2021 Global aviation industry outlook
By Dick Forsberg, Senior External Consultant, PwC Aviation Finance Advisory Services, Ireland
What a difference a year makes! The past 16 months have visited unprecedented disruption not only on the aviation industry but also on every aspect of the lives of the entire global population.
COVID-19 has disrupted economies and businesses, locked down billions of people, closed borders and brought airlines to their knees. The pandemic’s impact on aviation, in terms of financial losses, airline failures, unemployment and global connectivity, is already immense and has not yet reached its peak.
The consequences will include significant and permanent structural changes to the airline industry and its stakeholders.
The passenger airlines are firmly in the front line of this crisis, but their problems quickly cascade down to impact all other industry stakeholders.
Lenders and lessors have also been counting the cost of their exposure to airlines that can no longer meet their financial obligations as revenues collapse. Many of the traditional aviation lending banks are out of the market, with others repricing transactions and taking a more conservative approach to risk.
Lessors are starting to see revenues flowing in again, but the majority of their leases remain in arrears or have been substantially restructured and lessors have their own funding obligations to service.
MROs and part-out businesses are facing lean times as airlines have cut their maintenance spend to the bone and utilise their inactive fleets to keep the rest flying rather than repair and restore engines and components.
The OEMs have come through their worst ever year in terms of both orders and deliveries, compounded by Boeing’s 737MAX problems that are only now starting to be resolved. The lack of demand for new aircraft, added to an estimated 5,000 surplus aircraft already in the system, is impacting asset values, with larger, older and less efficient models expected to suffer permanent value reductions.
Yet, at the same time, seemingly record numbers of investors are lining up in anticipation of finding real value in distressed aviation-related transactions, arguably for the first time in over a decade.
Many of them are still in the early stages of due diligencing the sector and even seasoned players mostly feel that it is too early to commit in scale, but capital should be available in scale as the recovery trajectory becomes better defined.
2020 will hopefully prove to have been the low point in the current cycle for aircraft deliveries and funding, requiring an estimated US$50bn of finance, half of the 2019 volume. A shortage of available funding is clearly one reason for the reduced level.
However, despite many traditional aviation lenders and popular funding structures such as the ABS and JOLCO markets being on hold and limited capacity from the export credit agencies, these deliveries, at least, did get financed.
Government support, in the form of liquidity injections or by underwriting loan facilities, will have provided the means for some airlines to meet their delivery obligations, but for the majority of those that would normally rely on the debt capital markets, alternatives were required.
This led to a significant step-up in the use of the leasing channel, which accounted for 50% of new delivery funding in 2020 versus 43% in 2019, although the dollar quantum fell by 40% year on year.
In addition, lessors engaged in an elevated level of sale and leaseback activity on used unencumbered assets during the year, amounting to an estimated US$10bn, 70% of which was for aircraft less than five years old. This important additional source of airline liquidity has attracted more than 20 lessors to date, including several significant PE-funded platforms, and is set to continue for the duration of the crisis.
The debt burdens accumulated by many airlines during the crisis will inevitably limit their ability and appetite to further leverage their balance sheets to fund aircraft deliveries. Whilst some of the slack will undoubtedly be picked up by the Export Credit Agencies and the expanding insurance-based products, the leasing channel is well-placed to materially extend its share of delivery financing and overall fleet ownership towards the long-anticipated 50% level.
Of course, lessors are facing their own cash flow and liquidity crises. There was generally a high level of acceptance when the first round of lease payment relief requests came in from their customers, that were clearly unable to meet their obligations.
However, further requests for rental relief have not necessarily been met with the same response. Lessors have started to pick the winners and losers – the survivors and thrivers – as they deal with their own liquidity challenges.
The extent to which lessors can, or have already, secured a financial cushion that will allow them to ride out a further nine to 12 months of low income, is now starting to be tested. Undoubtedly, the largest players will have had both the foresight and the ability to build substantial financial bulwarks and will have the support of shareholders and bondholders.
Lessors will continue to be insurgent where opportunities arise to grow their portfolios through sale and leaseback transactions, on better terms than the recent past, but this will take place on a more subdued level than might have been seen during a normal downturn, as even the best-managed lessors will be concerned about the uncertain duration of the revenue drought.
Other lessors, though, face a growing risk of breaching financial covenants that may have existential consequences for their businesses. As the crisis continues, an increase in lessor restructuring and M&A activity may be expected, creating further opportunities for the growing number of investors that are considering a new or expanded role in the sector.
Their incremental liquidity, either funding lessor platforms or individual assets and portfolios, will be key to the continued ability of airlines to finance their aircraft and related assets, especially during the early stages of the recovery, when more risk-averse funding channels remain hesitant.
2020 passenger traffic, measured in RPKs1, was 2/3rds lower compared to 2019, with the last three months averaging falls of over 70%. The number of flights operated was down by 50%, with ASKs2 60% off, reflecting the more severe restrictions on long-haul international services.
Average passenger load factor consequently dropped from 2019’s record 82.5% to below 60% and utilisation of the active fleet was also well below pre-COVID levels, compounding the airlines’ economic conundrum of minimising cash outflows whilst trying to anticipate any recovery in demand.
Fleet planning processes have shrunk from a 12 to 18-month horizon to less than four weeks in some cases and cost per trip has temporarily replaced cost per seat as a key metric in aircraft deployment decisions.
Whilst 2020 ended with 30% of the global passenger airliner fleet inactive, a substantial improvement on the mid-April peak of over 60%, this is still more than 8,500 idle aircraft. Furthermore, having remained broadly stable for several months, hopes of further improvement have stalled since the start of the winter season, with further deterioration now inevitable as a resurgence of the virus, in a more virulent form, has led to the reintroduction of blanket travel restrictions and a variety of new testing and quarantine requirements in many parts of the world.
IATA has revised its 2021 outlook three times since the start of the pandemic. The latest forecast, published in late November 2020, predicts an industry net loss of US$118.5bn in 2020 and a further loss of US$38.7bn in 2021.
Cash outflows for Q2 to Q4 2020 are estimated at US$125bn, with potentially another US$45bn of cash burn over the next three quarters before turning marginally positive in Q4-2021.
It may come as a surprise to learn that the level of airline failures in 2020 did not reach a new record high. The extent of government support, estimated to be at least US$180bn to date, has played a major role in saving a number of weak legacy carriers from collapse, but in doing so has created a long-term un-levelling of the playing field. Despite the stop-start characteristics of the COVID crisis, the level of passenger recovery in a small number of key markets is encouraging, with the return of China’s domestic market to pre-COVID levels and a strong uptick in US demand around Thanksgiving supporting a view that the desire to travel is deeply embedded in our DNA and that, when appropriate levels of safety can be delivered and governments remove their widespread barriers to movement, leisure passengers, at least, will return.
Nevertheless, for the moment, air travel in most parts of the world largely consists of VFR trips, where arguably the urge to travel, linked to family ties, is strongest. With the borders of up to 60 countries still closed to all except residents and citizens, the return of international vacation travel remains a more distant prospect.
Business travel has been all but extinguished by a combination of economic recession, travel restrictions and the unwillingness of companies to accept the liability implications of their employees’ health when travelling at the behest of their employer.
As the global economy begins to find its feet again, high yielding long-haul business travellers will be amongst the last to return, and in smaller numbers since non-essential company travel (between corporate locations, or for conferences, off-sites and other non-core activities) will bear the brunt of corporate budget trimming.
This is especially worrying for full-service network carriers that have a high dependency on premium traffic and revenues for their overall profitability. Many such airlines have disproportionately large business class cabins and will struggle to attract sufficient premium business to cover the costs – a business class seat typically requires three to four times the revenue coverage of an economy seat just to make up for the additional cabin volume occupied.
With the most lucrative business travel market in the world – the North Atlantic – closed until further notice, the prospect for network carriers on both sides of the Atlantic, as well as further afield, is looking bleak.
Many airlines have already announced their plans for significant elements of their fleets to be taken out of service, either permanently or for an extended period until demand has substantially recovered. The affected passenger fleets include the obvious ageing Classic models such as B757s and B767s, but extend to B747-400s, A340s and A380s, as well as older vintages from the B737NG and A320 families.
Storage itself adds another dimension to the retirement story, since the amount of technical work and expenditure required to bring aircraft out of storage increases rapidly with the length of time spent in storage.
The challenges also increase with the size and vintage of aircraft, with older widebodies quickly becoming uneconomic to return to active service. In a prolonged recovery situation, the number of aircraft moving from storage to eventual retirement will increase, but even in an optimistic recovery scenario, it is likely that 5,000 aircraft may not fly again – around 20% of the previously active fleet.
At the other end of the age and efficiency spectrum, airlines will favour low risk, low trip cost fleet recovery plans which return the smaller family and fleet members and/or the youngest and most fuel efficient first.
The OEMs have also been severely impacted by the COVID crisis, which has prevented airlines from taking delivery of contracted aircraft, either through an inability to secure financing or due to the limitations imposed on travel that has made physical acceptance of aircraft challenging.
Total commercial deliveries in 2020 were 42% lower than in 2019 and 56% below the 2018 peak level when Boeing was still delivering a full complement of B737s.This represents the largest peak-to-trough decline in five cycles of jet airliner production.
Airbus and Boeing have been affected in different ways, due to the extended grounding of the B737MAX, but both have seen unprecedented year on year declines in orders and deliveries, triggering substantial cuts in production rates that reflect the market reality.
Airbus deliveries fell by 34% in 2020, to 566 aircraft. The impact was felt most severely during the summer months with a recovery during the final quarter as most of the backlog of aircraft that had been built but not delivered was cleared. Single aisle deliveries held up better than twin aisles, with falls of 30% and 53% respectively.
Boeing delivered a total of 157 aircraft in 2020, extending the collapse begun in 2019 to hit the lowest level in 35 years. Their performance remained heavily influenced by the B737MAX situation, with 28 B737s being delivered to commercial customers last year, including 26 MAX aircraft that were delivered during December following the lifting of the FAA’s grounding order.
Boeing’s ability to deliver widebodies was hampered not only by market conditions, but also by B787 manufacturing quality issues, and delivered only 103 widebodies to commercial customers during the year. Almost half of these were freighters, where stronger demand sustained deliveries close to 2019 levels, but the number of passenger models delivered was 2/3rds lower than 2019. The number of gross orders booked during the year fell by 60% overall. Lower numbers were achieved virtually across the board, but the greatest pain was felt in the widebody market, which has fallen off the proverbial cliff.
Airbus widebody orders were down by 90% compared to 2019, with Boeing experiencing a 66% reduction (78% for passenger variants), underscoring the serious challenges that have been facing the widebody market for a number of years.
Boeing scored a late burst of MAX activity, securing orders in December 2020 for 75 aircraft from Ryanair and 23 from Alaska Airlines (although Boeing did not include the latter in firm year-end totals), that brought welcome momentum to the task of restoring confidence in the programme. This cut Boeing’s overall gross order decline to 20%, well ahead of Airbus, which suffered a 67% drop, and Embraer, where no commercial orders were booked.
Unfortunately, 2020 also produced a record number of order cancellations, half coming from lessors, which drove net orders for commercial aircraft down to an estimated and unprecedented minus 117. Most of the cancellations came from the B737MAX programme, where over 600 aircraft were removed as delivery delays extended into the “non-excusable delay” timeframe, providing customers with a contractual option to cancel.
Airbus suffered from fewer cancellations, having held a firmer contractual line with customers, but a total of 115 cancellations took their net order total to 268, a level not seen since 2003.
In addition to cancellations, a substantial number of customers negotiated deferrals on their contracted delivery dates during the year, typically moving 2020 and 2021 slots between three and five years to the right.
According to Ascend by Cirium’s Fleets Analyzer, more than 1,600 aircraft deliveries were deferred or cancelled during 2020, roughly 12% of the backlog at the end of 2019. Some 80% of deferrals were originally scheduled between 2020 and 2022 and the average deferral is approximately 3.5 years.
This will have an impact on production and delivery rates over the next number of years, however the substantial remaining backlogs measured by years of production continue to provide the major OEMs with a considerable cushion within which to manage their manufacturing processes and supply chains.
In this regard, Airbus responded swiftly to the unfolding crisis, cutting A320 family production by 1/3rd, from 60 to 40 a month, and A330s and A350s by 43% and 50% respectively. Based on the strength of their backlog, however, Airbus has signalled an intention to raise A320 production to 47 a month, potentially during Q3-2021 depending on market conditions.
Boeing will reduce B777 production from five to two a month in 2021 and B787 output from 14 to five a month from mid-2021. Boeing also announced a further delay to the service entry of the new generation B777-9 by a year, to 2022, the end of B747 production in 2022 and the closure of the Seattle B787 production line to consolidate manufacturing in Charleston.
The extraordinary levels of additional indebtedness secured by airlines, through a combination of government support, loans, capital markets and lender and lessor concessions, will permanently realign the financial balance of the industry and impose an onerous burden on management teams that, in many cases, are not equipped to deal with the fundamental changes that will be required simply to survive.
For sure, there will be more airline casualties ahead, but for those that survive the ability to subsequently thrive will be more elusive.
Success will require not only an efficient cost structure that is not over-burdened with debt and a rock-steady brand and franchise, but also a leadership that has the vision and experience to challenge the broader industry norms and constraints, to embrace and harness technology and data and to champion sustainability and diversity.
These qualities, that will define success over the next decade, also, through their absence, define failure as the industry faces an inevitable down-sizing.
In order to survive and thrive in the post-COVID world, airlines will have to fundamentally rethink their fleets, their business models and their finances. This will not always lead to change, but for most a return to business as usual is not going to be a viable option.
Firstly, to put it bluntly, there are too many aircraft in the system relative to the realistic prospects for medium-term recovery. The new normal in many markets, and for the industry as a whole, is going to be a smaller industry, a market of 4.5 billion passengers will not return overnight.
Airlines will not be able to simply pick up where they left off – not only have markets shrunk, but the profile of their customers and their needs will have changed, and the way that they are required to serve their markets may have become uneconomic.
The crippling debt burden that is building across much of the airline industry will require root and branch restructuring in order to bring financial metrics back into line with long-term solvency and profitability.
In many cases, drastic surgery will be needed to right-size fleets, restructure business models and recapitalise businesses. This will regrettably also mean widespread job losses, well beyond those which have already been announced or mooted.
The fleet rationalisation process is already under way of course, but the process will continue and accelerate, as fleet decisions address multiple objectives. In the interests of efficiency, many airlines have already chosen to retire their oldest, least efficient and least reliable fleets or, if they are in storage, to bring them back into service last.
In line with the experience of previous shock events, most early generation and obsolete aircraft will not see active service again in any scale – these range from the handfuls of remaining DC9s and B737-200s through MD?80s and B737Classics, to include A340s, older A330s and the majority of the remaining passenger B747s, B757s and B767s.
As airlines look for greater efficiencies, they will also seek to simplify and rationalise their fleets, cutting down on sub-fleets and eliminating models that do a similar job to others that they will retain; or sacrificing a multi-supplier OEM policy for the single source benefits of crew commonality, training and maintenance.
Right-sizing will play a key role in airline restructuring plans, as traffic levels will no longer support the largest family members in the proportions that had been envisaged for the current fleet mix.
This presents an obvious challenge for A380s, but is also likely to extend to B777s, A350-1000s and B787-10s in the widebody spectrum, as well as having an impact on the mix of A321neos and larger B737MAXs delivered within the single aisle programs.
Regional aircraft, including the small mainline A220s and E-Jets, may well have an early advantage in this re-mix, as they present significantly lower risk in a world of uncertain demand. However, looking further into the future, an alternative scenario might see lower frequencies traded for larger gauge aircraft, especially if business travel remains subdued.
This right-sizing process will extend well beyond the delivered fleets to have a significant impact on existing order books and future ordering activity. However, few airlines will be looking to add new capacity for a while – there is more than enough surplus capacity to deploy from within idle fleets. Equally, lease extensions are likely to be fewer and farther between and new lease placements harder to secure.
Another category of aircraft becoming surplus to requirements are those that are released from failed or failing airlines. A higher proportion of these aircraft will be relatively young vintages that ordinarily would quickly be re-deployed into other operators. Under the new normal, though, they are likely to hang around in the surplus inventory park for longer, competing with other similar aircraft released by right-sizing airlines, those naturally coming off lease and new builds delivering from the OEMs.
In total, combining these channels for fleet reduction produces around 5,000 aircraft – half of which will become surplus and compete for future placement as the market recovers, and half that will either find their way into the cargo conversion pipeline or be permanently withdrawn from use.
Some 5,000 aircraft are almost 20% of the delivered fleet, but this may not be the final tally, as the process will extend over several iterations as the industry fine-tunes its requirements.
The aphorism “never let a good crisis go to waste” is generally attributed to Winston Churchill, although it’s doubtful that he actually spoke those words. Nevertheless, the advice is particularly sound today. Airlines have never been in a more pressing existential situation and bold and far-reaching decisions need to be taken.
Re-shaping a business to be a survivor and thriver in the new normal will require a holistic multi-step process, where each step will interact with others and with the wider industry picture.
Whilst the fleet is the most tangible of the moving parts in an airline business model, fleet changes will inevitably be influenced by decisions taken on the route network and the traffic flows across the network. These in turn will be influenced by the core elements selected for the go forward business and, to the extent that this focus changes, will have consequences for the product offering, the brand and the franchise.
Arguably, this last area should be the starting point for a deeper introspection. What is the franchise going to look like in a post-COVID world and in the context of a changing cast of players and competitors? However strong the brand and franchise have been in the past do they hold up and continue to have a role in the future marketplace? Most importantly, how can the business be profitable or, more specifically, which parts of the business can be profitable?
The crisis therefore presents a unique opportunity to build back the business layer by layer with a laser eye on enterprise value and profit contribution. The future airline industry route map is likely to be a good deal less dense that the pre-COVID one. This is the time to lop off overgrown branches, cut out dead wood, eliminate loss-making sectors flown to utilise excess capacity or to protect slots.
Environmental issues and sustainability may have taken a back seat as airlines deal with immediate existential issues, but they have neither gone away nor diminished in importance.
The industry has set some extremely challenging targets, including a 50% reduction in carbon emissions by 2050 compared to 2005. Achieving these goals will require considerable investment in developing new technologies.
The bottom line
COVID is not going away on its own and all indications are that it will get worse before it gets better. In the meantime, governments should not be expected to change their stance on movement, travel, border controls, quarantine, et al.
Flight schedules will remain stop-start, subject to uncertain and intermittent demand and requiring frequent amendments. Passenger airlines will therefore need ongoing access to emergency liquidity, including government support, for the foreseeable future. Where this is not forthcoming, some airlines will fail.
The level of fleet inactivity will get worse before getting better, resulting in more aircraft that are never returned to active service. Demand for additional capacity will remain muted, making lease extensions and placements more difficult, and OEM production rates may not return to 2018/19 levels before 2025.
Pressure on lenders and lessors will also continue well into 2021. More lending banks will find themselves in the position of unwilling operating lessors as defaults rise, and the leasing sector will see more restructurings and M&A activity.
Nevertheless, the outlook for operating leasing is very positive as airlines increase their use of the lessor channel to finance deliveries.
This in turn will create more opportunities for investors to put equity and debt to work in the sector, perhaps initially as partners jointly financing aircraft with established leasing platforms; then, as confidence in the recovery grows, making direct investments in existing lessor platforms or establishing new ones.
The most efficient aircraft technologies and smaller-gauge family members will continue to be the most attractive fleet choices for airlines seeking to minimise operating risk and cash outflows. Their values are unlikely to experience permanent reductions. Conversely, the largest and least efficient aircraft types will remain under-utilised for longer with an elevated risk of permanent value impairment.
Once the Coronavirus has been subdued, passenger demand will return as there is already evidence that the desire to travel is firmly embedded in our DNA and, given the opportunity and the confidence to fly again, the majority will do so. The industry has demonstrated its resilience many times in the past and will survive and thrive again, albeit with some sorely needed changes to its structure.
For investors considering opportunities in the sector, the downside risks should not be under-estimated, but there is real value out there, arguably to a greater extent than in any of the past ten years or more. Timing and forensic due diligence will be critical factors in making sound investment decisions, supported and guided by industry professionals with multi-cycle experience.
1 RPK = Revenue Passenger Kilometre. The number of commercial passengers carried x the distance flown.
2 ASK = Available Seat Kilometre. The total number of seats offered x the distance flown.
Dick Forsberg, Senior External Consultant
PwC Aviation Finance Advisory Services
One Spencer Dock, North Wall Quay, Dublin 1, Ireland
Tel: +353 87 969 1369