So, farewell the mammoth A380. None of us can be terrifically surprised that Airbus has decided to bite the bullet and abandon additional new production of these jumbo planes. The unwritten assumption has always been that this ambitious programme would wind down, fulfill existing orders and then call it a day. Evidence for this has been the anguished discussions about residual values for the planes in circulation – and especially those owned by a clutch of London listed funds targeted at wealth advisers. One element of the debate around final residual values has been the almost explicit assumption that some planes coming to the end of their contracts would be used as parts to keep the existing fleet going. By contrast, the debate amongst airlines looks to be largely over – they’ve voted as a majority against the planes. If you’re looking for any evidence of this look at the decision by Air France to reduce its fleet from 10 to 5, with running costs being cited as the main contributory factor. The airline is expected to return the five aircraft when leases run out in 2019 and 2020.
That leaves us with the tricky decision about how to value the A380s currently sitting on the balance sheet of my favored way of playing this niche – Amadeo Air Four Plus, ticker AA4 currently trading at 97.5p. I mentioned this fund only this weekend in the FT although I also pointed out the very obvious risk about valuation points on A380s. Clearly, my timing could have been better!
Nevertheless, I’m not inclined to cry wolf just yet, especially now that the yield is up at around 8.8%. The first observation is that the A380s only represent a (large) part of a diversified portfolio at AA$– currently 8 A380s and 6 other planes. Next up, this vehicle has a long runway (excuse the pun) with leases expiring between September 2026 and Jan 2030. So, that’s a fair old chunk of cash flow from leases still to come. There’s also the announcement by Emirates that this “wonderful” aircraft will “remain a pillar of our fleet into the 2030s”. Emirates currently operates 109 A380 aircraft and will have received 123 deliveries when production ceases, compared to their original orders totaling 178 aircraft (162 firm and 16 options). This reminds us that there may be a vibrant afterlife market for this plane for the coming decades, which might support valuations.
In a sense, there are two parallel debates going on here. The first is what use the planes might have. There is obviously a use of older planes as spares but that probably doesn’t apply to the younger and mid-life planes. They need a live customer and although Emirates and a few other airlines are obviously still committed, it’s clear to see that anyone buying a second-hand plane anew will have the whip hand in negotiations.
Then there’s an interrelated debate about how this impacts on resale values. This is more abstract because we don’t really have many valuation hooks to frame the debate – there haven’t been many transactions. Clearly there will be a massive reduction in the value of the planes (there’s always depreciation) but the debate will be about how big a haircut to take. The tone from two analysts covering the funds (Liberum and Numis) has been notably cautious but Matt Hose at Jefferies I think deserves listening to in more detail as he’s done as deep a dive as is possible into valuations. Like me, he thinks the AA4 vehicle is probably the best bet – partly because of the mixed portfolio planes and those long leases.
According to Matt “even at a 50% haircut, entailing receiving approximately 25% of purchase costs for the A380, there are still some nominally attractive returns on offer. This is particularly so for AA4, given that its double-digit IRR is supported by its A350 and 777 exposure, which hasn’t been haircut. Regarding AA4, we also note that haircutting the A380 assumed residual values by 50% still leaves enough net proceeds to comfortably fund the balloon/bullet payments on the debt…..assuming a zero residual value for the A380s would still result in a positive IRR, given the long ‘runway’ of dividend payments in the interim.”
If we’re all honest, there’s still a huge element of uncertainty about how to value these planes and thus the AA4 portfolio. We’re all a bit in the dark here and no-one can really assert any high probabilities to any scenario but I would suggest that AA4 probably represents one of the best ways of investing in this space – and with its share price much lower might even represent better value than before. Arguably another way of looking at this debate is to watch carefully if any of the institutions and wealth managers who have held shares in AA4 start to sell. If these key clients lose confidence, then the share price could slide sharply – but at this stage, I haven’t seen any signs of that happening. Most managers I’ve talked to who own the fund don’t think anything materially surprising has occurred and are sitting tight. All eyes will be on the first set of transactions in the secondary market.