Investors have been positively surprised by how rapidly the aviation market has recovered from what was “a near death experience” during the pandemic, as Michael Halaby, head of aviation advisory at Japanese bank MUFG, puts it.
Aviation has proved very resilient. The expected airline bankruptcies have largely not happened, for various reasons: government support, cargo operations and the ability of airlines to work constructively with their lessors and lenders, to name just a few.
Amanda McMillan, senior managing director in Macquarie Asset Management’s real assets team, says: “The pandemic put a stop to a lot of transaction processes, with many investors in the sector waiting to see how quickly traffic recovers. These days, investors are looking more closely at business plans, cost of capital and the capital structure of airports – building the impact of possible future pandemics into their stress tests and traffic forecasts.”
Fortunately, however, most operators of larger airports were able to restructure debt and negotiate concession extensions. Danny Elia, executive director at Australia-based IFM Investors, says: “When you consider the total life of an investment like an airport, over the period of time that long-term investors like IFM hold it, healthy returns can be generated, even when taking into account shock events.”
The recovery is now picking up pace as demonstrated by the recent results of airline companies. According to the International Air Transport Association (IATA), collective airline losses were $137.7 billion in 2020, and $42.0 billion in 2021. When results are finalised, the IATA anticipates airline net losses will only reach $6.9 billion for 2022. By contrast, this year airlines are expected to post a small net profit of $4.7 billion.
Despite the recent economic gloom, aviation investors say the industry is on the mend. “The concern that people would be materially less inclined to get on a plane post-pandemic is not something we are seeing,” says Elia. “As China opens up and airlines get more planes in the sky, we are expecting the recovery to continue.”
Many regions are very close to surpassing the 2019 travel levels, says Halaby, but at different rates. “The US has recovered strongly, Europe is recovering at different speeds in different markets, and Asia is coming back online.”
In addition, McMillan says that “air freight was less severely affected and there has been renewed interest in private aviation as frequent business travellers have placed greater value on the reliability and convenience it offers”.
Everywhere, ticket prices are going up as customer demand remains strong and the so-called phenomenon of ‘revenge travel’, a new term that describes making up for lost time and travel experiences, continues to build.
There is no escaping the fact that there are some short-term headwinds for the sector. Halaby worries we will see consumer price resistance eventually kick in, while Stephan Gundermann, head of portfolio management, aviation, at German manager KGAL, says: “Today, there are some obvious threats like high interest rates, fuel price and inflation, which give heavy burdens on the cost side as well as pressure to the demand side.”
Nevertheless, once inflation is tamed, he believes “this should reactivate the aircraft leasing sector to a wider group of investors again, including the more risk-averse groups. Investors can secure operating leases now at terms that provide upside scenarios in the medium term”.
Likewise, Elia believes in the strong fundamentals of airports. “Ultimately, over time, we expect passenger numbers will exceed what they were before the pandemic.” And with public finances constrained, there is “an opportunity to leverage private capital and expertise to help prepare the sector for the future”.
McMillan says: “Private sector involvement, together with well-designed economic regulation, has unlocked new sources of capital – allowing significant investment in upgraded and expanded airport infrastructure to meet growing capacity needs.” In a world where airlines are consolidating volume and being more selective about where they add capacity, she adds that it is likely hub and larger regional airports will attract more attention from investors. Airports will continue to “enhance their capacity and become diversified businesses with sources of income that extend beyond the charges levied on the airlines and passengers that rely on them”.
Everyone agrees on one thing. As Halaby puts it: “The developing markets are the most significant swing factor for future demand of aviation, principally China. We [forecast] enormous growth as it opens up its different regional markets.”
The focus on sustainability, including energy and carbon efficiency, will also be a priority in 2023 and beyond. Elia says: “Decarbonisation and improvements in operational sustainability are a key focus across the sector and present a significant area for potential growth for infrastructure investors.”
There have been major improvements in fuel efficiency, thanks to advances in engine and fuselage design over recent decades, while sustainable aviation fuels (SAF) will also be a key feature to decarbonising the industry.
With the cost of using fossil fuels increasing, and ongoing policy to drive decarbonisation, SAF is likely to become ever more attractive. Elia is “cautiously optimistic about the aviation sector’s transition to a low-carbon economy”. But scaling up SAF will “require a step change in the level of collaboration between airports, airlines, governments and producers”.
SAF is approximately 0.05 percent of the current total market, a long way from the 10 percent set by the World Economic Forum’s Clean Skies for Tomorrow initiative for 2030. “This will require a lot of SAF plants, and feedstock, to come up to speed,” says Halaby.
Fortunately, this is being boosted by the Inflation Reduction Act in the US, which is waving significant carrots for new SAF production, while in Europe there are various sticks being wielded as regulators seek mandatory blends.
McMillan says airports also have a leading role to play. “Alongside commitments to become net zero for emissions under their direct control, they can help facilitate, through investment in new technology and infrastructure, a reduction in the indirect carbon emissions from aircraft and ground transportation. The whole industry is on this journey – both airport operators and airlines.”
Airports are investing heavily to reduce their reliance on diesel ground power units, electrifying vehicle fleets, as well as using their large estates and real estate portfolios to generate renewable power, mostly through solar.
Halaby warns: “If we do not succeed in reducing emissions there is likely to be significant push back from governments and possibly citizens. It is noticeable Schiphol airport is talking about reducing the number of flights, and it seems likely that future expansion, such as the third runway at Heathrow, will be up against significant opposition.”