Recent air freighter lease deals for the 737-800 are but the slow beginnings of a market that is set to burgeon rapidly, just as soon as used prices and airframe availability reach their sweet spot.
The times are about to change for air freight operators and freighter lessors alike. Demand for air freight has grown and with it the need for aircraft. In recent years, the majority of narrowbody freighters have been based on the Boeing 737 classic, in particular the 737-400.
But GECAS’s recent announcement that it will lease two 737-800 freighters to Atran Airlines is entirely in keeping with the very beginnings of a new freight era, where traditional conversion feedstock becomes exhausted and industry turns to a new, ready source of material.
The passenger-converted aircraft are scheduled to be phased in during the remainder of 2018 and in the first half of 2019.
They will provide additional capacity to Atran’s existing fleet of three Boeing 737-400 freighters and will increase Altran’s fleet to five.
That source will be the Next Generation 737s, particularly the Dash 800, but Robert T. Convey, senior vice president sales and marketing at California-based Aeronautical Engineers, Inc (AEI), says the market’s not yet quite ready to be taken by storm.
“Two things are holding the NGs back. Used prices are still quite high and availability is almost as big a problem. Even those willing to pay the $13 to $14 million that an older -800 demands are struggling to find one. As we expected, the passenger airlines are extending the leases they have on 18 to 20-year old aircraft, but we thought they would be extending for a year, or maybe three.
“However, most are extending for five or even seven years. The oldest 737-800s turn 20 years old this year, and these extended leases will take a fair number of them out to 27 years before they become potential feedstock for conversion.”
It could be argued that modifying a younger aircraft might result in a more efficient air freighter and while he doesn’t disagree, Convey says it depends on the business model.
“If you wanted to pay $30 million for an -800 you’d have a really clean, new air freighter, but you might struggle to make money with it.”
It stands to reason that if operators might struggle to find a useful return through a newer -800 conversion, then lessors are unlikely to commission the work.
That leaves the industry with the double problem of diminishing 737-400 stocks, and faced with too high acquisition costs for the oldest -800s, even if suitable prospects can be found.
To make the conversion process really worthwhile, Convey reckons the industry needs to see $8 to $10 million purchase prices, a point still some way off.
At current values, he says adding the cost of conversion to the cost of buying an aircraft results in a $20 million air freighter, which brings particular problems to leasees.
“Even at a simple 1 per cent lease rate factor, lease rates are more than $200,000 per month. When you compare that to the 737-400 air freighters operators are looking to replace, those attract lease rates in the $120,000 to $130,000 per month region. The 737-800 carries one more pallet than the -400 and, put simply, these operators end up paying $80,000 per month for one extra pallet.”
Convey is mindful that while it may not work for most operators for now, there are examples where the extra pallet can attract a premium.
An operator flying ten-pallet 737-400s against a regular package contract for an especially strong or growing route might see that requirement increased to 11 pallets.
Placing two -400s on the route, effectively flying both at close to half capacity, makes no economic sense, but it’s where the 737-800 comes into its own. But for now, most routes require ten pallets and that’s not where the -800 excels.
Convey reckons AEI’s customer base is divided almost perfectly between operators and lessors.
“We supply to the operator; sometimes we supply to the operator’s customer, the integrators, including DHL, FedEx and UPS; we supply to lessors, both general and freight-focused, and we occasionally deliver to financial groups, including hedge funds and equity investors.”
He also explains that AEI, typically for its sector, doesn’t look to acquire assets for conversion, it leaves the lessor to provide feedstock.
“It would mean I started competing with the leasing companies and if they had an alternative, they’d start going to someone else. I’d always have a lower cost, always have the right of refusal on a slot and I’d get my airplanes out first. I’d always win, and the lessors don’t want to be competing with the people providing the service.”
Considering the asset AEI creates, Convey suggests a theoretical 20-year old 737 as an example and he’s confident the modified aircraft would be good for a further 15 to 20 years’ service at least.
Newly converted aircraft typically attract five to seven year leases, meaning an airframe might see out the first portion of its ‘second life’ with two or three leasees before the lessor sells it.
Narrowbody freighters typically find their final work with third level operators, where they gradually fade away – Convey says unlike widebody freighters, they’re seldom if ever parted out or scrapped.
Even more so than an airliner, the freighter is a hardworking machine and regular schedules take a predictable toll in terms of knocks and scrapes.
“They get bumped all the time, the industry sees a lot of that. People drive K-Loaders into them, or a dolly cart is towed under a wing at night and catches a flap, it probably happens more than anybody would like,” Convey explains.
Repairs resulting from operational incidents may come AEI’s way but they’re typically on-demand. Aftersales care is, nonetheless, an important factor in the company’s offering.
“We deliver with a five-year warranty under the purchase price and we offer 24-hour enduring support. But in most cases where a repair is needed they’ll get a local company to do the work and they’ll only need to come to us if it’s our structure that’s damaged.”
AEI’s conversion expertise spans a current product line of Bombardier CRJ200, McDonnell Douglas MD-80 and Boeing 737-300, 400 and 800; in the past it also produced 727-100/200 and 737-200 freighters.
Licensed as a third party supplemental type certificate (STC) provider by Boeing and Bombardier, it has three conversion centres in the US, plus one each in Canada and China.
In terms of experience, the numbers really do speak for themselves: 224 Boeing 727 conversions, AEI has so far added 20 737-200s, 17 737-300s, 110 737-400s, 14 MD-80s and 10 CRJ200s, while its 737-800 package is now available.
Convey says the 737-400 has lately been the ‘darling of the dance’ as far as lessors were concerned.
“We did 25 or so every year for the past five years; in addition to the 110 we’ve delivered, we’ve about another 10 in work. But that’s coming to an end. Our customers are having a hard time finding feedstock, which means the -400 programme is at the end of its life.
“The -800 is of interest, but hard to find, so we anticipate a lull, certainly compared to those 25-per year rates, between the end of one and beginning of the other. Then, looking at the CRJ, that’s still pretty new for us and still picking up interest. We’ve delivered around 10, we’ve got five in work and a bunch of orders we’re closing.
“Meanwhile, two operators still fly the MD-80 freighter, in Alaska and Mexico. They’re keeping the line ‘chugging along’ at one or two airplanes a year. So right now, I don’t have a particular product that’s in favour, but I’m confident the 737-800 will become that, as soon as it’s available and a little cheaper. My crystal ball isn’t that good, but I’m guessing it’ll happen in two or three years. I think I’ve been saying that for the past two or three years.”
In the meantime, the 737-400 remains the dominant narrowbody freighter moving packages for the likes of FedEx and UPS. As their market grows, 11-pallet contracts may appear to play nicely to the 737-800’s strengths.
At the same time, the market could grow with new 10-pallet routes needing more 737-400 freighters, but the model is rapidly becoming scarce as existing aircraft are committed and feedstock runs dry.
Convey believes that as more operators go back to the integrators with rates for flying the 737-800 on their new routes, because no -400s remain available for conversion, the integrators will have no choice but to upscale those routes to suit.
“At that point we’ll start to see more -800 conversions. There was a similar natural migration from the 737-300 to the -400 and now we seldom see -300 conversions because the routes are contracted for 10 rather than nine pallets.”
AEI has founded an exceptional business on narrowbody freighter conversions and Convey is perhaps its greatest proponent, but two major questions remain.
First, why has AEI no options for A320 Family conversions? And second, since there’s money to be made leasing and operating narrowbody freighters, why don’t the OEMs build them on their production lines?
“I don’t see any success for the A320, although I do expect the A321 to find a niche as a Boeing 757 replacement. As an Airbus the A320 is what I’d describe as a light-build, optimised aircraft. It’s a great airliner, but light build isn’t what the freight industry needs. And the A320 doesn’t do well parked in damp, cold environments for any length of time.”
How does a freighter operate? “It flies three, maybe five hours a day, then sits somewhere at the back of the airport where it’s often wet and cold.”
“And utilisation and cost rule out an OEM narrowbody freighter. The freight contracts are usually five days a week, covering two or three sectors over maybe five hours.
“It equates to a maximum of perhaps 1,000 hours per year in multiple cycles over short routes – the rest of the time the aircraft sits on the ground; it’s flying that doesn’t justify a $50 million air freighter – no one could afford it. With a widebody you can achieve high utilisation seven days a week and it pays for itself, but not a narrowbody.”
Looking to the future, Convey makes an interesting observation. “There were a little under 500 737-400s built. If there had been 2,000, I believe the -800 conversion would still be a long way off. Now more than 5,000 737-800s have been delivered. The oldest are just reaching 20 years old and a few are still being built.
“For me that’s a 50-year airplane and 25 years from now, people will still be converting the last examples coming off the line and then they’ll fly for another 20 years. That makes the 737-800 a useful air freighter until at least 2070.”