Posted on 14 January 2019

Diversifying the Aviation Industry

While well known for its cyclicality, the aviation industry has managed to continue its growth trajectory and is expected to continue through 2019 and beyond. 

As for the long term, research by Boeing indicates that global demand for commercial airplanes and services will reach $15 trillion over the next 20 years.

In the short term, the International Air Transport Association (IATA) has issued its 2019 forecast, which foresees a solid increase in passenger numbers, which should reach 4.59 billion. In addition, overall profits for the industry are set to increase from $32.3 billion to $35.5 billion by year-end.

Passengers can expect to reap the benefits, as well, with average return airfare (before surcharges and tax) of $324 forecast for 2019. As the IATA points out, this is 61% below 1998 levels after adjusting for inflation.

The global fleet is expected to grow by over 1,000, giving rise to 4.8 million seats by the end of the year. In 2019, we should expect to see close to 40 million flights– or an average of 76 flights every minute.

Investors can anticipate at least the normal return generated by assets of a similar risk profile, signifying a repeat of the 2018 return on invested capital (ROIC) of 8.6%.

The Impact of Market Diversification
While these industry projections are certainly positive, the assertion from strong experience is that the airline industry is cyclical and anticipating the turn of the cycle has been a continuing topic of discussion for a few years now.

Many investors with significant capital have entered the sector in recent years, but some only temporarily. This is due in large part to a prolonged low interest rate environment and significant dry powder pushing demand for yield. This begs the question: Is there potential for a significant portion of these investors to exit the sector in a changed economic environment? Would this give rise to a decline in liquidity and returns? It’s certainly a credible possibility but mainstay players in the sector will also see this as an opportunity to seize value in the sharp exits of “sometime” aircraft investors. 

While bank funding continues to play a key role in this environment, the market has steadily become more blended, with investors obtaining exposure through private equity, private debt and ABS. These markets have also seen some developments, such as the increased sophistication and demand of investors for example through the sale (rather than retention by the originator) of E-Notes along with additional control rights over the issuer/lessor’s activities.

The industry has also become more diverse in its sources of finance, increasingly tapping capital markets, which have themselves become more diverse in their investor base as banks and insurance companies must manage capital requirements around Basel III and Solvency II.

While markets like the aviation industry inevitably go through cycles with widely fluctuating returns, all of these variables at play have made it more challenging to predict the extent to which the aviation industry will be impacted by market disruptions.

On the Horizon: Brexit
No discussion of 2019 forecasts would be complete without recognizing the potential impact that Brexit may have on the market. For now, it appears that the EU regulators have been working steadfast to soften the blow of a potential hard exit.

Within the European Commission’s “no-deal” Contingency Action Plan, they’ve set out temporary measures to avoid full interruption of air traffic between the UK and the EU. They include the allowance of flights between the UK and EU for a 12 month period and address certification issues for up to 9 months.

However, as of the withdrawal date, aircraft operators from the United Kingdom will be considered “third country” operators under EU regulations (Regulation (EC) No 216/2008) on aviation safety. The European Aviation Safety Agency has started taking early applications for UK operators on a “third country” basis.

Clear Skies Ahead?
While market predictions show a forecast for clear skies, there are several factors at play that complicate the situation. The impact of “sometime” investors exiting the market in the case of an economic downturn as well as the impending results of the Brexit decision are two factors that make it simply impossible to know exactly how the year will go. One thing, though, is for certain: 2019 will be a year full of opportunities for those who are ready and willing to grasp them.

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