Taking stock of the industry; Scope issues aviation ratings methodology

Eleanor Steed
By Eleanor Steed May 16, 2018 10:32

Taking stock of the industry; Scope issues aviation ratings methodology

At this time, there are newly-delivered or produced 787, 737NG, A320Neo and 737Max aircraft on the ground due to a litany of problems, especially with their engines. Both Airbus and Boeing ramps are filling up like huge aircraft storage facilities because it is cheaper for them to delay delivery than it is to deliver to their customers and suffer more significant reparations. In some cases, it is being reported that Boeing is providing airlines awaiting 787 deliveries 777 aircraft to use as an interim measure, which speaks volumes of the current situation facing manufacturers. By the time this mess is all sorted out, the engine manufacturers in particular would have lost a fortune with some whittling down their margins to dangerous levels at this time due to the poor timing of these current problems with their products.

Oil is on the rise; up to $77 a barrel at one point this week. However, futures options remain static at around $67 and until those futures options start to move we should not be overly worried for the future of airlines. Recent history has shown us that the oil price dynamic is checked by US shale production; as soon as global prices hit $68 the US frackers can up production. This is an impressive fact given that only four years ago we were saying the same thing here if prices reached $82, in five more years US frackers could turn a profit at sub-$50 a barrel. This at a time when the world’s reliance on oil is reaching a turning point – with increased electric car sales in the major markets of the world expected to continue to rise, which could lead to more refineries turning over use to JET-A as they seek to find stable growing markets.

Although oil is creeping-up the near term, factors in play point to mid-to-long term reductions in fuel costs on top of the savings made by new aircraft technology entering fleets. Many airlines remain a good long-term investment. We should however be very worried for some airlines where aircraft have had to be grounded, particular attention should be paid to the margins of Virgin Atlantic and Norwegian Air Shuttle ASA (Norwegian). Virgin Atlantic has suffered engine removal on its 787s and has had to burn additional fuel on its core Atlantic routes due to ETOPS requirements on those reduced range 787s, as reported here previously. Norwegian on the other hand has never made a profit, even though load factors have been very high. The problems it has had with its 787s have put the airline close to the ropes and any significant move in oil futures will leave Norwegian in serious difficulties. It is those factors, more than anything else, which have brought the attentions of Willie Walsh’s IAG, which sees an opportunity to acquire aircraft and reduce competition in one low-cost swoop. The caveat though is that this would only make sense for IAG shareholders if Norwegian initially acquired its 787 fleet at a hugely-reduced cost. IATA will most likely downgrade its earnings forecasts for airlines in no small part due to problems with new equipment.

All of this once again means that lessors are having to extend lease agreements left right and centre and as airlines are in a bind the agreements are being extended at the same or better rates than the original agreement, more often than not. It is a good time to be a lessor. Then there is GECAS; will 2018 be the year that the most interesting of all lessor consolidation deals since ILFC/AerCap goes through? It is looking likely and who knows maybe once again it will be a nimble shark taking on a leasing whale.

Meanwhile, Scope Ratings is seeking to expand its coverage of the aviation sector, pitching the company as a new perspective to the other rating agencies, which are all based in the USA.

“Due to the international nature of the industry we believe that more than one perspective is needed. Scope is the leading European rating agency and offer a perspective that is different and can help investors further understand the underlying risks of their aviation investments.”

The company issued its dedicated aviation finance methodology on Friday, May 11.

Scope has rated several aviation transactions, some public (like Investec’s debt fund PR Aircraft https://scoperatings.com/#search/research/detail/155781EN ) and others private.

Scope states that the methodology differs from the other rating agencies’ methodologies, with a high focus on the aircraft in question using a bottom up approach. “This means that the underlying aircraft are properly credited and build the foundation of the rating outcome, contrary to looking at the operator and notching up or down depending on the aircraft type as a second step,” says Scope.

Transparency is also important to Scope, the published methodology explains step by step explain exactly how it analyses aviation transactions, not leaving investors, arrangers or other market players with “vague statements or a black box”.

“This mean that the industry can feel comfortable that we understand the dynamic of the industry and that we are giving proper focus to industry specific and transaction specific risks. We have designed the methodology with transparency in mind, with extensive explanations of how we view different risk factors.”

The methodology is out for comments until June 11 (click here to access the methodology). Scope is also holding a brief online web-presentation to introduce the methodology on 23 May.

Eleanor Steed
By Eleanor Steed May 16, 2018 10:32