04/08/2016

CALC bets big on the ARJ21

CALC bets big on the ARJ21

The announcement at Farnborough that Chinese lessor, China Aircraft Leasing Group (CALC), placed a firm order for 30 ARJ21 regional jets with options for a further 30, seems unorthodox for a lessor whose fleet is mainly composed of Western narrowbody aircraft, although they do also hold orders for COMACs larger C919 narrowbody aircraft.  CALC has announced clear plans that its parent company Friedmann Pacific Asset Management (FPAM) will place these ARJ21 aircraft with an undisclosed Indonesian carrier in which it also plans to invest.

The Ishka view is that there is some logic behind the order, but a concern is that the Indonesian market has shown signs of overcapacity. Similarly COMAC has struggled with the ARJ21 certification and production. Delivery of the first batch of aircraft is scheduled to take place in the next two years, with the remainder following in the next five years, but after all the delays that have besieged the ARJ21 programme to date, Ishka’s assessment is that the timely entry in service of these aircraft remains uncertain.

CALC’s history

CALC is one of the largest independent aircraft operating lessors in China. It has to date placed aircraft with carriers in Southeast Asia, India and Turkey.  The company is also involved in ‘full-life aircraft solutions’ and it plans to operate the largest part-out facility in China. The company has progressively increased its portfolio of aircraft since inception in 2006 with a current fleet of nearly 70 aircraft. It placed an order for 100 Airbus A320 family aircraft in November 2014 and plans to have a fleet of 172 aircraft by 2022, excluding the recent ARJ21 order. 

At the end of 2015 there were 54 A320 aircraft in the fleet, five Boeing 737s and four A330s. CALC expects to end 2016 with a fleet of 80 aircraft.

Funding of the fleet expansion

The group’s fleet has grown six fold since 2011. CALC has funded this expansion mainly with debt. A detailed breakdown of these liabilities shows that the largest item is bank loans, 86% of the total. 

CALC’s total liabilities increased by 31.5% during 2015.  The lessor has a total bank debt of HKD18.7 billion ($2.4 billion) of which HKD2 billion ($257.7 million) corresponds to pre-delivery payments made to Airbus as part of the order placed in 2014. In 2015 the lessor also issued convertible bonds and medium-term notes. 

The group has made full use of capital leverage to sustain the rate of aircraft deliveries. The gearing ratio of the company is 86.7%. This ratio has remained high but the group is bullish that it has the right approach to funding, to support its business and maximise shareholder value; as part of this policy the group actively wants to pursue alternative funding sources including equity funding.

 

CALC in the Chinese market

CALC remains focused on the Chinese market. Its long-term plan is to build a balanced portfolio of Chinese and non-Chinese airline customers. The Chinese economy has slowed in recent years but air travel demand has remained relatively strong. Both Boeing and Airbus have increased their forecast for deliveries to China in the next 20 years. It has been argued that the transition to a service based economy has kept traffic healthy. Domestic consumption has also remained strong and this has translated into robust demand for air traffic. There is concern over excess capacity but CALC is confident in the prospects of the Chinese market and that its current backlog of narrowbody aircraft should be absorbed easily by the country’s carriers. To illustrate this point the lessor took delivery of four extra aircraft in 2015 to keep pace with demand from the market.

CALC’s two core strategies are to provide more aircraft full-life solutions and to achieve globalisation. This is likely to be one of the driving factors behind the decision to place the order for the ARJ21 as it  helps the group diversify outside of the Chinese market.

Chinese leasing interest in the ARJ21

Both CALC and AVIC were keen to announce orders for the ARJ21 during the Farnborough show. It is not uncommon for Chinese companies to cooperate with other Chinese enterprises and support the development of indigenous products. This tripartite deal with COMAC and FPAM is part of China’s effort to foster the nation’s aerospace industry. CALC is also a customer of the C919 aircraft.  In a wider sense the ARJ21 order has been treated as part of the central government’s Belt and Road Initiative which aims to enlarge China’s role in global affairs, and stimulate China's exports in areas of overproduction. This deal has also benefited from China’s policy of export financial support.  After securing favourable financing terms from other Chinese institutions the group has been able to acquire these aviation assets at a relatively low cost according to CALC’s deputy CEO and chief commercial officer, Winnie Liu.

The Indonesian market and the ARJ21

Indonesia is home to the largest airline conglomerate in Southeast Asia, the Lion Air Group with a current fleet of 252 aircraft of which almost half are allocated to the Indonesian market. The country is also one of the main markets for Southeast’s Asia second largest airline, AirAsia. Both carriers have significant aircraft order backlogs but in recent years have slowed the pace of deliveries with announced deferrals and swapped orders. Garuda Indonesia is the third largest carrier in Southeast Asia with a current fleet of 185 aircraft. Not surprisingly some commentators have suggested that the Indonesian market is showing signs of overcapacity. CALC has stated that the ARJ21 is the ideal aircraft for the operations planned by Friedmann Pacific’s airline in Indonesia.  Friedmann has chosen Indonesia, an island country, as the first overseas market to operate a pure fleet  of ARJ21 aircraft. Turboprops are extensively used in Asia-Pacific for interisland operations. It is still too early to say if such a jet design is suited for this type of missions; the ARJ21 programme has accumulated delays of more than 10 years. The aircraft has received its type certificate but is still to achieve production certification which means that COMAC’s initial target of delivering 30 aircraft to CALC in the coming years seems more than ambitious..

CALC and the ARJ21 fleet

The order demonstrates CALCs confidence in exposing itself to a potentially risky asset. If the 30 aircraft from CALC’S firm order are delivered according to schedule then around 15% of CALC fleet will be formed by the ARJ21.  If the lessor decides to firm its options the ARJ21 would account for almost 26% of CALC’s portfolio, all else being equal. If the Friedmann Pacific’s venture in Indonesia is unsuccessful the lessor faces the real risk of having to place a relatively unknown asset with another airline, which could prove difficult, although there is likely to be some form of backup support from the OEM.  CALC is highly leveraged. The lessor could be faced with financial difficulties if the Indonesian enterprise fails to deliver, subject to the terms of the deal struck with COMAC.

 

The Ishka view
CALC’s portfolio has grown significantly and the group has been successful in funding this growth and in delivering profits. This is likely to also be the case in the coming years as the lessor plans to gain share in markets outside of China for future growth.  This will help the company diversify its risk profile.  The addition of the ARJ21 fleet poses more serious questions for CALC due to the uncertainty over the ARJ21 in terms of future deliveries, operational and residual value performance. Incumbents in the Indonesian market have slowed their fleet expansion plans in recent years, consequently it is not yet clear how the ARJ21 fleet can be successfully deployed in this market.  However if the focus is on supporting the domestic inter-island market, the opportunity may lie there. 

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