Aircraft values vs. engine values
When an aircraft is operated, flight hours and flight cycles are consumed against time-limited and cycle-limited components of its engines and airframe. The disparity between appraisals for aircraft of a similar age can often be explained by different maintenance conditions. It is usual to quantify the value of an aircraft’s maintenance status through the analysis of key, high-cost major maintenance events with mandatory intervals. Overhaul, inspection, and restoration events tend to become ever more expensive as the repair needs and work scope increase. The difference between full value and half-time value may represent over 15% for a new aircraft (although a new aircraft always has full potential, making this somewhat theoretical but still meaningful for the purpose of value projections) and will increase significantly with age. In contrast, the economic life of an aircraft engine is only really limited by the market for the airframe types it supports as engines can outlast any given airframe.
As a consequence, aircraft residual values tend to depreciate over time, during which time the engines (if properly maintained) become an increasingly significant part of the overall value of the aircraft (as a complete unit). At any given time, a significant amount of the value of an aircraft engine lies in its condition and maintenance status, and in the records that evidence such status. Accordingly, the service life and therefore the value of an engine can be restored through the installation of new life limited parts (LLPs). Indeed, following a full refurbishment, the value of an aircraft engine can exceed the value of the same engine on delivery owing to the inflation in the value of the parts installed.
Of course, there will be a tipping point in an engine’s economic life (usually once retirements of the aircraft type that it supports have commenced) at which it is no longer sensible to restore the engines, and of course, older engines cost more to maintain than newer ones; as they age, they require a disproportionate amount of material, parts experience higher deterioration, and shop visits increase due to build standard objectives.
Technical life of an aircraft asset: Maintenance value vs. market value
Aircraft have a limited economic life. As the direct operating costs equal or exceed the revenue an aircraft can generate, the aircraft will become economically obsolete and will therefore be scrapped (although components and parts may be used as spares). In some cases, aircraft are scrapped earlier, mainly because the parts are in high demand as spares – although, as we have seen recently, that will in part be a function of the availability of sufficient aircraft in the market. For a young aircraft, it is reasonable to assume that maintenance value equals maintenance cost. However, as an aircraft ages, and an aircraft type matures, the market may become awash with second-hand spare parts, and engines with remaining “green time.”
A tell-tale sign is when the half-time current market value for an aircraft falls below 50% of the total maintenance cost for a full overhaul and engine shop visit. It is then a reasonable assumption that the maintenance cost no longer equates to the maintenance value. An important part of the value of an aircraft is therefore determined by reference to its remaining maintenance status. Maintenance status itself is directly linked to maintenance value and, depending on the age of the aircraft, can account for a significant portion of the aircraft’s market value. However, the impact of maintenance status is rarely predictable: in much the same way as aircraft values, maintenance status values are highly influenced by the prevailing market conditions.
Commercial airlines have learned how to cope with an unprecedented drop in passenger demand during times of recession, after the September 11 attacks, and as a consequence of the global pandemic. Now they are grappling with the opposite challenge: not enough aircraft to support the growing travel demand. Even if the deliveries of new aircraft exceed expectations over the next couple of years, fewer deliveries during the pandemic and teething issues associated with next-generation engines will likely leave airlines without enough aircraft. Although the leading manufacturers are attempting to ramp up aircraft production, supply chain and quality challenges are interfering with their efforts as a result of which, airlines have been forced to cancel flights, and passengers and freight have all been disrupted.
To narrow the supply–demand gap, many airlines are currently delaying aircraft retirements as a stopgap measure, and this action is driving increased demand for maintenance, repair, and overhaul (MRO) services. Simultaneously, the reduction in retirements is limiting feedstock for used serviceable materials (USM), a traditional lever used to mitigate MRO costs for older fleets, increasing both the cost for airlines and the prices for brokers and sellers of these parts. As a result, aircraft lessors are benefiting from lease extensions that command higher lease rates, with utilization and reserves (supplemental/maintenance rent) also being carefully priced owing to the significant increases in material and labor costs. Notably, wet lease operators have experienced rapid growth over the last few years as a result of the post-pandemic recovery. They are now looking at 20-year-old aircraft as viable – another driver of demand in the engine market. However, mid-life lessors do not typically want to carry out an overhaul and be left with a zero-time engine with a large book value and the price point of that engine has gone up (although lease rates have risen somewhat to help offset it).
Taking all of these factors together, today’s low retirement rates are having a ripple effect through the value chain.
Maintenance values and engine investments
Maintenance value declines with time on-wing. However, depending on the nature of the maintenance event, the value may neither fully amortize to zero, nor fully recapitalize to 100% of its market value. In general, maintenance events that are subject to a hard-time interval (e.g., airframe heavy checks and landing gear overhauls) see their corresponding values decline to zero and are subsequently recapitalized to their full value after each check. On the other hand, on-condition and condition-monitored maintenance events, such as engine shop visits, rarely see their maintenance value fully exhausted.
Since the value of an engine in the later stages of its economic life is strongly correlated to the operational green time remaining, the maintenance status of engines has a growing impact on value. During the final phase of its economic life, when an engine shop visit is required, the engine owner must make a decision to either invest in an engine shop visit or disassemble the engine and sell the parts. Further, cash-constrained operators may view the cost associated with an optimized work scope as being prohibitive, and instead will opt to minimize their liabilities by scaling down the engine’s build standard, which translates into a lower maintenance value. MROs and other engine shops often now seek to combine similarly aged modules to “create” a single engine.
When an engine does require repair and overhaul, the primary objective of the work scope is to restore its performance and build it to a standard that minimizes the long-term direct maintenance costs. This process, however, can be quite challenging given parts and modules have different rates of deterioration. Most repair shops assess the life remaining on LLPs when an engine is inducted for maintenance and manage time-limited components to coincide with subsequent shop visits. Ideally, the repair shop ensures that LLP stub-lives closely match the expected time on-wing. So, for example, if an engine’s LLP stub-life is 10,000 flight cycles, then the repair center will ensure that the engine has sufficient EGT margin to stay on-wing for 10,000 cycles (otherwise known as the “engine build standard”).
As a result of these factors, investing in aircraft engines (whether as an owner/lessor, a secured lender, or another investor) requires periodic monitoring of maintenance-adjusted values. Understanding changes in those values requires a good technical knowledge of aircraft engine conditions and an ability to review records and modification status. Technology enables lessors, lenders and operators to track this information almost in real time, so as to be able to develop fleet plan strategies for engine swaps that maximize the life of each engine.
Impact of the supply chain backlog
With aerospace supply chains finely balanced, even minor disruptions can escalate into major logistical challenges. However, Airbus and Boeing are struggling to meet demand within the scheduled timeframes; lead times to procure items such as metals can be as much as five times longer than pre-2020 owing to reduced production, a loss of skilled personnel and labor issues, as well as reduced supply sources caused by the war in Ukraine. Prices for some aircraft parts have surged, and some metals are difficult and expensive to source due to the increased demand from other sectors, most notably defense. And, of course, the airlines themselves often delayed maintenance during the travel slump, whether for reasons of cost or because it was simply impossible.
The current record-level order backlog results from strong aircraft demand, compounded by ongoing supply chain challenges. Post-pandemic travel demand has rebounded globally, prompting airlines to order new, more efficient aircraft to expand operations and reduce operating costs. Cargo operators are also facing potential delays, introducing additional uncertainty in an already pressured global logistics system. These limitations have forced cargo operators to reconfigure routing and adjust freight schedules. As a result, freight forwarders have less space and higher costs. For businesses in sectors like electronics, perishable goods and pharmaceuticals, these delays can cause massive dislocation, supply failures, and price rises.
These delays in deliveries may be easing, but it could take up to two years to fully resolve them. As a consequence, aircraft engine shops around the world are overflowing, with a lengthy lead time for any repairs and overhauls of aircraft engines. With an engine overhaul, speed is crucial. The current trend of keeping older aircraft for longer means more routine maintenance and overhaul is required. On top of that, some newer engines are coming into engine shops earlier than expected. Any business has to keep its key revenue-generating assets in play and as a result, the repair and overhaul business has almost doubled in size over the last five years, creating lucrative opportunities for engine manufacturers and smaller shops that provide MRO and service capabilities.
Conclusion
The shortage of engines available looks set to continue. The delays in production, compounded by supply chain disruptions, have prompted operators to explore alternative solutions such as lease extensions, which in turn necessitate maintenance and repair services. However, it remains the case that there is a real scarcity of available engines, and demand for mid-life and older aircraft has skyrocketed in the last 18 months. Some engine lessors are now short on engine inventory, and adding to their portfolios has necessitated older engines with less life remaining. Assets that would have been heading for part-out at the end of a lease are being put back into service, and sourcing green-time engines has become increasingly challenging, exacerbated by instances of recently overhauled engines being sold above the price for equivalent new models. This shortage looks set to persist, compounded by issues with new deliveries. While sending engines for performance restoration or for repair is a partial solution, many engines are now stuck with MROs due to diminished numbers of suitably skilled employees and a lack of available parts (both new and USM).
Those engines that are available are more expensive, a lot of due diligence is required, and they may not be the more fuel-efficient models. Opening more MROs and developing new product lines might be a solution, but finding qualified staff to support them remains a challenge. Fixing the supply chain and reaching previous aircraft production rates would have a material impact, but in the meantime the value in the MRO and parts business, as well as green-time engines, is clear for all to see. Aircraft owners and financiers also stand to benefit as lease contracts are renewed, providing a useful opportunity to stand shoulder to shoulder with the industry as it attempts to address challenges with its supply chains and with the availability of engines. However, the owners and financiers keen to take advantage of this opportunity will be rewarded for their creativity in replenishing the diminished stockpile of engines.
Taking all of these factors into consideration, the current supply chain dislocations and other contributing factors make attracting sources of investment in aircraft engines both a more valuable proposition for the industry and a more attractive proposition for investors than ever before.
