Avitas’ Kelly on 747 values as production fades

Historically, ending production for an aircraft drags down values. However, t hat’s not the case with the 747-8F, which Boeing last month decided to formally end production on. In this episode of Cargo Facts ’ monthly webinar series, Industry Pulse, Doug Kelly, SVP of a sset v aluation at Avitas , discusses the value trajectory for the 747 freighter now that an end to the line is in sight. Unlike the majority of out-of-production aircraft types, which are readily replaced by new technology, the nose-loading capability of the -8F is a unique feature that is not being replaced. “Because of this nose-loading capability, and an operator base that's committed to the type, we think this will keep values reasonably firm for the for the foreseeable future,” added Kelly. Now months into the COVID-19 pandemic, Kelly also provides an update on values for freighter aircraft, and popular conversion types. Industry Pulse : Doug Kelly The accompanying presentation is available for download here . In the coming months we will roll out the full Cargo Facts Premium Plus product, which encompasses registration to all our live events, exclusive monthly webinars, like the Pulse of the Industry, access to an archive of our event recordings and a premium subscription to Cargo Facts . Transcript A transcript is available below. This transcript has been generated by software and is being presented as is. Some transcription errors may remain. Charles Kauffman Thank you again for joining us today. I just now my privilege to hand it over to you. Doug Kelly Thanks, Charles, good to be here with you. Last time I was with cargo facts doing a webinar was on April 2. And during that situation, we were right in the middle of trying to figure out the impact of COVID on aircraft values and why this crisis is different from the past downturns that we had. So on the agenda today is to give you a little bit of update on where we are. Since that time, we've published a special edition blue book and savvy market forecasts dealing with the impact of COVID on passenger forecast and the fleet and aircraft values. So I will share some of those a few slides from those publications today. And also want to talk about Boeing's recent announcement about Indian production on the 747 , and what kind of effect that might have on values. So let's get into it. This chart I had last time, we were just looking at March at that time. This is TSA traveler checkpoint numbers comparing to last year. So typically, each day you get about 2500 passengers going through TSA checkpoint. Back in March, obviously it dropped to almost zero so you had a 93% drop. And passenger numbers is no surprise given the lockdowns and people not being able to travel and the quarantine restrictions. So look pretty dramatic. And then we've been building out since then. And so there's been somewhat of a recovery. But we're still down 70% from last year. So it looked like we're trending up and then since then, July, we've been flat. And the expectation is that we're not going to get back to 50% of 2019 levels until we have a vaccine and therapeutics. So, about 50% as best we can assume until we get a vaccine, which right now we're estimating that that might be around spring of next year. This is a chart that we included in our our special edition blue book and savvy dealing with a look at world GDP and traffic growth through the past cycles from 1990. To present, what you'll notice that the GDP axis on the left is up to 10%, whereas the RPK axis is 10 times the GDP axis. So what you see in the downturn 2020 is is a 60% decline in traffic and an 8.7% decline in GDP. So that's where we estimate 2020 to end up. We've been estimating that since in the April beginning of May, and it looks like you know, it's going to be pretty close to that. So you do see a rebound in GDP and RPK growth the following year. But we're not back to 2019 levels for a while. Now, if you compare that to past downturns, even though 19 92,001 and 2008 were major downturns, you can see traffic growth only declined by one to 2% at most compared to the current downturn and 60%. So what does that mean going forward when we get back to 2019 levels, while for GDP, we think there will be a rebound GDP. 2019 levels by somewhere around 2021 2022. However, the RPK level will not get back to 2019 levels until till after 2023. So somewhere around 2023 2024 to get back to 2019 traffic levels, and you can see by our chart down at the bottom of the screen, that there's been a permanent shift downward to RPK forecast. So as you can see, get back to the 2019 levels somewhere around 2024. But it's a permanent shift down so we've lost that amount of traffic forever. And that's assuming a base case assuming that we have a vaccine sometime in March of next year. So what does that do to the demand for for passenger aircraft? Well, we had a forecast of A meet of 37,000 over 37,000 passenger jets by 2030. And that forecast is now dropped by 5000 aircraft. And over the short term, you know, over the next year we should see retirements increase by 2000 aircraft. We're already seeing manufacturers reduce production by dramatic amounts. And I think that's going to continue. We just don't need as many aircraft as we did before this pandemic. And so, the 5000 reduction in aircraft that we need over the next 10 years is going to come from greater retirements, earlier retirements of aircraft and reduced production rate from the manufacturers. That's passenger aircraft. What about cargo? Well, showed this chart before, we were talking about the impact on the trade war on cargo. The trade wars started around September of 2018. And at that point, you can see the downward sloping month to month, year over year, percent traffic change turned negative sometime around December 20 18th and continued negative through June. Well, that was the impact of the trade war, and then all sudden, you get the pandemic. And we have a fall in GDP. economic activity, which obviously Air Cargo is a function of economic economic activity that's going to have further downward pressures. And this is a chart that, that habitats we don't do our own freighter forecasts, we rely on cargo facts. We've borrowed their chart to To show the expected fall and, and air cargo growth in 2020 to be 15%. rebounding the following year, and now some of the drivers of air cargo, obviously the lockdowns, people being not being able to fly affects the demand for air cargo, the business, fallen in air cargo, but what the other thing that's happening is with 50%, over 50% of the passenger fleet grounded, that reduces the amount of belly capacity available. And so you've had a reduction of belly capacity up to 90% on some key key markets. And so overall, we expect the capacity to be down by 22% compared to 15%, that's creating a shortage of dedicated freighters. So that's good news for dedicated freighter values. So even though we expect to decline at 15% overall for 2020 because of the capacity shortage of 22% that creates this gap and a shortage of dedicated freighter aircraft. Now, the other thing that's happening because of this lockdown, ecommerce growth is exploding. Right now it seems like we're in a peak season so since may be expressed carriers. It feels like it's October through December peak. And, and we think that's going to continue it's going to get more severe once we get into the real peak season starting in October, and that will last through January. So there's going to be a shortage of dedicated freighter aircraft. And obviously with Express cares they would prefer To truck, this freight, it's much cheaper, much more economical, but because of the demand, you're going to have to fly some of it. And normally that's that's downward pressure on yields when you have this type of traffic growth, but in this case because of the shortage of lift, we've seen the Express carriers announced surcharges recently. So, UPS, FedEx, USPS, all these rates are going up. I heard Darryl Darren Holst from Boeing, he had a presentation on Boeing's view of where we are in this pandemic. He mentioned that he felt that cargo yields were up 50% on average, but in some key markets, it can Yep, three, six times 2019 levels. So with this shortage of dedicated freighters, we're seeing an increase in rates. And that's leading to record profits for Express shippers. But even these record profits and increase demand is not going to save the 747. So Boeing did announce recently that after more than 50 years and service are going to cease production in 2020 2022. This of course, is not a surprise. I've been intending cargo facts on on the value panel for the last four or five years we've been talking about. When will Boeing cease production? I think it's no surprise everyone was predicting that the current orders would expire around 2022 and then they will And production, even cargo faxes forecast that was released in April hinted to an expectation that they would cease production in 2020. So even though it's happened, certainly no surprise, given the lack of orders, so. So, given that the situation that Boeing announces the end of the production of the 747 and 2022 question is what will happen to 747 values? I would say typically, you know, when we look at aircraft ending production, we tend to see a steeper depreciation value depreciation curve for the last ones off the line. This is an example of 747 400 freighter. Now, in 2009 into production it obviously was really Place by the 7478 freighter. So you have a bigger more economical freighter replacing it led to steeper value depreciation at that time. And that's typical of what we see when, when an aircraft is replaced by a newer, better technology, better economics. That last one off the line is going to have a steeper slope. So if you look at this chart, the 1993 vintage is the blue line 2000 vintages, the green line and 2009 vintage that last year production is the purple line. And you can see a much steeper production. So look at the trend line through those points, much steeper for the last off the line. That's what we'd normally expect into production because usually, it ends production and is replaced by higher technology, more efficient aircraft in this case 7478 is not being replaced by new technology. So we expect something different this time around. This chart shows constant age. So looking at the historical values on a constant age basis, meaning that that top line is brand new airplane age zero, the orange lines age five through the cycle, age 10 is a gray line, age 15 in age 20, down below. So this gives a look at how those constant age aircraft behave through the cycle. Not surprising that during a downturn in 2001 2002, that that value drops and then recovers up until 2008. And the next downturn, financial crisis falls again, a little bit of a recovery And then downward and then flattens out. So that's typical of what we would see from a type that's been replaced by new technology. However, with the 7478, because it's not really being replaced, it has unique capabilities. The fact that it's a nose loader capability, which is very unique. Only the 747 Production 400 production freighter has that. An Antonov has that in the 7478 freighter. So if you're flying outsize cargo, then you're going to need that capability. So, as I said before, this is not your typical aircraft that ends productions, it's no replacements available. And because of this nose loading capability and an operator base that's committed to the type. We think this will keep values reasonably firm for the for the foreseeable future, so basically we have market value equal to base value. So there's no difference in that line. So I see that green line going from 2020 to 2024. When we get to the, to the recovery period, traffic returns to normal for passenger traffic, and then we end up with a upcycle again. So after 2024, now we have market value above base value continuing until the next downturn, which would be after 2030. So we actually see a little flattered appreciation for this type, because we have there is no replacement available, and you have a operator base that's committed to keeping this aircraft long term. So good news for values. I wanted to share this this is a chart from our special edition blue book that kind of summarizes the indicative current market value changes due to COVID. So we've summarized the changes in four categories, the narrow body, in production out of production, wide body and production out of production, regional jet, and freighters. And so normally we would expect, looking at past downturns that narrow bodies and wide bodies that are brand new, we don't expect large decreases in pricing. The manufacturers deal with that drop in demand by lowering production rates which they're doing now. So they can control the drop in and falling values by by controlling that production. However, when you get into older vintages, those declines in values can be anywhere from 15 to 45%, depending on the type and the age of the aircraft. So for narrowbody widebodies spec somewhere in the five to 35% to five to 45% freighters. If you look at the bottom row there, they're the only type that has avoided any, any downturn in and values. And that's because of the shortage of dedicated traders given the fact that we have half the world's fleet parked and all that belly capacity that's not available. So 50% of air cargo flies in the belly of passenger airplanes and without those airplanes flying, there's not available, it's creating a severe shortage of lift, and that's helping dedicated freighter values. And then again, the explosion of e commerce growth is also driving demand. So all those things are Helping dedicated Raiders. So for the special edition blue book, which we released in May, no change in dedicated freighter values and in some cases, some freighters actually went up in value. What about future values, and I've shown an A 320 passenger aircraft to kind of show the cycle. So at habitasse, we've been using quantitative modeling system to help forecast values since 2001 911 crisis that's evolved into our current savvy model system that we have today. And we've been using the savvy model since 2008 downturn to forecast the cycle. So this chart shows the dotted blue line shows our forecast prior to the pandemic, so we were forecasting a dam Since 2008, that would happen somewhere around 2021. That was our previous forecast that we had. And now we've had to obviously move that forward to 2020. So now we're in a downturn Currently, we do expect that it's more severe than what we had predicted before, obviously. And so the red line is below the blue dotted line, and then recovers back to base values some time around 2024. So even though there's a sharp increase, we're really just getting back to to the long term base value at that point before then, being above base value after 2024. So that's how our forecast looks prior to COVID. And after COVID for the a 320. I did show some of these feeder stock values back in April. And some of the more popular ones 737 800, a 321, a 330 300, all types that we expect to be going into conversion over the next few years. And back in April, we were forecasting the downturn of may 20% for the 737 808 321 and 25% for the a 330. So it's a little bit more severe than what we had forecasted back in April. So currently we're at 24% decline for the narrow bodies and 35% decline for the a 330 300. So a little bit weaker than we anticipated. That's where we see values today. Obviously, there's some a 330 300 is being converted. We think that price has to be below 20 million to Make to make economic sense. And there should be plenty in that 12 to 20 million range that would make economic sense for conversion 737 883 21 we think makes sense somewhere around these numbers right here. So obviously, g cast has been converting 77 800 for for Amazon for some time at higher values than these these values because they got a jump on the conversion. But for most operators, we think the, the real sweet spot is close to 10 million number and you're there if you consider run out, airframe run out to a D check you should be below 10 million. So there should be plenty of aircraft that are available for conversion at these prices. So that kind of wraps up my presentation for today. I'm happy to answer any questions. Charles Kauffman Thank you very much, again for, for walking us through. What do you see as the trajectory for the 747. And this is this is quite an interesting place to wrap up your presentation. Seeing that, despite this, this terrible crisis, we're in there, there are opportunities for the conversion market and with these lower price points for for some of the emerging conversion types. Some of these conversions are now more palatable for operators. I do have a few questions for you. You know, if we go back a couple slides you provided a nice Overview of those four different aircraft categories. And you mentioned that, you know for freighters on the whole, you you don't see see much of a change because of the capacity environment and some of these new sources of demand are increased sources of demand from e commerce and whatnot. You also mentioned that for some Frater types, you you actually expect an upward revision of values and I'm curious where where you see this as a possibility. Doug Kelly Yeah, so. So for the ones that we see a possibility of increasing why certainly 767 the medium capacity wide body traders, we think are can continue to be in demand. Obviously, Amazon is very much interested in growing that fleet. 767 we've seen a little bit of increase in the a 300 600 freighter. So I think those traders that are in already in operation with the package carriers, FedEx ups, especially those package carriers, they're going to be a shortage of left come October. And I think they've already been seen that and then trying to organize a purchase of additional lifts requiring different, more lift and anticipation of that peak season. And so I think it's going to be a real problem. And because of that problem, that's why you saw that slide about increasing the yields. So, UPS, FedEx, USPS, and all announced, increases, surcharges as they call them getting ready for peak season. Right? So that's a good thing for their profitability. So if you looked at stock prices recently, you know, they've all been going up quite dramatically. profitability is increasing. So when you have a shortage of lift, like we're seeing now, and and I think it's going to be a long term demand. So obviously we'll see a cycle at some point for freighters also, right, so they're not immune to cyclic behavior, like the passengers also get cyclic behavior. So but for this peak season, being October through January, we expect a severe shortage of lift and then after January, it might slow down a little bit. But also I think, you know, this this increase in e commerce that we're seeing, since April, everybody's locked down and, and ordering packages from home. I think ultimately that's about a 20. Anywhere from 10 to 20%. Increase long term in demand that will stay with us because everyone's getting used to ordering packages on their phone, or tablets. And I think that continues at the expense of, of the malls and retail traditional retail. So it's just too easy to order from home. And I think that continues and so there is this long term shift in demand to the package carriers. That will continue. Charles Kauffman Right. So that's actually a nice segue into my next question. Mom term demand for for these large wide body packaged freighters is good remains quite robust the future outlook for those types of aircraft. Now last year, I launched a conversion program for the triple seven 300 VR, which is certainly a replacement for some of the freighter converted seven, four sevens that are currently operating. This slide does show that for triple sevens, grantor Dr. airframes there there is an expectation of a drop in feedstock values. But what impact if any, has has the form of long ship conversion program had on triple seven 300 er values? Doug Kelly Well, of course that's a positive. I can't say it's, it's, it's led to an increase in passenger 300 er values, but it's a good news for those who who own 300 yards that are coming off lease in the next few years. that are available. I think you will see a large number of 300 yards converted. So g cast got the early start on it. And they will start being converted around 2022. So the program's launched, it was launched in 2019. You'll see the first ones 2022. And I think you'll see over 100, triple sevens 300 yards converted maybe 150. At what price? Does that make sense? I think, you know, the on ramp price has to be probably somewhere around 65 or under. So that's going to keep a lid on, on the expectation on pricing. So I think we're kind of there now on values. So you should see triple seven 300 er values Below $30 million, and with a conversion price estimated at 30 million and that that gets you in that sweet spot of under 65 million. We don't really know what that conversion price is, is it? Is it 25? Is that 35? I've heard 35 I don't, I don't believe that's realistic. I think it's, it's gonna be around 30 or less, ultimately, so. So you assume 30 million and if you can get the aircraft for 30 million or below that, then I think that's gonna make a great trader. Charles Kauffman All right, yeah, no, we'll definitely see where that that conversion cost ultimately ends up in a few years. You've also in your presentation, you provided a nice overview of feedstock values for some of the emerging conversion types, including the seven or seven 803 21 208 3300 particularly for the year the D seven or 783 21 200, these are seen as replacements for 77 Classic traders and 757 200 conversions. You know, another issue on the for operators at least has been the, you know, the comparatively higher cost of, of engines. And, you know, broadly speaking, are you are you expecting similar value trends for the, for the engines powering some of these aircraft as well or is that different? Doug Kelly Now, we do expect the decline in engine values, maybe not to the extent that you're seeing the airframe values but our initial estimate was 15% decline in Engine value. So obviously, when you saw the chart 5000 aircraft that are not needed over the next 10 years, and that's gonna lead to more retirements of aircraft. And more retirements of aircraft may mean that there's more engines available also. And so you don't need to overhaul the engines as much and so you can burn off the green time before overhaul, and so there's a natural reduction in demand for spare engines. So that's gonna lead to lower values on those engines. So it but at some point, when all that green time is burned off, then there will be overhauls again, and that may be independent of the general economic cycle. So they don't necessarily follow together. So the spare engine, market and Values don't necessarily correlate with the general economic activity, they can have a different cycle. And so when you burn off all that green time, and I'll send you have to go and overhaul then you can see those engine values go up again. But that may not be happening for a number of years. Charles Kauffman years Yep. All right. Well, Doug, we've we've touched on a number of different topics and and airframe types today. You know, it's August 26 2020. You're looking at looking at today's presentation, what are your What are your three key takeaways? Doug Kelly Well, Charles, actually I have four. So here's my summary. Obviously, it's it's the most severe global downturn in history. But the takeaway key one is that it's going to take a while for power. passenger aircraft values to get back to 2019. At least demand traffic demand get back to 2019 levels. And so you know, to get back to the long term base value for passenger aircraft, we're looking at 2024 on average. The other takeaway, as I mentioned, dedicated traders are the the good news story in all this and that they're in short supply and values are holding firm, even going up a little bit. So a passenger aircraft is going to take a while to sort of sort through this surplus and return to long term base values. It will take a few years for that the freighters are doing well. And we think we'll we'll maintain that for a while. And there's a long term shift in the e commerce that I think we'll help demand for freighters. But obviously, once the passenger aircraft returned to service, then you have this increase in belly capacity that's going to come back. And then that may put downward pressure on, on, on demand for dedicated traders. But that may take a while. Of course, the last point we touched on is a 747 ending production in 2022. Even though that's not a surprise to anyone, and we've been predicting it for a while. 7478 has unique capabilities because of the nose loading capability and the fact that it's operator basis committed to as tight so even though it's any production and normally we would expect a steeper depreciation curve because of that. We actually expect a flattening curve for the 7478 F and probably for the 747 400 f2 production freighter, which has no loading capability, so that should be a positive for those types. Charles Kauffman All right, well thank you very much for those takeaways and thank you again for your your presentation today and for joining us on this cargo FX webinar. Doug Kelly Happy to do it. Thank you

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