Is the passenger-freighter conversion market overheating?

Going into 2021, we are asking ourselves a number of key questions in relation to the passenger-freighter conversion market, namely: Has the underlying demand for narrowbody and medium freighters been permanently brought forward by a surge in express and e-commerce demand in 2020? Will underlying market demand for freighters fall off a cliff in a year or two as we come out of the pandemic and more passenger capacity returns to the market? Is there too much supply chasing too little demand? Are leasing companies and other aircraft owners overeager, with regard to the 737-800 and 767, without the underlying medium market demand to support it? Who is most at risk of getting burned? Airlines, lessors or conversion houses? 2020 Review

Last year was one of milestones for the passenger-freighter conversion business, both in the narrowbody and medium widebody space, including: The first EFW A321P2F redelivery; The first Pemco 737-700FC; The first flight Precision A321P2F; and The first IAI 737-800BSF redelivery to DHL operated by iAero. At least five new lessors entered the 737-800 conversion market with fourteen announced orders. This includes Aero Capital Solutions with four; Aircraft Finance Germany with two; BlackRock with four; BoComm with two; and GA Telesis with two. Further orders placed by other lessors have not yet been announced. Amazon purchased its first aircraft for conversion instead of leasing, seven Delta 767-300s and four West Jet aircraft. Two new lessors entered the A330-300 conversion market: Stratos with one unit, and CDB with two. In addition, 2020 saw the redelivery of about forty-six to forty-eight narrowbody conversions and about seventeen medium widebody conversions. That is roughly in line with the annual figure foreseen in our 2020-2039 Freighter Forecast , published in May 2020, and which forecasted an average of forty-eight narrowbodies per year and about fifteen medium widebodies. Freighter retirements, on the other hand, have been below average since at least 2017, since the demand for freighters has remained high. Last year only seventeen jet freighter aircraft were permanently withdrawn from service and thirty-four were withdrawn the previous year. This is much lower than the average of about eighty-five per year during the last fifteen years. By contrast, our twenty-year forecast estimates approximately fifty-six retirements per year for the first five years of the forecast.

Last year again also saw the reactivation of a number of parked units. Overall, the narrowbody freighter fleet increased by 5%, the medium widebody fleet by 4%, and the large widebody fleet by 3%. Growth has been primarily driven by a mix of 737 classics, 757s, and 737-800s, 767s, new 777 deliveries, and a mix of reactivations.

Outlook for 2021

Judging by recent announced and unannounced order activity and slot availability, we expect to see continued above-average narrowbody and medium widebody passenger-freighter conversion activity in 2021 and 2022. At this stage, approximately sixty narrowbody freighter conversions and thirty medium widebody conversions appear likely for 2021, and the same is expected for 2022. Most narrowbody conversions in 2021 will focus on the 737-800, and most medium widebody conversions will center around the 767-300. Part of that is driven by supply, as in the case of the A321, and part is driven by demand, as in the case of the A330. For the 737 NG and 767 conversion programs, slots are tight despite extra line capacity added in 2020.

The Max reentry will support lower feedstock prices for the 737-800. Deliveries of the A321 are being held back by supply constraints and the fact that STC approval dates continue moving to the right for those programs. As such, we don't expect more than a handful of A321 redeliveries this year. The 737 classics and 757 remain attractive because of low on-ramp costs compared to NG options, but viable feedstock is coming to an end. We expect a couple more years of life out of those programs. Jet Freighter Conversion Programs Status, Jan 2021

The 767 continues to power along on the medium widebody side, and conversion capacity from both Boeing and IAI will support additional redeliveries to DHL, ATSG, SF and Amazon, as well as to some smaller customers. ATSG is committed to twenty additional conversions over the next eighteen months. DHL has committed to seven conversions by end of 2021; there will be at least forty-six new 767s for FedEx during the next three and a half years, and UPS and SF are also adding capacity. Amazon will account for fifteen to twenty additions during the next couple of years. We feel that A330P2F orders and redeliveries will continue to be sluggish for the next couple of years since most of the main customers remain committed to the 767, and feedstock prices are attractive relative to the A330-200 and A330-300. The table below provides an overview of the differences.

Too hot or not?

While there is a lot of interest from both leasing companies and operators in freighter conversions, the actual customer base is well-defined, consisting of express companies (DHL, FedEx, UPS, SF Express, China Postal Airlines), Amazon, contract operators to express and e-commerce companies, and a handful of smaller express companies. While there are some general cargo operators with narrowbodies and medium widebodies, they do not drive large-scale aircraft demand in this segment. The large widebody segment is more diverse, but until the 777-300ERSF hits the market after 2022, there are no conversion options available, unless one takes into account IAI's 747-400 conversion program, which has not redelivered any aircraft for several years.

While FedEx is bringing more 737-800s into its European network via ASL and West Atlantic, DHL has been placing additional 737-800s across its network in the Americas, Africa and Asia through an array of subcontractors. This trend is likely to continue, and will provide new opportunities for leasing companies and conversion houses.

With Amazon's purchase of 11 767-300s, the opportunities in the leasing market for this type are changing but, given that the express business has been operating at higher volume levels since the onset of the pandemic, the demand base for medium widebodies has changed.

However, we do see a risk that demand will soften overall after 2022 as belly capacity normalizes. There is also the danger that some of the uptick in business-to-consumer traffic disappears as physical retail picks up at least some of its lost ground. The kind of growth rates seen in the U.S. domestic express market, where we expect air express volumes to grow by more than 9% in 2020, and the Chinese domestic market, where SF saw an increase of shipment volumes by 70%, are not sustainable in the medium term.

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