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Aviation cyclicality

Aviation cyclicality

Issues to be addressed

We will attempt to answer two questions in this research paper:

  1. Whilst widely recognised that the aviation industry in general is a cyclical industry, how cyclical is aircraft leasing?
  2. Given the rapid ageing of people across the OECD, how big is the likely impact on the aviation industry and more specifically on aircraft leasing?

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Cyclicality in the aviation industry

As far as the first point is concerned, few would disagree that the aviation industry in general is cyclical. This perception is probably due to the fact that many people consider the aviation industry as identical to the airline industry – an industry (or sub-industry as we shall call it in the following) which is admittedly very cyclical. However, in reality, the aviation industry consists of many different sub-industries, some of which are far more cyclical than others (chart 1).

Chart 1: ROIC of various aviation businesses and ROIC volatility
Chart 1: ROIC of various aviation businesses and ROIC volatility
*CRS = Computer Reservation Systems
Source: Investec, IATA

Aircraft leasing is the second most profitable aviation sub-industry when measured on ROIC (the most profitable being computer reservation systems) and is characterised by substantially less earnings volatility than the most volatile sub-industries in the aviation industry (being catering and airlines – see chart 1 again).

Overall, air travel is very much a function of economic growth (chart 2). Various industry insiders provide estimates on income elasticity, which fall between 1.3x and 2.0x. In other words, provided global GDP increases by 1%, air travel should increase by 1.3-2.0%. Air travel has doubled every 15-20 years over the past many decades and is expected to continue to do so - at least globally, even if local factors may cause significant variations in growth.

Chart 2: Global real GDP (LHS) vs RPK traffic growth (RHS)
Chart 2: Global real GDP (LHS) vs RPK traffic growth (RHS)
Source: Investec, HIS Global Insight, ICAO, Airbus

We also note that, despite the obvious cyclicality, air travel has only fallen in 3 years out of the last 42 (since the first oil crisis in 1973) – in 1991, 2001 and 2009. We have profit data on the last two downturns and note that, whereas the airline industry turned unprofitable in both of those instances, aircraft lessors did not (chart 3).

A closer look at chart 3 will reveal some limited, but delayed, cyclicality in the aircraft leasing industry. Whereas overall economic growth turned negative in 2001 and 2008 respectively, aircraft lessors weren’t negatively impacted until 1-2 years later, which is not surprising given the nature of the leasing business (i.e. long lead times).

Chart 3: Profit margins in the aviation industry
Chart 3: Profit margins in the aviation industry
Source: Investec, Boeing

We would actually go as far as to suggest that there is also an element of counter-cyclicality involved. In both of the economic downturns mentioned above, aircraft lessors’ profit margins increased at first, while airlines’ profits decreased. The counter-cyclicality is, in our opinion, to a large degree linked to the capital constraints that often arise in economic downturns, providing lessors with a strong bargaining position when negotiating contracts.

One final note on the industry’s cyclicality: Despite falling profit margins in both the 2001 and the 2008 recession, profit margins in the aircraft leasing industry rarely slipped much below 15%, supporting our view that the aircraft leasing industry is much less cyclical than the airline industry.

Mitigating Factors

The consistent growth in overall air travel (chart 4) obviously reduces the effect of cyclicality. Emerging markets in particular are widely expected to undergo significant growth with Asia expected to benefit the most. Even Europe, despite the demographic headwinds, is likely to see some growth in air travel. This is largely due to projected per capita wealth improvements and planned infrastructure enhancements.

Chart 4: Aviation market growth rates – 2013 to 2033
Chart 4: Aviation market growth rates – 2013 to 2033
Source: Boeing

Another factor, which will help reduce the cyclicality of the aircraft leasing industry, is the strong growth in leased vs. bought aircraft. 35 years ago less than 1% of all commercial aircraft were leased. Today the number is over 36%, and the trend is expected to continue (chart 5).

Chart 5: Growth in aircraft operating leasing
Chart 5: Growth in aircraft operating leasing
Source: Investec, Ascend

This trend is driven by the airlines who seek to better manage their balance sheets and who wish to introduce more flexibility as to how their fleet is managed.

Having said that, the contractual payment nature of the leasing industry is a significant factor in reducing the volatility of lessors’ profitability compared to the airline industry. The leasing industry is less exposed to changes in traffic volumes, as that risk is borne by the lessee (i.e. the airline). If the capital provided by lessors is more stable and the operating lease structure provides revenue protection to the lessor, then that should make the lessor less sensitive to economic cycles.

The last mitigating factor we will mention in this context is not one that the entire industry will benefit from but one investors in regional aircraft lessors should profit from.

As per (at least) one definition, a regional aircraft is defined as an aircraft with less than 149 passenger seats. In other words, it is the segment of the market dealing in the smallest jets and turboprops. For whatever reason it is considered by many to be the least ‘sexy’ segment, and the dynamics of the regional market are therefore not well recognised by many.

In reality, operating as a lessor in the market for regional aircraft has proven less cyclical than other and bigger types of aircraft. This is due to the fact that airlines typically downsize when the economy turns negative. If a route was previously served by a Boeing 737 or an Airbus 320, the airline may decide to substitute that aircraft with a smaller Bombardier, thus maintaining profitability of the route, at least until air traffic recovers.

It is conceivable that the overall profitability of leasing regional aircraft, when times are gung-ho, may not be quite as strong as it is likely to be for lessors of narrow-body and wide-body jets (but we have no proof of this), even if it is still an attractive business proposition. However, when times turn more difficult, lessors of regional aircraft have, as already mentioned, a significant advantage.

In summary, and in response to the first question raised, we think there is ample evidence to suggest that aircraft leasing in general, and regional aircraft leasing in particular, is a business likely to suffer from only modest cyclicality.

As already mentioned, the 2008 recession was the most severe since the 1930s. In the UK, total passenger numbers dropped by approx. 13% with charter airlines seeing the biggest impact (down 17%). If the leasing industry could generate a profit in those unforgiving circumstances, it doesn’t seem unreasonable to expect it to be profitable in most conditions.

The impact on air travel from changing demographics

Moving on to the second question, research and anecdotal evidence suggests that air travel increases with income and socioeconomic group. In a UK survey conducted in 2014, 71% of all respondents in a managerial or professional occupation made at least one flight in the previous 12 months compared with 50% of those in intermediate or routine jobs and 36% in manual occupations.

Likewise, circumstantial evidence from emerging economies suggests that people in those countries do more air travel as living standards improve. It is therefore fair to assume that, for many years to come, the aviation industry will see strongly rising demand from emerging markets in general and from Asia in particular.

Air travel by age group is less well documented; however, people of working age appear to be flying more than those older and younger (chart 6). The frequency of flying is greatest among the 25-34 and 55-64 year olds, with slightly less flying by the age groups in between. This tendency is more marked for leisure flying, where the 55-64 and 25-34 year olds fly substantially more than the 35-44 and 45-54 year olds (chart not shown here).

Chart 6: Frequency of flying by age group
Chart 6: Frequency of flying by age group
Source: Intergenerational Foundation

The most likely reason for this trend is that people do the most air travel for leisure in early adulthood, before they have children, and later after the children have left home. On the other hand, the 35-44 and 45-54 olds do the most business air travel.

In order to assess the effect of ageing on air travel, let’s look at a research paper produced by the European Commission (chart 7). The authors of the paper estimate that over time, on an accumulated basis, GDP growth in the EU will be more negatively affected by ageing than it is likely to be in the U.S. or Japan. The U.S. benefit from better demographics and much of the damage in Japan has already happened.

GDP growth across the EU is estimated to be 18% lower by 2040 than it would have been, had the age profile remained unchanged, or approx 0.43% per annum. Given the income elasticity referred to earlier, one would expect annual air travel to fall no more than 1%, which is obviously not the best of news but nowhere near recession-like conditions. The corresponding numbers for GDP growth in the U.S. and Japan are -0.21% and -0.49% respectively.

Chart 7: Impact of ageing on GDP
Chart 7: Impact of ageing on GDP
Source: The economic consequences of ageing populations, K. McCorrow and W. Roeger, The European Commission

In reality, ageing will impact air travel in two ways - partly because older people travel less than younger people do, and partly because ageing causes a slowdown in GDP growth, and air travel falls when GDP growth does. In other words, ageing is likely to have both a direct and an indirect effect on air travel.


We raised question 2 above not because we think ageing will be the only factor affecting air travel in the years to come but because, at least in the OECD area, demographics are going to change so dramatically that they are likely to affect air travel meaningfully. In reality, there are (and we know) plenty of cyclical factors affecting air travel.

In terms of overall cyclicality, we take great comfort from the fact that the aircraft leasing industry managed to negotiate itself through extraordinarily difficult conditions in 2008-09 without losing a penny and, if that was possible, we don’t think a ‘normal’ cyclical downturn is going to cause the industry too much of a headache.

On top of that if history repeats itself a temporary slowdown in GDP growth could, and should, lead to a material increase in demand for regional aircraft, as airlines downsize. Having said that, statistically, recessions occur only every seven years or so and last for about a year on average. Over a ten year period, a cyclical downturn is therefore likely to only have a modest impact on overall business conditions.

In terms of ageing, as observed earlier in this paper, the negative impact on GDP in Europe from ageing may result in a 1% reduction in annual air travel across the European continent. If you add to that the direct effect on air travel from older people travelling less, it is conceivable that the aviation industry in a small number of countries may face a material challenge and even (mild) recession-like conditions, but it will almost certainly be in a very small number of countries - those with the worst demographics.

Overall, on a global basis, ageing is not likely to materially and negatively affect air travel, and we don’t think ageing is the key risk to the aviation industry. We would consider other – and more traditional - cyclical factors a higher risk, at least in the short to medium term, but what makes demographics unusual is the fact that they are likely to affect air travel for at least the next 25-30 years.

Niels C. Jensen

4 June 2015

About the Author

Niels Clemen Jensen founded Absolute Return Partners in 2002 and is Chief Investment Officer. He has over 30 years of investment banking and investment management experience and is author of The Absolute Return Letter.

In 2018, Harriman House published The End of Indexing, Niels' first book.