By William Loh, International Aviation Advisors and

Dr. David Yu, CFA, Senior ISTAT Appraiser, AAVA Group, NYU Shanghai and Stern

Airbus A320neo. Credit: Leeham News.

Oct. 17, 2023, © Leeham News: We have seen over many years that mainstream commercial aircraft are attractive assets to own and lease. They are easily recoverable, and produced by a stable duopoly of manufacturers.  In normal times, aircraft generate fairly predictable US dollar cash flows over their long economic lives. There is no near-term risk of technological obsolescence, especially for the latest generation narrowbody aircraft.

Demand for travel drives demand for aircraft. On average, the aircraft fleet has doubled approximately every 15 years as travel demand has risen by 5% annually.  Passenger growth has grown by 1.6 to two times world GDP growth over the last 30 years, but these relationships have been shaken to the core since 2019.

The airline industry is a derivative of the economic cycle. It is also prone to occasional external shocks as the result of war, terrorism or as we’ve recently seen, disease.  Historically the industry has a proven resilience to these shocks. Over the last 30 years, the industry generally recovered within a relatively short time, with demand reverting to the long-term trend line.

Such stability does not mean that investors should be lulled into a false sense of believing that they understand the details well enough.  This is where the rubber meets the runway and good advice plus prudent models come into play.

In this article, we discuss our Internal Rate of Return/Net Present Value (IRR/NPV) Model and the results of changes in some of the parameters.  The main drivers of the return are normally the equipment cost, the monthly lease rate, and future sale value (FSV) (and year).  Downtime is obviously also important, but we will assume none in this case.  The following is a table of (pre-tax, annual) IRRs based on changes in these parameters, for a 2023 Airbus A320-200neo.  Note that the parameters that have changed from row to row are in bold.

Financial Analysis

We have developed a simulation module as well, and this provides decision-makers with a probability distribution of IRRs, based on the inherently random uncertainty involved.

The simulation varies certain parameters through a User-defined range.  This lets us take advantage of the computing power we all benefit from, and helps investors price deals based on understanding the reality of what might happen over time.

Simulation is the only reasonable way to take into account things like the pandemic/shutdowns, and other market changes or unexpected events that are difficult if not impossible to forecast.  This makes it a powerful tool to use to forecast future values too.

We’ll go into more detail about the models in our next Risk Adjusted Business article.