Date: Thursday, September 14th, 2023
Source: Freight Waves
WASHINGTON — Aerospace companies that specialize in converting passenger planes to freighters are expected to crank out a record number of units this year, but deteriorating international freight and e-commerce volumes have chilled orders for new and aftermarket aircraft.
Although more cargo aircraft are being produced than currently needed, airlines and lessors are mostly sticking with aircraft commitments to take advantage of forecast growth in e-commerce and international trade, and to modernize their fleets.
Warnings about a looming glut of narrowbody cargo jets serving short- and medium-haul express routes are tempered by the fact that, while some conversions have been postponed, few have been canceled so far.
There are 270 factory-built cargo aircraft on back order, according to London-based aviation analytics and appraisal firm IBA. Data provided by U.S. consultancy AeroDynamic Advisory shows more than double that number (600) of passenger planes in queue for retrofits.
Meanwhile, aftermarket airframers are adding more production lines around the world by partnering with repair and overhaul shops that tear down the passenger compartment and install features such as a wide cargo door, heavy-duty floor beams and a container loading system. Boeing this year announced plans to establish conversion centers in the Middle East and India.
The lag in time from when airlines place orders in response to demand and manufacturers’ ability to fulfill them is impacting the supply balance. Analysts say freighter deliveries typically peak two to four years after strong demand growth, which means conversion activity could stay strong through 2024.
Overhaul specialists completed about 130 freighter conversions last year, up from the previous record of 116 in 2021, according to various industry databases. During the 30 years prior to the COVID crisis, by comparison, cargo changeovers of used passenger jets averaged 60 to 70 per year.
At the same time, IBA estimates deliveries of new factory freighters will increase to 52 units next year from 35 in 2023.
“The assumption is there is massive overcapacity in the freighter market, but it’s more nuanced,” said Tom Crabtree, managing director at consultancy Trade and Transport and former chief editor of Boeing’s biennial World Cargo Forecast, on the Aug. 24 edition of the “Time on Wing” podcast.
“What’s not widely appreciated in the air cargo sector is that e-commerce has a lot of runway for growth ahead of it in the developing world. And that is a segment of the market that is often served by medium widebody freighters or narrowbody freighters,” he said.
Air transport market hits bottom
Airfreight demand has dropped 8% to 10% since the spring of 2022 due to a slowing global economy, inflation, high retail inventories and the end of ocean shipping backlogs. Meanwhile, available shipping space on aircraft is about 10% higher than a year ago and 4% more than before the COVID crisis. Growth in cargo capacity associated with the comeback of international passenger flights, combined with weak demand, has led to a 45% fall in freight rates and similar declines in airlines’ cargo revenue. With less stuff to haul, flight activity for dedicated cargo aircraft is down 4.5% on average over the past 12 months, according to BMO Capital Markets.
The reduction in operating efficiency is compounded by the presence of more freighters. Cirium data shows there are nearly 2,200 dedicated cargo jets in service now, 5.6% higher than at the end of 2022 as the number of new entrants outpaces retirements.
The air cargo sector is likely to stay near the bottom of the freight cycle for another year, but Boeing projects robust demand for dedicated cargo jets will continue due to e-commerce growth and changing supply chain networks.
Boeing’s commercial market outlook, released in June, shows the global freighter fleet growing by 65% to more than 3,700 in 2042. The increase will require more than 2,825 production and converted freighter deliveries, including about 1,300 standard-body conversions, such as the 737-800, and 555 widebody conversions. The number of deliveries inched up from 2,795 in Boeing’s previous cargo forecast in November.
The fleet outlook is partly based on a projection that world trade will more than double over the next 20 years. Boeing also revised its annual growth rate for cargo traffic to 4.5% from 4.1% because the 2022 decline lowered the forecast’s baseline.
Most concerns about freighter oversupply focus on standard-size jets like the 737-800 and the Airbus A321. The number of conversions for small, standard-size jets exploded during the past three years to unprecedented levels.
Many planes are going to startup airlines or freighter operations born out of the high demand for freighter capacity during the pandemic, when e-commerce sales shot through the roof and passenger belly capacity evaporated. Brazil-based Gol, for example, launched a 737-800 freighter division last year to fly packages for an e-commerce retailer. Pure leasing companies made more speculative investments in conversions than usual when airlines were bleeding money and eager to reduce their fleets.
In April of 2020 there were 12 737-800 converted freighter operators with a total fleet of 30 aircraft. Three years later, the number of operators had more than quadrupled to 51 with 147 converted planes added to the global fleet, according to research by freighter consultant Stephen Fortune.
And more companies have moved into that space since the spring. Mexico-based startup Awesome Cargo, for example, plans to add two 737-800 by the end of the year, according to trade publication and consulting firm Cargo Facts.
Retrofit shops are busy working through existing order books, but the soft market is taking a toll on new orders for aircraft conversions. Aftermarket programs received 251 orders last year, but activity began to decelerate in the second half, Cargo Facts reported.
“Demand for 737-800 conversions has slowed to a trickle and is mainly coming from operators. Lessors continue to have a difficult time placing converted -800s, which is causing them to pause their programs until the market returns. To complicate matters the [narrowbody] engine market is red hot. Prices have gone up 30% from a year ago, which makes finding a freighter engine almost impossible,” said Robert Convey, senior vice president for sales and marketing at Aeronautical Engineers Inc. (AEI), an independent firm that offers aftermarket conversion kits.
AEI only booked a handful of orders in the first half of 2023 compared to more than 30 last year. “Customers are either trying to cancel or at least push out the start date in hopes the market will return,” Convey told FreightWaves.
Orders for factory freighters have also dried up. Boeing recorded 43 net orders in 2022 (minus two cancellations from bankrupt Western Global Airlines) versus six 777s so far this year, according to the company’s online database.
So far more conversion commitments have been deferred than canceled. The only publicly announced cancellation has been from all-cargo operator Cargojet, which is in the process of selling three used Boeing 777-300 passenger jets, originally purchased for conversion, to maintain financial flexibility and align fleet size with demand. A planned fourth aircraft was never purchased.
The airline is holding on to reservations for production slots at Israel Aerospace Industries so it can quickly resume expansion plans if demand improves. Executives said they are still proceeding with U.S. startup Mammoth Freighters for four Boeing 777-200 passenger-to-freighter conversions.
FreightWaves also reported that Vietnam Airlines quietly pulled out of a deal with Air Transport Services Group for two A321 converted freighters. ATSG’s management said on a recent earnings call that the company is purchasing two fewer A321s than anticipated.
An April report by Fortune, whose long background in aircraft acquisition and management includes stints at FedEx and the former Gemini Air Cargo, showed that lessors had placed less than half of their 737-800 and A321 conversion orders for 2023 with customers, leaving 49 aircraft without a home.
It can take four to eight months to reconfigure an aircraft for cargo, depending on size and the number of available repair bays for particular aircraft types. And conversion shops are having difficulty completing jobs because of supply chain backlogs, personnel shortages and slow regulatory approval of new modification designs, which actually works in favor of buyers that don’t need aircraft right away.
AerSale, an aftermarket aircraft services company, in June downgraded its full-year outlook for passenger-to-freighter (P2F) conversions to three sales and three leases, compared to its prior forecast of six sales because of the soft cargo market.
“Cargo operators currently suffering from reduced demand and an associated lack of liquidity has tempered the sale of our P2F converted 757s and will likely result in a heavier mix of leases versus sales in the near term,” said CEO Nicolas Finazzo on the company’s Aug. 8 earnings call.
The 757 is a large narrowbody plane admired for hitting the economic sweet spot in terms of capacity, efficiency, ease of loading and reliability. It is nearing the end of its conversion life because there are few qualified passenger aircraft left.
Mike Stengel, principal at AeroDynamic Advisory, projected the number of conversions will top out at 136 this year before starting to decline in 2025 and 2026 — but still above pre-COVID levels. Activity will be bolstered by the addition of more production lines, especially in the widebody segment, as two overhaul specialists, including Mammoth, launch first-ever programs for turning large 777 jets into freighters, he said.
IBA recently estimated that up to 60 737-800 converted freighters could be produced this year, up from 56 in 2022, creating a risk for a large oversupply if the trend continues. The forecast doesn’t extend beyond this year.
Fortune has warned of a short-term glut in standard freighters since early 2022.
There are seven 737-800 freighters available for lease or purchase on MyAirTrade.com, which suggests the planes aren’t being placed as quickly as they once were.
IBA’s analysis notably shows that the 737-800 has been converted at a faster rate than other cargo retrofit programs. The global fleet of 737-800 converted freighters has rapidly grown to 200 aircraft since the first modification by Boeing six years ago — about 50 of them by AEI. By contrast, it took the 757 and 767-300 conversion programs 15 years to reach the same size. The 737-400 took 20 years to reach 200 units.
The total 737-800 fleet is on track to surpass the 757-200 freighter fleet of 311 aircraft.
Meanwhile, IBA projects Airbus will deliver 20 A321 passenger-to-freighter aircraft this year. The A321 conversion program is trying to catch up with the 737-800, which had a three-year head start and the advantage of Boeing’s extensive cargo history compared to the new focus at Airbus. A positive factor is a large potential feedstock of relatively late-model A321s for cargo as passenger airlines seek out more efficient A321neos.
A drop in lease rates, especially for older variants, illustrates the caution being exhibited by cargo operators.
A321 leases have fallen below $200,000 per month this year after a couple of years well above that market, but aircraft with only about 15 years of age can command tens of thousands of dollars more, depending on the perceived risk of the operator and country location, IBA said. Monthly lease rates for the 737-800 have contracted to about $160,000.
The situation is different in the widebody freighter sector, where Crabtree said there is under capacity because some combination carriers pulled back from investment more than a decade ago when the air cargo market stagnated for several years.
767-300 conversions continue to lead in the widebody category, but the pipeline of available passenger jets is getting thinner. That is why Air Transport Services Group, which operates two cargo airlines and passenger charters in addition to being a major lessor, has branched out to acquire and convert the Airbus A330. Airbus resuscitated its A330 modification program about three years ago and ATSG reserved 29 production slots. The first plane is scheduled to begin remodeling in October.
IBA estimates 18 to 20 A330s will eventually be converted per year between Airbus affiliate EFW and Israel Aerospace Industries, overtaking the 767s. Lease rates have ticked up to about $450,000 as the programs gain traction, especially for younger A330-300s with extra volume suited for express parcel business. A 767-300 lease costs between $220,000 and $300,000, with the higher range reserved for aircraft under 20 years of age.
No replacement aircraft are available until Airbus and Boeing start delivering the large A350 and 777-8F, respectively, in 2026 and 2027. Boeing must stop production of the legacy 767 and 777 freighters at the end of 2027 to comply with international noise and emissions standards, although executives have said they will appeal to the U.N.’s civil aviation administration for an exemption.
But Kristian Lindberg, head of finance at aviation investment firm Stratos, during a June webinar hosted by Cirium’s consulting arm, suggested that even widebody freighters might not make the best short-term investment because the rental spread versus a passenger jet has narrowed by more than two-thirds to a mere $100,000, notwithstanding the $20 million, or more, cost to convert a large plane for cargo.
Challenges sourcing aircraft
By the time cargo demand improves again, conversions could be constrained by limited feedstock related to the gyrating passenger sector.
Passenger airlines are coveting standard-size aircraft, such as the 737-800 and Airbus A320/321, because manufacturers Boeing and Airbus have severe production issues that are slowing delivery of aircraft the carriers want to grow their fleets during a travel boom.
Boeing, for example, recently discovered a supplier defect on bulkheads that will potentially delay delivery of hundreds of top-selling 737 MAX jets. It’s the latest in a series of quality flaws Boeing has disclosed on the MAX and other programs as it gears up production capacity. And current delays follow three years when more than 2,500 aircraft were not delivered because of COVID and MAX safety problems.
High passenger demand is leading airlines to extend leases, or enter into new lease deals, for several years, reducing the available supply of used jets for conversion and driving up aircraft values on the secondary market. That helps lessors because aircraft that otherwise might have been removed from service, or seen diminished value, are more marketable. At the same time lease rates for freighters are coming down. Aviation experts say it makes more financial sense for leasing companies to rent their planes in the passenger market because they can make more money without incurring the cost to convert an aircraft.
“Lessors may now opt for a cabin refresh and put the plane back in service for another six or seven years with a second-tier operator, or it may even be a first-tier operator,” said Crabtree. “Why cut a cargo door if you can repeddle the asset for another five to eight years?”
Some lessors may be better off canceling cargo overhauls until production issues are resolved, Lindberg concurred.
“It’s potentially not worth converting the 737-800 and incurring the additional cost — $5 million to $6 million for conversion — because the passenger demand is so strong that lease rates have been coming up more than $10,000 in the past year,” he said.
The strongest tailwind for long-term air cargo growth is e-commerce, which has more than doubled its share of retail sales over the past seven years and is projected to account for a fifth of total sales by the end of this year, according to eMarketer. By 2026, e-commerce, which heavily relies on air express delivery networks to fulfill orders, is estimated to grow to 23% of all retail sales.
Growth of online sales is decelerating from its peak of 17% early in the pandemic to 8.2% in 2026, eMarketer predicts. But that is three times global GDP growth and twice the expected growth rate for general air cargo.
Over the next two decades, express fleets are expected to grow 58%, according to Boeing.
Manufacturers and lessors say online shopping has fundamentally improved growth prospects for air cargo, with much of the demand coming from new express networks in Southeast Asia, Latin America and other developing economies. The e-commerce share of total retail sales is less than 4% in India and 5% in Brazil – both massive markets. Airbus, for example, projects air volumes for the express sector will grow 4.9% annually, significantly higher than its projection for general air cargo.
“Those [parcel carriers] need a certain amount of critical mass — routes and aircraft into the hubs to support these overnight or second-day air networks. So the emergence of e-commerce in these economies is a structural driver of demand, not just a cyclical one,” said Darren Hulst, Boeing’s vice president of marketing for commercial airplanes, on a recent episode of the “Time on Wing” podcast.
Executives at ATSG, which operates two cargo airlines in addition to being a major lessor, are steadfast in believing that rapid fulfillment of e-commerce purchases via air express networks will persist for the long term and drive demand for converted freighters.
Michael Steen, the chief executive of all-cargo operator Atlas Air, said e-commerce will continue to turbocharge interest in freighter aircraft because online sellers need to quickly adjust their distribution activity in response to customer preferences.
“The supply chain is changing to cater more to the end consumer, which means that it’s very hard to predict where you keep your inventories, and how much, depending on what the purchase cycles look like. New companies are popping up in fast fashion that are not selling through stores,” he said in an onstage interview Tuesday at the U.S. Chamber of Commerce’s Global Aerospace Summit here. “And the majority of that is airfreight based, even for low cost products. That is a significant change from what we have seen in the past.”
Meanwhile, many companies are geographically diversifying their supply chains to increase resiliency after the pandemic upended economic activity and shipping capacity, resulting in factory stoppages and retail shelves that were out of stock. It’s unclear how new sourcing and logistics requirements will play out. Some believe they increase the need for air cargo, especially at the start while businesses are still establishing their full complement of new suppliers, warehouses and surface transportation networks. Others say pressure to decouple from global trade, nearshoring and rising geopolitical tensions pose a risk for air cargo growth.
Even if the cargo market doesn’t grow, aging fleets need to be replaced. Airlines pulled freighters out of long-term storage and delayed retiring other planes to meet soaring demand during the pandemic, with many aircraft flying 20% to 30% more hours than normal per day. Only 15 planes per year were retired during the three years of the pandemic compared to a normal average of about 70, according to Cirium.
Last year, 38 cargo jets were retired compared to 131 at the peak in 2010, IBA said.
With the market back to equilibrium, carriers are beginning to sideline older, expensive-to-operate cargo jets, especially as they come up against major maintenance checks.
Steen said there are about 650 widebody freighters currently in service and 125 of them are older than 30 years. Many more are nearing retirement age, while more than 700 older technology standard aircraft with an average age of 30 years are still in service, Cirium recently reported.
UPS, for example, has begun phasing out 41 legacy MD-11 freighters that will be replaced by 28 new Boeing 767-300s. FedEx Express retired 18 aircraft in the just-completed fiscal year: 12 MD-11s, four Boeing 757-200s and two Airbus A300-600s.
“I think that we will see a faster decline in supply than we will see an ability to replace that capacity” in the widebody segment, Steen said.
Changes in belly capacity
Structural changes in the passenger market, beyond the short-term dynamics, could also increase interest in freighters. Market share for single-aisle aircraft, which provide less room for cargo, has increased with the growth of low-cost and ultra-low cost passenger carriers. In the past 20 years, the narrowbody fleet has increased from 9,000 to 16,200 aircraft, more than a third of which are operated by low-cost carriers. Boeing’s forecast anticipates the low-cost share rising to 41% of the single-aisle fleet by 2041.
As aircraft become more fuel efficient and smaller aircraft can fly longer distances, airlines are beginning to fill some trans-Atlantic and other international routes with extended-range planes such as the 737 MAX and Airbus A321LR instead of widebody aircraft.
Dedicated freighters and passenger aircraft carried an even split of cargo prior to the pandemic, but the balance now tilts 60% toward cargo aircraft because they offer guaranteed capacity for logistics and airfreight companies that want greater control over shipments without being constrained by passenger requirements.
Less than 50% of the available belly capacity worldwide is actually used for freight because many new routes go to leisure destinations instead of industrial centers and more deployment of capable narrowbody aircraft, Steen noted.
“So, I think we’re looking at the scenario where we will see demand coming back and supplies [of aircraft] can be challenged,” he said.