Blain’s Morning Porridge, July 30 2020: Where did the planes go?

Blain’s Morning Porridge – July 30 2020 – Where did the planes go?

“With a lick of her lips she undid all the clips….”

I shall be sending Jerome Powell a No S**t Sherlock award for yesterday’s insightful gem: “The path of the economy will depend significantly on the course of the virus.”

Boeing’s miserable results and outlook yesterday will be reinforced by similar dire numbers from Airbus.  The US plane maker delivered a mere 20 aircraft in Q2.  Revenues from passenger plane sales tumbled 68% while income from service and maintenance nose-dived. It’s cutting production as orders are delayed or cancelled.  It doesn’t expect aviation to return to normal for 3 years, and plans to lay off 19,000 workers.  Boeing is a critical cog of the US economy – 1% of US GDP with massive multiplier effects across industry and growth. GE posted a $2bln loss, mainly on the back of crashing orders for jet engines. Rolls Royce and a host of other aerospace firms are in serious trouble. 

Even if the pandemic was magically cured tomorrow, Boeing would still be in massive trouble because of management failure, the B-737 Max clusterf*** saga, and declining orders for its out-of-date list of planes. 

Aviation-backed finance was one of my favourite markets.  The deals were illiquid, but generally offered decent returns secured on assets with clear and predictable resale values. The maths worked – until suddenly COVID literally threw it all in the air… Unlike corporate debt, which rapidly recovered on the back of Central Bank QE Infinity, aircraft backed issues remain in limbo on the back of uncertainty for the industry. Prices for used aircraft are… messy. There has never been a shock like it.

The overnight collapse of tourism and business travel means aviation has taken the biggest and most obvious pandemic hit – over 40 airlines around the globe have gone bust or are in some form of bankruptcy protection. The Boeing/Airbus duopoly looks in serious trouble as orders and deliveries plummet.  

According to my chum Miran Bastajian of Cirium, (the aviation data and information experts (if you a serious investor – read their stuff, and tell em Bill sent you if you don’t) – 34% of the world’s passenger aircraft, over 7600 planes, are sitting unused around the globe.  It was over 14400 planes at one point! Many of the smaller B-737s and A-320/321s are getting back in the skies – but only because they are cheaper to fly half-empty. 

That’s still an awful lot of aircraft that aren’t earning their owners – mainly aircraft leasing companies – reliable rentals. (They are funded through the market.) Immediately after the crisis began airlines scrambled to raise cash to survive – they tried to borrow from the market or close sale and leaseback deals on the aircraft they still owned.  It became quickly apparent many airlines had little perception of how transformational the crisis would be. Some airlines got lucky vie grants and bailouts, while others have been forced to accept dangerous money – expensive and conditional.

We simply don’t know how quickly aviation will recover.  As long as the virus remains a threat, passengers will remain fearful of flying, and governments will continue to over-react in the absence of clear data. Will business travel ever “take-off” again now that we all know how to Zoom? Probably.. but slowly. Business travel is vital for airlines – 20% of tickets and 80% of profits. Tourism seemed set to recover quickly with repressed demand for holidays after lockdown, but that’s been whacked by Spain being put back on the quarantine list. 

We could be looking at a worse-case scenario where it takes years for passenger numbers to recover, and airlines and manufacturers remain massively stressed. Even the best case – assuming an effective vaccine and the end of social distancing, it could be a year before travel returns to anything like “normal”. Airlines will still be facing a solvency issue. They are going to struggle to raise additional debt required to kick start new routes or re-equip their fleets – which means there could be some value in some of the apron-queens sitting in the aircraft bone-yards.  It will be a buyers market.

The equation is made even more complex because aviation was already facing a number of major challenges. In addition to the usual cut-throat competition between airlines: 

1) The business model was evolving. Low-cost carriers had eaten the business of flag carriers in regional travel, and were beginning to open up cheap intercontinental flights.  The hub and spoke model was broken, larger twin aisle aircraft proving far less popular than predicted – airlines were looking to maximise returns via smaller single-aisle point-to-point routes. The B-747 is history, the A-380 super-jumbo production lines has closed and there are few buyers of second-hand models. No one is keen to buy Boeing’s new B-777x. 

2) As millennials became the target market, environmental concerns and “Flygskam” have become a massive consideration for the airlines as they tried to appeal to new customers. 

3) The Boeing/Airbus duopoly was stifling the market – they had little incentive to develop new environmentally friendly or point-to-point new designs, and focused on re-hashed versions of tried old designs – resulting in the B-737Max disaster. To be blunt.. new aircraft like the A-350 and B-787 are more efficient and pleasant to fly, but they are basically evolved tech from the 1950s when fuel was cheap and no one worried about where polar-bears live.

And it will get worse. 

For the last 10-years Airbus and Boeing have been pointing to China as their most promising and exciting markets. They expected thousands of China orders in coming decades. With an escalating cold-war between the US and China, much of that order backlog could be refocused on China’s domestic Comac design (old tech, but cheap…. If it works.) 

Could things change for aviation? 

Whatever the coronavirus has done to the global economy – it clearly isn’t going to kill us all….. Aside from Aviation, the effects on the global economy are likely to be fairly short-term. In a few years we’ll have learnt to cope, and growth will be back on some kind of track again. Unfortunately, airports will become even more depressing experiences because of virus measures, but we will still want holidays in the sun. 

While history tells us pandemics are bad, but survivable, it may not be the same story with the environment – it’s a threat of a different order and magnitude.  While the environmental campaigners have taken second seat to the immediacy of the Pandemic – their message hasn’t changed. Many social analysts now expect the Pandemic will trigger renewed and reinvigorated demand for environmental change… and Aviation will be a major target. Smart politicians get that and will play to the Millennial and Gen Z vote.

Green flying might be just around the corner. Airbus recently expressed its ambition to innovate a hydrogen fuelled airliner by the mid 2030s. Airbus CEO CEO Guillaume Faury said they are: “committed to developing sustainable flight and believes hydrogen is one of the most viable solutions”, adding: “hydrogen is one of the most promising technologies available to help us reach zero-emission flights by 2035.”

But developing a commercial green airliner will cost billions and billions – at a time when airlines will likely still be strapped for cash, and the wheezing Airbus/Boeing duopoly will remain barely profitable turning out old-style polluters. It’s going to require massive government investment and a reset to the current aviation market. 

Including the aircraft that have been “retired” because of the pandemic – there are around 22,000 Av-Gas fuelled commercial airliners available today. To replace all these “clunkers” with clean flyers to achieve zero emissions by 2050 aint going to happen unless someone – ie tax-payers – fund it. 

Five Things to Read This Morning

BBerg – Winter Virus Surge Down Under Shows Europe, US What May Come

FT – Calm before the storm: UK SMEs fear for the future 

WSJ – Softbank saw opportunity in Wirecard before it unravelled.

Zerohedge – Visualising the World’s most heavily indebted companies

Torygraph – UK car production driven down to lowest level since 1954

Out of time, and back to the day job… 

Bill Blain
Shard Capital