Dublin 17 Aviation Finance Festival: Lessors react to Middle East risk
Ishka summarises some of the recent highlights from Ishka’s 2017 Dublin Aviation Finance Festival, held at the Clontarf castle in Dublin.
Lessors react to turmoil in the Middle East
The Gulf was discussed widely at Ishka’s 2017 Dublin Aviation Finance Festival held last week. Lessors were surprisingly sanguine about Qatar’s prospects as its current diplomatic crisis with its neighbours, Saudi Arabia, the UAE, Bahrain and Egypt continues. A few participants expressed the view that the crisis had no immediate end in sight but were relaxed about Qatar Airline’s continued support from its government.
“There is no way they will let it fail,” confided one lessor. But others questioned that if the carrier’s revenues declined sharply how long the state would be happy to prop up a carrier, and gloomily wondered what might happen to Qatar’s multiple widebody orders if the carrier faced continued pressure. Qatar has publicly stated it continues to keep to its original delivery schedule.
Lessors also discussed the risk of slowing passenger traffic in the Middle East with one participant pointing out that nearly 40 lessors lease to the big three Middle Eastern carriers. But the overwhelming sense in the room was a steady confidence in the strength of the carriers to withstand disappointing traffic growth.
Another issue, touched on briefly, was whether lessors were willing to fund Iran Air ‘s aircraft orders from Airbus and Boeing, given the potential threat of sanctions being re-imposed by the US under Trump’s administration. The short answer is that without further assurances most lessors were still reluctant to agree leases in Iran. Even with clawback provisions agreed in any sale/leasebacks lessors are wary of the risk of repossessing aircraft if leases were suddenly terminated because of a sharp reversal in US policy.
The Ishka View
As Ishka has previously argued, (See Insight: What’s next for Qatar Airways?) the main reason that lessors are relaxed has a lot to do with Qatar’s robust balance sheet. The carrier currently has around $6 billion in cash assets and a healthy debt to equity ratio of 0.34:1. The carrier’s strong financials and the continued implicit support of the state means that many lessors are watching but not worried, yet about the airline.
Ishka estimates that if the current crisis continues for more than six months then lessors will begin to question Qatar’s fleet plans more closely. Ishka is watching Castelake’s latest ABS offering currently in the market. Qatar is the biggest lessee in the deal accounting for 19% of the ABS by value.
Iran, on the other hand remains a tantalising prospect for many lessors but the political risk surrounding any leasing deal has paralysed any number of potential deals from many European or US lessors. Iran Air may need to rely on Chinese lessors to agree to the deal, but will be hoping that export credit agencies will resurface.
The limited success of long haul low cost
One area under discussion at the conference was the rise of the long-haul low-cost (LHLC) carriers. (See Ishka insight: Can the low-cost long-haul model be profitable?)
Norwegian Air Shuttle (Norwegian) has been successful in raising the profile of the business model but many LCLH carriers, including Norwegian, have had mixed financial results. Several airlines, including Air Asia, are tweaking their model and network to still find an optimum mix. The general consensus in the conference is that LHLC represents the long-term future of the industry but these carriers still face significant hurdles to make the business model work.
One challenge is that these airlines cannot simply replicate the short-haul model. Longer routes mean fewer flights per day which significantly raises costs and lowers ancillary revenues. Another hurdle is that the lack of availability of secondary airports. Many of these airlines are facing slot restrictions against larger legacy carriers. And last but not least, these carriers need to ensure a constant demand for these routes, the so-called need for feed, in order to ensure they can iron out seasonal fluctuation in the leisure market. Ultimately the question that has dogged many of these airlines is that if LCLH carriers chase the lucrative business segment with premium economy offering, do they undercut their own model?
The Ishka View
LCLH may represent the future but the question is over what time frame? In the long-term Ishka predicts that the creation of secondary airports and more point to point flights will eventually transform the low-cost sector. In the immediate and short-term however, the LCLH model is still evolving and many carriers are still effectively experimenting with different routes and different aircraft types to make it work. The interesting question is how the new range and capability of new technology narrowbodies may help spur the development of the market. Legacy airlines have launched low-cost subsidiaries deliberately in some cases to frustrate the growth of this market.
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