Projecting the market future of commercial narrow-body aircraft

The COVID-19 pandemic has had a severe effect on the world's economies and industries—including air travel. According to the International Air Transport Association (IATA), 2020 will go down as the worst year in history for its member airlines, with net forecast losses of $84.3 billion to continue well into 2021.

ICF anticipates that the effects of the COVID-19 pandemic will continue for several years, with recovery to 2019 traffic levels anticipated around 2024. Air travel recovery is likely to begin with domestic flights, followed by regional international services. Given international restrictions on travel, long-haul markets will be the last to reopen.

Narrow-body aircraft, or aircraft featuring a single aisle, operate both domestic and regional international flights. What this means: the narrow-body market should be less affected than the wide-body (twin-aisle) market, which had already been softening prior to the economic impacts wrought by the COVID-19 pandemic.

Given the narrow-body fleet outlook in the coming years, airlines, aircraft lessors, and maintenance and repair organizations (MROs) will have to adapt to an unprecedented, long-term contraction in their markets. What will the fallout look like? How will they adjust to new market opportunities?

Airlines: reduced size and orders

Since the beginning of 2020, new aircraft deliveries are down nearly 40% on original plans. Airlines, seeking to reduce costs and preserve cash liquidity during the COVID-19 pandemic, are expected to request additional cancellations and deferrals into 2021. Continuing airline failures will further reduce order backlogs.

ICF expects new orders for narrow-body aircraft to be well below historical levels. In May, Boeing and Airbus logged a mere 18 and 286 gross orders respectively for the 737MAX and A320neo products. We expect even more restrained orders for wide-body aircraft as long-haul operations remain moribund. The retainment of older aircraft in a low-fuel price environment and the disposal or sale-leaseback of newer aircraft are options airlines seek to preserve and build cash reserves.

Nevertheless, many observers predict airlines typically will reduce in size by around 30% - compared to pre-COVID-19 size - as economic conditions slowly improve in a post-pandemic environment. We predict a similar reduction in passenger traffic, as airlines favor newer, smaller, and more fuel-efficient aircraft which respond to investor needs and weak demand. As airlines strive to serve strategic city pairs while facing slow demand and low fares, we expect to see improved demand for the Airbus A220 and Embraer E2 regional jets.

Older aircraft requiring major airframe and engine overhauls are leading candidates for retirement, as are the less popular members of the Airbus A320 and Boeing 737 family, including the A318 and 737-600. Other prime disposal candidates are large fleets of Boeing 717, 737 Classics, Boeing 757s, and the MD-80/-90 (which has been all but removed from service by first tier operators - all of which are now two generations behind current technology aircraft.

Aircraft asset marketability may vary significantly throughout the different stages of recovery—from initial slow demand through the restoration of more normal services should a COVID-19 vaccine be deployed successfully.

Bearing the brunt of initial value declines is the regional airline sector. Many airlines in this sector have collapsed given weak financial structures, and as a result, several fleets of regional aircraft have been placed on the market in a short period of time. The very large aircraft (VLA) sector, where international passenger traffic has practically evaporated, is unlikely to recover for some time. Neither sector has enjoyed lessor favor, exposing aircraft in both sectors.

What has retained favor: the production of narrow-body aircraft and the latest-generation wide-body aircraft. Current Market Value (CMV) for 2019 vintage aircraft has dropped around 5% to 10%. Older narrow-body aircraft, unencumbered by leases and requiring expensive heavy maintenance, have exhibited significant declines of 15% to 20%. These aircraft are likely to remain parked and eventually retired as economic conditions improve, and as new aircraft begin to deliver again in earnest.

Lessors: dealing with deferrals and customer survival

For aircraft lessors, the prime impact of the COVID-19 pandemic will be the airlines' request for lease rental deferrals and holidays for in-service aircraft. Most lessors have indicated these requests to be in the order of 80% of lessees.

To date, however, lessors have granted only short-term deferrals of two to three months, typically to preferred operators, with payback expected immediately following the deferral period (including interest). We expect lessors will strive to reduce rentals rather than provide complete deferrals. This reduction will help ensure sufficient cash flows to cover operating costs and meet the interest costs of banks and bondholders.

Typically, lease extension requests and future seasonal overpayments counter longer-term rental reduction requests. In other cases, lessors negotiate early return and termination, with aircraft moved to other operators and jurisdictions on short-term leases (e.g., three years) as markets return to pre-pandemic levels.

Alternatively, lessors can draw down security deposits and negotiate around maintenance reserves and redelivery conditions. Lessors can also enter power-by-the-hour (PBH) arrangements with the lessee and, where relevant, pay for storage/maintenance/insurance costs.

At the macro level, OEMs can and have negotiated deferred deliveries and cancellations with lessor customers. Several lessors already have canceled large blocks of aircraft (mainly the 737MAX) as the aviation industry navigates a return to service.

Given the unprecedented downturn in airline operations and passenger demand, there is an immediate and seemingly prolonged decline in aircraft values and lease rentals. While the long-term impact of the COVID-19 pandemic is difficult to determine at present, many observers (including us at ICF) suggest a period of three to five years before traffic volumes return to pre-COVID-19 levels.

MROs: airframes and freighter conversion

As a result of a predicted lengthy recovery from the COVID-19 pandemic, many airlines have made cuts to their operating fleets, parking some temporarily while announcing early retirements for several of the fleet types they operate. Current fleet data suggests that in early June, global carriers had 12,000 airliners parked; another 3,500 airlines (around 10%) were used only intermittently.

Industry analysis suggests engine MRO demand will drop over the next two to three years by around 60%. There will be negative MRO revenue implications over $1.5 billion as airlines deploy green-time engines harvested from parked aircraft instead of contracting shop visits with overhaul facilities.

As airlines seek to maintain cash liquidity, they will revisit heavy airframe check schedules, delay non-mandatory tasks and checks, strip airframe parts from parked or retired aircraft, and use the pandemic to renegotiate supplier contracts to realize discounts. In some cases, they may choose to enter the third-party MRO business and compete with existing facilities to increase lines of revenue-generating business. Adding pressure to third-party MRO finances will be the loss of income from PBH agreements from airlines flying less—or not at all.

With older aircraft unlikely to return to service, a glut of harvested spare parts for some fleet types will arise. This glut may lead to value deterioration (albeit tempered by teardown capacity) and may pose a risk to new parts sales and used spare parts traders alike.

Historically, the continued popularity of replacement types in passenger service has tempered the narrow-body freighter conversion demand. However, a recent and significant increase in retirements of older passenger aircraft linked to the COVID-19 pandemic will boost not just legacy conversion programs (such as the wide-body Boeing 767) but also emerging ones (including the narrow-body Airbus A321 and Boeing 737-800 types).

Even in the face of global uncertainties on trade, manufacturing sectors, and regional slowdowns, the global e-commerce market shows little slowdown, which, in turn, will boost conversion revenues for established shops, such as AEI, EFW, IAI, and Pemco.

Opportunities to focus on

Air cargo has proved to be one of the few sectors to perform relatively well during the COVID-19 pandemic.

Several Chinese cargo airlines reported rising volumes, even during the worst of the outbreak in the region. While belly-hold freight suffered from a collapse in passenger operations, a rapid increase in the demand for dedicated freighter capacity has evolved.

In response, many airlines are now converting aircraft to take freight in both passenger and freight compartments to ease freight hub congestion and maintain operating revenues. MROs can focus advantage on the aircraft conversion market, including the removal of passenger seating, for interim operations or permanent conversion.

Opportunities also exist for seating reconfiguration for health and safety reasons or upgrading cabin air filtration and anti-microbial toilets and surfaces.

As airlines ground aircraft and lessors repossess (or take early lease returns) on aircraft, a significant short-term role exists for MRO facilities. This role: to provide lease return and storage maintenance support (including periodic ground checks and engine preservation), as well as to transition packages to retrieve, store, and reconfigure aircraft for re-lease to new airlines.

Well-funded MROs can offer targeted airline support by entering into sale-leaseback agreements on major aircraft parts and engines or providing long-term MRO support contracts to relieve airlines of the cost burden of fixed internal costs. Larger and well-resourced MRO facilities can pursue diversification opportunities in related business aviation and defense industry maintenance support.

As the airline industry—and the world—moves through the evolving COVID-19 pandemic and recovery, airlines, lessors, and MROs need to review their strategy, footprint, and operating models. With the right framework in place, they can emerge in the coming years stronger than ever.