E-commerce explosion and fleet replacement underpin growth in demand for both new and converted freighters
The improvement in the world market for freight, reflected in improved rates and load factors and in part stimulated by an explosion in e-commerce, have helped support values of dedicated freight aircraft and of those aircraft suitable for conversion. Freight aviation consultant and investment advisor Stephen Fortune, Principal of Fortune Aviation, who has over 30 years experience buying, selling, leasing and converting freighters, told Aviation Finance in an interview that he sees a bright future ahead.

'I think we're in a better position than we've been in a long time,' said Stephen Fortune. 'The January numbers were better than normal and the remainder of the year looks positive. I think it's an incredibly exciting time in air cargo, creating additional demand for freighters. There's a number of new things going on and the industry is in better shape than it has been in quite a long time, certainly since before the global recession.'
Stephen Fortune


Although airfreight typically follows changes in world GDP fairly closely, Fortune said, 'There's a new paradigm now. B2B e-commerce has just exploded and is continuing to explode and Amazon's aggressive moves to get into the actual carriage of their own goods is a significant step. Alibaba has not directly done that yet but that certainly remains a possibility.'

Amazon’s decision to contract for the operation of 40 aircraft, all 767 conversions, took the market by surprise. The 767 conversion market was pretty much dying,' Fortune said. “Amazon’s move soaked up the available 767 feedstock and they are expected to add additional capacity. And Amazon’s move was not at the expense of the integrators who have not experienced a loss of business and remain bullish about demand. In short, the growth in e-commerce has generated demand for additional freighters that no-one expected, even two years ago. But it's a reality.'

Fortune identifies two other significant trends in the airfreight industry. 'The first is the significant volume of replacement in the narrowbody freighter market. Over the past few years, with no narrowbody freighter production and the existing freighter fleet getting older, there's been a significant number of aircraft being converted to replace those older aircraft. While the narrowbody freighter market is growing, it’s only doing so very slowly. But the demand for replacement is significant and that's likely to continue.'

The second major trend that Fortune identifies is on the widebody side. Major operators have traditionally bought already converted aircraft or aircraft to convert. But now the big international carriers, such as FedEx, DHL TNT, Atlas and UPS, are exclusively buying new equipment.

'That's a major shift which really took off when FedEx ordered 767-300ERFs from Boeing and followed it with a 777F order. In addition, UPS placed an order for 14 747-8Fs and is quite likely to take additional aircraft. So this shift to new production widebody freighters is significant. When you look at the 747-400 fleet for example, there has not been a single freighter conversion since 2012.'

The need for additional conversions, however, to replace ageing aircraft retiring from the world freight fleet is having a positive impact on the residual values of aircraft that are suitable feedstock, such as the 737-400. ‘Feedstock has been diminishing rapidly and its now at a point where there are not many good 737-400 candidates for conversion left,' Fortune noted. 'So although there hasn't been an increase in values, it has certainly stopped what would have been a normal decline in values due to ageing.'
“Amazon’s move soaked up the available 767 feedstock and they are expected to add additional capacity. And Amazon’s move was not at the expense of the integrators who have not experienced a loss of business and remain bullish about demand. In short, the growth in e-commerce has generated demand for additional freighters that no-one expected, even two years ago. But it's a reality.'

The same is true for the 767. 'American had a number of leased 767s and returned quite a few of them last year,' Fortune said. 'They would likely have sat in the desert for quite some time and the lessors would have had to take an impairment. But then along comes Amazon, which certainly helped stabilize 767 residual values.'

Investors considering a widebody for acquisition, conversion and lease need to carefully evaluate the asset and the market. 'Widebody conversions are always more difficult from a clean sheet investor point of view,' Fortune observed. It's a large investment at the top of the equipment pyramid in terms of the small number of potential customers. If you have a default or unexpected return, your placement options are limited. In general, a widebody investment is a high risk opportunity that is not commensurate with the likely return. If you're an operator and have a specific use for the airplane that's one thing, but to do it on spec and try to find a customer - that's difficult.

'On the narrowbody side, you're taking a much smaller financial risk, there's more players in the market and more opportunities to place the aircraft. There's also more product and more investors out there looking for opportunities. There's a lot of niches in the freighter world and those will continue to thrive. Anyone interested in investing in the used freighter space would be better served on the narrowbody side, but should be cognizant of the risks and rewards.’

Despite the improved market conditions, interest in freight aircraft remains limited to niche investors who understand the market, Fortune confirmed. ‘Presenting investors with an opportunity to invest in a freighter aircraft conversion for lease to less than stellar credits usually produces a unfavorable response. You're recommending they put money into an airplane that will have a hole cut in the side and a conversion that takes three or four months, during which time they will be required to write big cheques without receiving any income. And only after all that, will you begin to receive rental income that hopefully will be sufficient to cover the investment and achieve an acceptable return.

'It's a much higher risk type of investment than lessors typically want to entertain. So the pool of investors who are willing to look at it is much smaller than for passenger airplanes. There's a lot of money in the market, but the money for doing this kind of investment is much more difficult to find.' That said, there are some specialist lessors that are interested. 'VX Capital, I think, has done a very good job of acquiring, converting and leasing 737s and there are several others, Aerolease for instance,' Fortune noted.

One of the things Fortune watches is the number of 747 freighters on the ground. 'At the height of the recession there were 70 plus sitting idle - an amount of capacity that is just staggering,' he said. 'The problem with the 747 is that the longer it sits on the ground, the more expensive it is to put it back into the air.
‘Feedstock has been diminishing rapidly and its now at a point where there are not many good 737-400 candidates for conversion left. So although there hasn't been an increase in values, it has certainly stopped what would have been a normal decline in values due to ageing.'

'But in the last couple of years there's been quite a few that have come out. The current number still parked is between 35 and 40. But at the same time the number of 747 freighters that have been permanently retired has reached 138, indicating that the market has cleared excess capacity and is poised to grow.'

Fortune is also impressed with the turnaround for the 747-8F. 'The 747-8F is the queen of the skies in terms of freighters with the largest capacity other than the Russian outsize cargo airplanes. The 747-8F in general suffered from a lack of orders, with only seven orders in the beginning of 2016. Boeing wanted to keep the 747 line active in anticipation of the next Air Force One, which is not expected until the early ‘20s, and there was a real question about whether it would be able to keep production going until then. Today the picture looks completely different with a backlog of 20 units for delivery through 2020.

'As I mentioned, the number of aircraft being returned to service has increased, however, what remains in the desert is a geriatric fleet. As the active 747-400 freighter fleet continues to age, prospects for the 747-8F should further improve around 2020 or 2021. Although the 777 is an excellent freighter, there are things that a 747 can do that a 777 cannot, particularly as it is a noseloader and has outsize cargo capability.'

Related News
BOC acquires two 747-8Fs for AirBridge
BOC Aviation has purchased two Boeing 747-8 freighter aircraft. Both aircraft have been committed on long-term leases to a new customer, AirBridgeCargo. Russia's largest freight airline, AirBridge scheduled cargo services connect the largest trade hubs in Europe, Asia and the US using a fleet of 16 modern Boeing 747 aircraft, including nine 747-8Fs.

Commenting on the transaction Steven Townend, Chief Commercial Officer (Europe, Americas and Africa) at BOC Aviation, said: 'The Boeing 747-8F is a technologically advanced aircraft and is one of the most capable long-haul freighter aircraft. This transaction further diversifies our portfolio as we continue to grow our fleet through accretive investment.' At end December 2016 BOC owned two freighters and managed four, out of a total fleet of 246 owned aircraft and 38 managed.