Ask the Expert: Where is the money?
Question: How far will market values decline in 2009?
Expert: Ascend, director of valuations Les Weal
In ‘normal times’ a downcycle is seen by many as an opportunity to acquire good long term assets at attractive prices, however this strategy is being undermined by the financial crisis (or is it a debacle?) which has introduced an element not previously seen and is exacerbating the situation. Today, cash clearly is king and deals are being concluded at much lower values, where the buyer does not have any ‘subject to finance’ provision in a purchase offer. In essence, where is the money?
I would argue that the end of the ‘bull’ market for aircraft values was in late 2007 and further softening was evident when the US airline industry responded to the rise in fuel prices with wholesale fleet cuts. However, the failure of investment bank Lehman Brothers in September 2008 was the straw that broke the camel’s back.
The result has been a major realignment in aircraft values, as passenger and freight demand has slumped and the world’s airlines find themselves with excess capacity.
The capacity-cutting strategy rightly adopted by the US airlines, albeit initially for the wrong reasons, is the only cure.
These essential capacity reductions, be it through fleet lay downs (Ascend has tracked over 1600 aircraft cuts announced since mid 2008) or lower utilisation of aircraft, are in simple terms bad news for owners of assets and have led to significant softening in commercial aircraft market values. The first types to be impacted were the likes of Classic 737s in late 2007, followed by the in-production single aisles. More recently the effects have become manifest in widebody types.
It is hard to generalise, but market value declines in the past year have been in the 15% to 30% range. It is worth mentioning that for many types the recent value declines have simply brought market values back to (or indeed below) the underlying balanced market ‘base’ values and have removed the overheated element in the values witnessed in recent years.
The question on everyone’s lips is now ‘how much further have market values to fall?’ Perhaps the closest parallel to the market today is the early 1990s when the peak to trough for in-production types’ market values was approximately 35% - this implies we have a way to go yet. However the consensus is that the dislocation in the finance sector may deepen the trough.
I do not see any evidence to suggest that airlines are slowing capacity reductions, which will mean even more aircraft parked – the likelihood is that a total of 3000 in storage will be surpassed in the coming year.
The overcapacity situation is being compounded by what one could politely put as the slowness of the OEMs to respond to the evident stress their core customers are feeling by building less aircraft. This stubbornness is hurting values and my prognosis is that 2010 and 2011 will see significant cutbacks over and above what I would term the ‘window dressing’ contemplated so far.
The likelihood is that the next market values peak may not be as pronounced as that recently witnessed, so to get the spread they need on returns, investors actually want values to be even lower now.
I am expecting a little more resilience in values of the core widebody types, the likes of the A330-200/300 family and 777ERs. The delays in the 787, the firmer orderbook and the capacity cuts mostly falling on the likes of the 747-400, older A340s and B767-300ERs are all contributing to this relatively better outlook. As an example, the market values for the oldest A330-200 and 777-200ER are currently US$53 million and $58 million. By year end I expect the values to be closer to $46 million and $50 million.
In the single-aisle category, if we take A320s and 737-800s of 2009 build as a benchmark, their current market values are circa $40 million assuming generic specification. By year end, with the assumption that both manufacturers stick to their production plans, I would suggest that values in the mid 30s could be the norm.
I would like to end on a positive, but good news is in short supply unless you own a desert storage facility for aircraft. However the fiscal stimuli being countenanced by Western governments could be inflationary and isn’t that good news for asset owners?