Guest Comment: Aircraft Lessors Achieve Good Results Despite Challenging Environment | New

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The inflationary cycle continues to weigh on economic recovery and hamper the recovery process at all levels and in all sectors. Despite this unpromising situation, marked by a still very weak post-Covid recovery and a long-lasting war between Russia and Ukraine, the aircraft leasing industry continues to perform well.

The causes of inflation

The war in Ukraine has brought geopolitical uncertainty, causing the prices of everything from materials to energy to food to soar. Western countries have imposed crippling sanctions on the Russian economy and restricted the use of its oil. Russia is the world’s largest exporter of oil and natural gas and the world’s second largest exporter of crude oil after Saudi Arabia, meaning the sanctions have rattled energy markets. Ukraine, on the other hand, is often called “the breadbasket of Europe” due to its strong wheat and grain exports. The conflict has sharply reduced these exports, leading to higher grain and food prices.

The forces of inflation, however, set in motion before the start of the conflict in February this year. When the pandemic took hold in early 2021, pent-up demand for goods was met with shortages of inventory and personnel, driving up prices in economies around the world, both advanced and developing.

Aviation Challenges

Inflationary pressures have created a difficult environment for all industries, including aviation. The ripple effects are multiple, ranging from labor shortages to high debt levels.

  • Staff shortages: Many airlines have experienced staff shortages in recent months. Some of the reasons are strikes, which lead to staff shortages and massive flight cancellations. These cancellations increase the demand for flights on other flights, which in turn increases the price.
  • Longer routes: The war in Ukraine is also forcing many airlines to and from Asia to divert their routes around Russia, Belarus and Ukraine, often making them longer and therefore more expensive.
  • Higher Airfares: Labor shortages and rising oil prices are among the factors prompting carriers to raise airfares. This could threaten the business models of some low-cost carriers as discretionary spending by some consumers will be curtailed until inflation and air fares are reduced. Airfares charged by low-cost carriers will also increase as airlines reduce capacity. If prices exceed a certain level, customers may not believe the model is attractive for stripped-down service with limited seat space and food that is not included in the ticket price.
  • High levels of debt: Separately, some airlines have incurred significant debt during the pandemic and are now facing rising operating costs. However, inflation helps people in debt because it reduces its real value and therefore the real value repaid. Nominal interest rates should remain below the rate of inflation, which should give airlines the opportunity to repay their debts at a lower cost. Airlines that have high levels of debt and lack the cash to repay it may face significant challenges and may have to pull out unless they can secure state support. Given that governments have provided significant support during the pandemic, the patience to continue to do so is running out.

In addition, many aircraft purchase and lease agreements will have price escalation terms – that is, lease rates increasing as they are linked to the purchase price of the aircraft which increases based on inflation – the price of the aircraft increases if a manufacturer’s costs to produce it go up. In addition, base fares and benchmark fares are increasing, which will make it more expensive for airlines and lessors to raise capital.

  • Delayed deliveries: The rapid economic reopening has caught everyone off guard and, together with supply chain issues, this is the main reason new aircraft deliveries are behind schedule for all manufacturers. Less control and difficult planning on deliveries. Raw materials are currently not a big issue for this year as OEMs usually plan a year ahead to avoid any work stoppages, but rising prices will certainly have a negative impact as OEMs will deliver fewer aircraft than scheduled for this year.
  • Reactivating older planes: Another effect of the rapid economic reopening is the surge in demand and the lack of capacity for planes, forcing airlines around the world to reactivate planes that were originally due to reach end of life.

The positives for aviation

Despite these pressures, we believe that a sector such as aircraft leasing will have every chance of benefiting from such an environment. Certainly, the airline industry is affected by the general increase in airfares, which should dampen demand and slow the recovery of the industry. However, real assets, such as aircraft, will be less affected by inflation because they are able to generate attractive yield premiums.

Not only is inflation likely to help offset the decline in resale value of lessor-owned aircraft over time, aircraft ownership is also likely to generate rental income until it be resold.

Real assets, such as aircraft, are far from suffering from inflationary shocks: and for good reason, these assets are still capable of generating performance bonuses in the event of resale or modification of the fleet.

This is because inflation causes aircraft prices to increase over time, including the value of an aircraft as it ages, which can help offset the depreciation in value. At the extreme, the value of an aircraft will depreciate more slowly than it would in the absence of inflation. In the best-case scenario, this can allow the aircraft to be sold for a higher value than the original.

Even better, owning an aircraft gives you the opportunity to continue to benefit from the rental income it generates until it is resold.

Perspectives

Inflation will lead to increased costs for many airlines who may try to pass these costs on to customers by increasing airfares. However, the industry can continue to rebound if airlines are consumer-centric.

In a highly inflationary environment, airlines must be able to walk the line between recovery and making post-pandemic profits, which in some cases will mean charging more without stifling demand to propel the rebound.

The aircraft leasing industry has enough flexibility to withstand inflation. It should be remembered that when operational leasing of aircraft was introduced in the late 1970s and early 1980s, aircraft were a huge hedge against inflation.

Sometimes aircraft were even sold at the end of their 10-year lease at a higher price than when newly purchased due to inflation. The fact that aviation was seen as a hedge against inflation was a major factor in the aircraft leasing boom of the 1980s. At the time, investors lined up to enter the market.

It’s clear that today’s transportation companies need a more agile and dynamic approach to financing and optimizing fleets. Airlines need innovative solutions, which offer them optimal agility to face the difficult inflationary cycle which affects the whole world. These solutions, coupled with strong fundamentals, position the airline industry well for years to come.

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