:: July 2010 Letter ::


Dear Fellow Potential Aircraft Leasing Investors,

Jumbo Shrimp. Freezer burn. Friendly Fire. Profitable Airlines. Everyone chuckles at oxymorons. I would add a new one: Happy Farnborough. As in, ďwhat a happy Farnborough Air Show.Ē Yet we just had one (strangely, we have profitable airlines too). Unlike the grim 2008 Farnborough (described in my May 2010 letter), this yearís show featured optimism, strong commercial sales and fine weather. In all, Airbus and Boeing received 290 firm orders and over 200 more commitments. The air transport recovery is well underway.

Iím not really comfortable with industry oxymorons. And I certainly canít accept a happy Farnborough. So itís no surprise that I have a reservation about those happy-sounding orders: about 85% of them came from lessors, not airlines. In keeping with my job as industry critic guy, Iíll offer six reasons to feel concerned about what those lessor orders mean for the industry:

1. Thereís a degree of separation between these orders and the air travel market. Private banks are getting cash at cheap rates from central banks. Sovereign wealth funds and other investors have cash burning holes in their pockets. There arenít very many other investment opportunities in the world economy, so banks and funds are investing this cash with lessors, who then go shopping for jets. This isnít dumb. Putting cash into proven assets like A320s and 737s (90% of the orders at the show were for these two planes) is historically a profitable business (then again, so was housing a few years ago). If the current strong traffic recovery continues, airlines will be under-ordered, giving lessors an opportunity to meet surging demand. But this isnít the same thing as airlines feeling good about the future and ordering jets to meet demand. Perhaps those airlines are under-ordered because theyíre understandably wary of the macroeconomic environment. Speaking of that...

2. Thereís a degree of separation between the air travel market and the economy. Passenger and cargo traffic are doing great, and airlines are making money. Yet todayís traffic numbers are now completely disconnected from, and way better than, the economic indicators that typically drive them. Stock prices, GDP growth, inflation (or even deflation), bond rates, retail sales, housing inventories, employment, and consumer confidence numbers in the US and Europe all show continuing uncertainty. Weíve seen this disconnect before. 2008/2009ís plummeting traffic numbers were way worse than the prevailing economic indicators. So, we really donít know how sustainable this air travel recovery is.

The jetliner primes say we should ignore US and European numbers and focus on China and the Mideastís strong economies, but those Chinese and Mideast airlines already have large order positions of their own (so, for that matter, do the established LCCs). The lessors arenít looking at China and the Mideast as their core markets. Theyíre betting that the rest of the world economy keeps coming back, despite economic uncertainties. Yet if thereís a double dip recession, traffic will drop again. And then none of these orders will matter at all.

3. Thereís a fundamental imbalance between used and new jet finance. The world is awash in finance for new jets. Finance for old jets? Not so much. I know there are powerful arguments for new jets, particularly in a time of expensive fuel and environmental concerns. But if the wide spread between new and old jet values and lease rates gets even wider, those old jets will get irresistibly cheap, undermining new jet values and demand.

4. The backlog implications. As Airbus execs yammered on about their double-booked supercharged invincible backlog, they announced a large A320 order from Air Lease with deliveries beginning in six months. If the backlog is so strong, where did those production slots come from? Power8 clearly taught Airbus top management the value of being economical, including, possibly, with the truth. After reporting 2.1% margins in the first half of 2010 (despite record production rates), Airbus went on to further raise narrowbody rates to 40 per month in 2012, proving that price discipline is only for capitalists.

5. That whole damn leverage thing. Sure, aircraft are great assets. But weíre still talking about taking on debt to invest in assets on spec, in anticipation of demand that people are convinced will be there. That sounds so 2007. It also sounds like something we all agreed the broader economy should never do again. The Onion said it best in a July 2008 headline, Recession-Plagued Nation Demands New Bubble To Invest In. Does everyone feel 100% comfortable about RBS getting back into the big ordering game? Just 12 months ago, most people thought those Dubai Aerospace Enterprise orders were a sure thing.

6. It quickly got into Cloud Cuckooland. Sure, letís cheer as Steve Udvar-Hazy comes roaring back with Air Lease, and GECAS is always a welcome player in this business. But then it got kind of dumb. Russiaís MS-21 was ordered by Ilyushin Finance, infamous for doing a less than stellar job rescuing its own Il-96. The MS-21 was also ďorderedĒ by Malaysiaís Crecom Burj, which is not only a great name for an intergalactic space pirate but also some kind of very new trading company that has something close to a website ( The website basically covers that theoretical MS-21 order, and not much else. Similarly, Sukhoi touted 30 Superjet orders from Pearl Aircraft Corporation, another highly aspirational lessor whose website makes it look about as tangible as those guys with the Ukrainian KC-X tanker. All of these orders were taken very seriously, a sure sign that people wanted to see big numbers, no matter how silly.

By the way, you can try this at home: isnít taken as a domain name. Grab it, and go sign up for some C919s or A380s or something. Everyone will report this as great news and add the numbers to the orders totals.

Should you worry about a market bust and resultant overcapacity? You canít rule it out. The disconnect between a booming air transport industry and a shaky world economy might not last. Still, Teal isnít forecasting a deliveries downturn, and our new Jetliner market overview (out this month) features healthy long-term growth. Iím just pointing out that thereís risk on the way to even higher record production rates, and that irrational exuberance is not warranted.

Also, the lessors and their backers are bringing cash to this industry. Cash is a good thing, even if there is a danger that it goes towards speculative and leveraged orders. And if a reliance on speculative orders is bad, the alternative, no orders, is much worse. Bombardierís CSeries really could have used some kind of order at this show. Even from space pirates.

In addition to the Jetliner overview, WMCAB July updates include the CSeries, 747, 767, F-4, F-5, Dash 8Q, ERJ 170/190, Do. 228, C-27, BK.117/UH-72/EC 145, EC 120, Hawker 800/4000, Nimrod, UH-1/412, SH/MH-60, and UH-60 reports. Also, we are initiating coverage of COMACís C919. And a happy summer to all.

Yours, ĎTil TealAirLeasing Co. Orders Fokker NGs,
Richard Aboulafia

© Richard Aboulafia 1997-2006, All rights reserved.
  ~  Last updated on January 08, 2006