Blain's Morning Porridge, submitted by Bill Blain of Shard Capital
"If you can walk away from a landing, it’s a good landing. If you can use the plane the next day, its an outstanding landing."
No US China trade deal! Just threats of more tariffs - quelle surprise. After Tesla made a surprise profit and announced cash in the bank, I’m glad I held onto 6 Shares – they are going to make me indescribably wealthy in dotage (dream on...) After not watching the indescribably awful Boris vs Corbyn debate last night (I tried, but it was just too painful), I am wondering why we put our trust in such frankly terrible people? I guess it’s because we share their worst characteristics and aspirations….
I did watch a masterclass on comparative media-handling skills this morning; a very erudite and engaging chap from the SNP sat on the Brek-drek couch, held an open and engaging posture, listened to the presenters, nodding in agreement with them, kept calm, considered and answered conversationally, all the while still giving the same response about it being Scotland’s right to another referendum to every question. He was good. Then some dimwit Tory/Labour spokesperson proceeded to talk down to the presenter, ranted combatively about how Corbyn/Boris said something they didn’t, and treated everyone with disdain. She seemed to think constantly repeating the same stock answer made what she was declaring fact.
This election just ain’t working for me……
So, lets get back to business and talk about finance and markets…
Boeing is having a decent Dubai Airshow this week. They have sold 60 new B-737 Max jets to Kazakhstan and Turkish airlines – despite the Max remaining grounded. Even better, they will sell 40 Dreamliner B-787’s to Emirates, (but lost orders for the delayed B-777x), plus another 3 to Ghana. It’s the first good news for Boeing in a long while – although its clouded by the fact Airbus is outselling them across the board. Both aircraft makers have been offering substantial discounts on new orders.
Sales at an airshow don’t fix Boeing.
Investors in the sector have to be even more careful.
It’s not just the effects of global economic slowing, or the cost implications of cheaper new aircraft pushing down second-hand values. Aviation is no longer a fashionable investment market. Many investors I speak with are particularly concerned about ESG and aviation, but that’s a red herring. They should focus on pricing transparency – more on which below!
But first…. Boeing
When writing about aviation, I have to start with the Jumbo in the Room. I am still trying to figure out how Boeing survives. Despite the likely 40 plane order from Emirates, the Boeing narrative is terrible.
I don’t think I’ve ever looked at a firm where there are so many reasons to sell, so few to buy, but is still a stock so many investors have to hold to “index track”. If any company has ever had an “annus horribilus”, then it’s been 2019 for Boeing. If you fancy a good read then try The Case Against Boeing in the New Yorker.
Boeing was trading at $30 in March 2009, a low after the collapse of Lehman when the Global Financial Crisis meant everything and anything looked appalling. Everyone thought business travel was finished, no one would ever take a holiday again, and global recession was inevitable. How wrong we were… Today, Boeing is trading nearly 1200% higher around $370.
But the firm is mired in crisis. Following a second wholly avoidable crash of the flawed B-737 Max, the stock tumbled – but it’s only 16% from its high of $440. Since the crash Boeing has been hit by a cascading cataclysm of revealing failures. Its corporate culture has been exposed as rotten. I last wrote about Boeing on 22nd October – “Boeing Boing Gone” – outlining a succession of problems of its own making:
- Abysmal management failure; the board paid out billions in dividends, boosted their bonuses and approved some $43 bln of stock buybacks, but decided not to spend cash to develop a new short-haul regional aircraft that could have generated trillions in profits and a long-term sustainable future.
- Internal rot as Boeing morphed from being the premier Tech and Engineering led aviation company with superb designers able to address any aeronautical challenges, into a cash cow for box-ticking cost-accountants led by a C-Suite of greedy senior management.
- There are unaddressed build quality problems across the fleet, parts falling off older 737s, failed “pickle-fork” wing joints that never should have been a problem, and a suspicion there is much more bad news to come re Boeing’s apparent regulatory capture of the FAA which will confirm its pursuit of profit over safety.
- Boeing’s product list comprises the effectively unsellable 737 Max aircraft no passenger will want to fly on, the superb B-787 Dreamliner which (Emirates aside) nobody really needs, and the greatly delayed new B-777x which no one particularly wants. There is literally nothing on its product list anyone really wants to buy.
- In the face of slowing/stopped Dreamliner sales and the dodgy accounting used to smooth-off the B-787 development costs, the 400 odd unpaid for 737 Maxes blocking the parking lots, the $9 bln in compensation claims from airlines, and the still unresolved issue of just how guilty or contributory Boeing has been in terms of dead passenger claims, its difficult to see how Boeing will ever actually make money.
Management failure, internal disunity, a sub-optimal product list, and a looming cash crisis could sound terminal for any business. There are even rumours Boeing’s internal problems are so great and unsolvable it could be split into a new-co selling civilian airliners (with the government stepping in with aid to develop new modern aircraft), and/or a residual company to complete the production backlog, with the Boeing name going to its military business. It would require Chapter 11 protection to unravel and split the company. It could be … very messy.
I could go on, but Boeing’s stock remains high for 2 reasons: First, it’s the largest component of the ridiculous Dow Jones index which means it gets autoloaded into to every index trade. Second, it’s part of a global duopoly which will be impossible to duplicate – only Airbus and Boeing have the logistical capacity to build airliners in the quantities needed. (For the record, its not all rosy at Airbus either. They also have build problems caused by a skills shortage and to many types.)
It’s not just Boeing – it’s about the future of Aviation
Thus far I’ve only written about Boeing’s internal problems. Its failure to deliver on the 737 Max may actually be good news for the Aviation Investment Sector. If Boeing isn’t producing many new planes, then it enhances the value of aircraft already safely in service… you might think.
But Aviation Finance looks likely to face its own challenges.
“Flygskam” is the new mantra – flight shame. Environmental concerns and the concept of zero emissions have gone from a lunatic fringe concern just a few years ago, to top priority today. Excessive flight miles, it’s not OK Boomer, have gone from an extremist position to a central core belief very quickly. Woe betide the celebrity who risks taking a private flight. (You can calculate how much you are destroying the environment and raising sea-levels by checking your flight carbon emissions on the ICAO Carbon Emissions Calculator.)
Standard aviation finance deals are based on a strong flow of rental earnings from airlines leasing aircraft from aircraft leasing companies. The deal principal is either amortised or repaid when the aircraft are sold at the end of the lease. It’s been a great business for investors and leasing companies.
Until recently, no one ever particularly queried the assumptions made about the sale of aircraft at the end of a lease. Everyone assumed the “conservative” valuations used by leasing companies would work. However, smart investors who asked to see records of secondary aircraft sales have got worried about the lack of transparency on price points where sales have occurred. I’ve raised the lack of transparency on pricing many times at aviation finance conferences, and have been confidentially told I’ve
pissed off upset some of the Irish Aviation Mafia experts who still control swathes of aviation finance.
Over the last few years future valuations have become an issue – particularly after the A380 Superjumbo programme was abandoned by Airbus. Most of these aircraft were leased for 10-years in the expectation there would be strong secondary demand for the planes when the original aircraft leases end. Not so. No airline found a way to work the Superjumbos effectively – although investors got regular coupon income, their principal is at risk when they discover the expected resale prices become a scrap valuation.
The problem with the aviation finance business is uncertainty on what valuations will be at the end of a lease in 5-10 years time. It’s never been a transparent market. I’ve been speaking with my chums at Ishka Global who’ve introduced a new Transactions Economics Platform to analyze aircraft valuations. It is well worth a look.
Their data shows the spreads between the highest and lowest valuations on 10-year old aircraft can vary by over 50% - even for the most “liquid” aircraft types. That makes for tremendous pricing volatility. Their data platform gives market views on values backed up by real transaction info. Its absolutely critical information for analysing potential deals.
If you’d like an intro to Iskha, more than happy to set it up – if you call them direct, mention the Porridge! Any investor thinking about the aviation market should at least try it out. (And they are offering a free trial for Porridge Readers!)
Perhaps an issue of even more concern is the how slow the market for second-hand distressed asset aircraft is at the moment. Recently, we’ve seen a large number of airlines go bust – Berlin, Monarch, Jet, Thomas Cook, and these gave us insights on how quickly aircraft would go back into service with new airlines. Jet Airways went bust in March 2019 – of its 78 B-737 aircraft, only half have found new homes in India – suggesting there had been over-supply in the market! 9 of the remaining aircraft are still unplaced, despite the apparent shortage of planes caused by the B-737 Max grounding. Jet’s widebody B-777s and A-330s are still sitting on the tarmac unloved by other users. It’s a warning that investment is all about choosing the right aircraft type to invest in.
Don’t misunderstand this Morning’s Porridge – I’m not bearish on Aviation assets. I’m saying it’s a complex market where the credit worthiness of airlines is critical in what looks to be a bear growth scenario.
As an asset secured market, its critical to understand the deals and valuations – and test them. They will tell you aircraft will get placed, but at what price and under what terms remains a key question based on useful lives, residual values and depreciation rates, plus a host of other reasons.
As for Boeing, that’s another issue. With China unlikely to buy any Boeing planes anytime soon, and the possibility Airbus decides its worth risking Donald Trump’s ire to develop and launch a new regional passenger jet, it could yet shock us!
All that said, if you get a chance to finance the new Emirates Dreamliners lift that offer faster than a £50 from the pavement.