deliveries. With Boeing struggling to deliver even 2 new Dreamliners a month, it will be over a decade before anyone order a new one can expect delivery. Overall, Boeing has probably made a loss on the whole programme despite the magic of programme accounting.
The high cost of developing new aircraft is prohibitive. Especially for Boeing. They squandered the substantial profits from the B-747 Jumbo Jet and B-737 narrowbody, plus market borrowing, to finance their stock buy-back programme – pushing up the price of shares to the particular benefit of the executive suite who voted themselves massive stock option performance rewards.
Instead of investing the $40 bln it may have cost to develop and entirely new, lightweight, aerodynamic plane designed from the ground up to be powered by the next generation of fuel efficient engines, Boeing went for the easy option. The disastrous Boeing B-737 Max programme was a Frankenstein; taking a 60 year old design and jamming on some modern, bigger, unbalanced engines to allow them to claim fuel efficiency. It saved money, but the result was 346 deaths as the unbalanced planes crashed because Boeing hid details of its jerry-rigged fix.
Today, however, everyone wants Boeing Maxes because they have fuel efficient engines. Yet, they are less reliable than older models.
The new NEOs and Maxes were introduced quickly and soon the problems became apparent. To attain their 20% greater fuel efficiency, the new engines are subject to greater strain and stress. Older model A-320s and B-737 engines would typically do 30000 cycles, 8 years of takeoff-landings before a major engine maintenance/overhaul. The new engines are needing major work after 18 months, taking them completely out of service.
For the next decade the shortage of aircraft is likely to dominate the aviation market. New aircraft will remain in extremely short supply with long delivery times. Airlines are extending leases on older planes, and leasing older, pre-used planes from the market to service routes. That’s a massive opportunity – it’s going to support the price of older planes high for a decade till the current supply bottleneck is eased.
As I’ve noted before, Shard and a major leasing company are out with a new private credit deal based on a diversified portfolio of older aircraft leased to a range of sound airlines. It will come with a double-digit coupon, with further upside at maturity. The deal is targeted at institutional investors and family offices. The underlying investment thesis is based upon the rising value of older, midlife aircraft – which we believe will prove a sustained factor in aircraft markets.
If you are an institutional investor or family office and want to learn more, give me a shout.
Out of time, have a great weekend and back to the day job..
Strategist – Shard Capital