Clark McGinn – “it’s the Cycle, stupid!”
While the mood of our industry may not be truly optimistic, it’s certainly nowhere near as pessimistic as in the last two years. However, two things worry me.
First, a basic principle: it’s the Cycle, stupid! I know it’s axiomatic for those of us who’ve been around the block a few times, but while this is the worst downturn (by far) since the 1970s, we all joined this industry perfectly aware that it was cyclical, and we should have made our investment decisions accordingly. I was genuinely surprised that a couple of lessor presentations still had very negative views on the number of idle helicopters there would be in 2017. These predictions were certainly too conservative as they missed a couple of unusual aspects in the structure of the helicopter market which mitigate the effect of the cycle.
Uniquely in aviation, the discipline of the helicopter OEMs in terms of new production is a key underpinning of the long-term value of helicopters. Hats off to our manufacturing friends (in alphabetical order) at Airbus, Bell, Leonardo and Sikorsky who once again have responded decisively in the face of short term oversupply by sharply ramping back oil and gas configured (‘OGP’) production to create organic absorption of the idle fleet. It is work in progress, but it is real and positive progress.
Leaving aside the question of the H225 (although we are pleased to have placed one of Waypoint’s new deliveries to support humanitarian missions), the rest of the idle fleet comes from two sources: the total collapse of exploration and development and the retention of older machines which normally would have transitioned into non-OGP markets at this stage in their working lives.
In the crazy days of the boom there were double the number of helicopters assigned to exploration and development compared to the long-term average. That bubble burst quickly leaving many aircraft on the ground. Additionally, during the first H225 grounding (especially in the North Sea) many older machines were taken off the ‘for sale’ docket and dragooned back into service – that was an impressive operating project which showed the resilience and ‘can do’ inherent in our industry, but when the 225 returned to service, then the market was softening and the buyers for those off the run machines were less interested. Then to add to that we had CHC. But remember that CHC’s rejections did not increase the global idle fleet – it only made it more transparent!
Just taking our fleet at Waypoint as a microcosm, we are keeping to the classic business model. Our focus in OGP was in the relative stability of the production sector, rather than the shorter termed exploration and development contracts. While we are helping our operators upgrade their core production fleet of liquid modern types we are also supporting their mid-life assets while remarketing older or less popular aircraft into smaller markets and/or utility or specialist roles. This return to trend has begun the rebalancing transition that in time will also see this idle pool re-missioned or in the case of the very old machines, retired at the end of a traditionally long working life.
This will pick up momentum through the first stage of the growth cycle: already we can see the statistics; new reserve discoveries were lower in 2016 than in any year since 1953 as swinging cuts to capex find their natural outcome. The incredible success in supply chain cost control makes selective projects an interesting and economic route to start to counter the depletion of proven reserves. This trend will turn when we see the classic next phase of the oil cycle as the strongest companies looking to refill reserves – in a very cautious way – to support the future cashflows needed to guarantee the all-important dividends to their own investors in the future.
I am not saying all is rosy today, or this quarter will see the real turn in the cycle. But the market is moving in the right direction (albeit slowly), with less volatility, and so as far as I can see, we are following the traditional playbook.
So back to those two worrying thoughts from the conference.
The first overblown concern is that there will be no near term solution to the idle fleet. As discussed above, I strongly feel that we are already seeing absorption (partly aided by the 225 grounding) through the production discipline of the OEMs alongside some repurposing of older equipment. Given Waypoint’s strong balance sheet, and the long life of our helicopter fleet, we are not in the knee-jerk world of the public companies that are scared of having one or two aircraft on the ground or AoG – that can impact certain aircraft such as the A320 but can easily be absorbed across the 40 year or 50-year life of a core helicopter.
If you want confirmation of that, then look at the quantum of decline in valuations of helicopters over the last two difficult years and compare then to the far greater falls in value experienced in the downcycles for corporate jets, commercial airliners, or other aviation assets. All the historical data shows a long term value retention in our assets.
The second worry – which struck me in one presentation in particular (since followed up in an article) – is a creeping fixed wing view of the lifecycle of our helicopters. I hope our industry will not be colonised by the ‘shiny guys’ – whose worldview is based on making big OEM orders, pumping new deliveries and dumping them in homogenised packets to capital markets investors, before selling their business to a huge institution (and then starting as a challenger lessor once again.)
The lifecycle management in our industry is not ‘flawed’, as one senior lessor executive recently claimed. In fact, the real investment value in helicopters lies in the long view over several leases, not in making your lessor profit through the OEM discount on a torrent of new deliveries. Our industry’s core fleet is still based on prime assets, capable of holding their value for at least twice as long as commercial airliners and then they have a secondary (and even a tertiary) life for a couple of decades after that. It’s all a question of understanding your customer and their customer too. We have many good leases on old aircraft outside oil and gas that help make our lessees good money with full mission utility and no compromise on safety. There is no need to accelerate the graveyard slot!
In some ways you could agree with the argument that ‘too much capital came into the helicopter market’ but if you remember five years ago, commentators and market participants were more concerned about the new generation lessors gargantuan new orders. Waypoint’s business model was always more attuned to the historical cycle: built around a meaningful order book (which does not have to be the biggest on the street) with significant capital left over to invest in sale and leaseback (which is the organic core of the market for many of our lessee relationships) while ensuring we maintain robust liquidity to allow reasonable time between leases for rational remarketing efforts often into more challenging countries and missions through our comprehensive network of regional offices.
Of course we have seen a lot of pain in the oil and gas sector over the last two years but the winners amongst operators, OEMs, financiers and the new lessor community are those who can combine a reputation for committed and safe customer service with the patient capital and strong liquidity needed to weather the market storm.
This is not either foolish optimism nor is it talking up my own book. The Waypoint team has been through cycles in our helicopter industry before. This is a hard one, but it will recover one day -possibly in the relatively near future – and we should not forget that there are inbuilt resiliencies in this market which are self-correcting mechanisms. I have mainly talked about oil and gas in this article, and there are great stories in the other sectors which only add to the overall investment thesis. This remains a long term and highly valuable sector. Let us all keep the long view and listen to our past experience and the current heartbeat of our specialised market. Lessors like Waypoint are here to provide liquidity to the market, not the other way round.
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