Executive Summary

A generation shift in technology is spawning the twin-aisle evolution. In

this decade, eight twin-aisle types will enter into service. Demand for new-

technology aircraft is immense, filling order books to the end of the decade,

while current generation twin-aisles are approaching the end of production.

Both new and used types are creating opportunities for airlines to evolve

their business model, increasing travel options for passengers. Recent

attention given to the availability of used twin-aisle aircraft has demonstrated

a critical point: size matters. Small and intermediate twin-aisles are the right-

sized aircraft to expand international networks. Lower trip cost and less

revenue risk appeals to a broader operator base, supporting a secondary

market. Sophisticated owners of twin-aisle aircraft will leverage connections

and technical expertise to create value in transitioning current generation

aircraft and placing new-technology types.

By Steve Mason & James K.D. Morrison

The Twin Aisle EvolutionTechnology Transition Is Creating Opportunities for Aircraft Owners Where Experience and Strategy Are the Keys to Unlocking Value

The Twin Aisle Evolution

© 2016 CIT Group Inc. CIT and the CIT logo are registered service marks of CIT Group Inc.

Generation Shift

A generation shift in technology is spawning the twin-aisle evolution. As the 767, 777-300ER and A330ceo approach the end of production, the improved performance and economics of new-technology types, such as the 787, A350 and A330neo, are enabling service to new markets by new airline business models.

Boeing promotes the 787 as having already opened 90 new non-stop routes — with less than one-third of ordered aircraft delivered. Singapore Airlines committed to re-opening ultra-long range routes to the United States using the A350-900ULR, catering to premium passengers who value the shortest trip time. Not to be outdone, United Airlines (United States) announced non-stop 787-9 service between San Francisco and Singapore commencing in June 2016. The improved performance and operating economics of new-technology aircraft enable direct connections for city-pairs that were previously served by one- or more-stop itineraries. Network opportunities enabled by new-technology aircraft allow carriers to differentiate their service from competitors, growing revenues while reducing costs.

Just as new-technology types open new markets, current generation twin-aisles are opening new business models. As network carriers re-fleet, agile competitors have an opportunity to experiment with their business model, deploying lower capital cost aircraft in new network structures.

Size (and Market Liquidity) Matters

Recent attention given to the availability of used twin-aisle aircraft has alarmed some industry observers and investors. Aircraft size and the liquidity of the secondary market for the type matter when assessing an investment opportunity. Large twin-aisle aircraft, such as the 777, 747 and A380, need to start or end their flights at a hub airport to fill the seats. While a 777-300ER opens enormous revenue opportunities, it will burn close to a quarter of a billion dollars of fuel over the course of ten years.1 Premium cabins in the largest aircraft attract premium yields, but these seats are typically only filled with paying passengers on prime weekdays. Operators pay the cost of transporting premium cabins every day of the week. The potential operator base of large twin-aisles is limited to the airlines with the network scale to operate profitably, day-in and day-out. Small and intermediate twin-aisles, such as the 767, 787, A330 and A350, have broad appeal. The combined 767 and A330 operator count equals that of the 737 Next Generation. With the right size to either feed international gateways or serve point-to-

point markets, a variety of airline business models deploy these aircraft. New-technology types offer the range capabilities of current generation large twin-aisles at a fraction of the trip cost. Lower trip cost and less revenue risk appeal to a broader operator base, supporting a secondary market.

The liquidity of aircraft types can be compared using market mass, a function of the number of airline operators and the number of units in-service or on order. The A350 and 787 have achieved substantial market mass that is expected to continue to grow. With 1,435 aircraft in-service or on order and 101 airline operators, the A330 has the broadest twin-aisle market appeal. While the 777 has more aircraft in-service or on order (1,645), it has not attracted the same operator base (57), reducing the number of opportunities to remarket used aircraft (Ascend). Aircraft types with multiple engine options can fragment the operator base, reducing market liquidity. While the 777-200ER has three engine options, the 777-300ER has only one, which should ease the remarketing effort required for that model. The A330ceo also has three engine options, however, almost 20% of the operator base has chosen to operate at least two different engine types.

Airlines in financial difficulty can stress the supply and demand equation for a specific aircraft type, making multiple units available in a short period of time. For example, the bankruptcies of Transaero Airlines (Russia), Skymark Airlines (Japan) and Malaysia Airlines pressured the market for 777-200ERs and A330-300s in 2015. Long transition and reconfiguration times exacerbated the situation. New aircraft built for financially distressed carriers further stress the market due to the high value of the asset, customized for a carrier no longer in need of the lift.

Transition FrictionGeneration shifts often come with growing pains. Transitioning twin-aisle fleets between operators can be an expensive endeavor. For carriers integrating fleets of new-technology types, the cost of training and initial provisioning of spares can rival the cost of the first aircraft delivered. For operators seeking twin-aisles on the secondary market, engine overhauls and cabin reconfigurations inflate the on-ramp cost.

Twin-engine, large twin-aisles come with high-thrust engines that typically have shorter lives for life limited parts (LLPs) than small twin-aisles. This may be acceptable to the first operator flying long-haul missions, one cycle per day. However, aircraft that are attractive on the secondary market must be versatile, capable of operating on shorter legs at higher frequency. A330s are used

Figure 1: Twin-aisle market mass. Passenger usage, airline operators, as of December 31, 2015 and 2010 (Ascend)

Figure 2: Boeing 787 has opened 90 new non-stop routes (Courtesy of Boeing)

on missions ranging from 500 miles to 6,500 miles. High-thrust engines operating on shorter legs trip LLP limits sooner, resulting in significant engine overhaul costs. In 2015, twin-aisle flights originating in Asia and the Middle East were flown on average 1,731nm and 2,108nm, respectively, according to Innovata schedule data. In comparison, the average stage length of twin-aisle flights originating in North America and Europe were 3,690nm and 3,329nm. Asia and the Middle East accounted for 60% of the twin-aisle seat growth from 2010 to 2015, whereas North America and Europe accounted for 33%. Growth markets require twin-aisles suited to shorter stage lengths. Maintenance cycles impact the economic life of aircraft. The 777-200ER has eight year heavy check intervals and 10,000 cycle LLP limits for high-thrust engine variants. Owners face a decision when the aircraft approaches 16 years of age: incur the cost for eight more years of operations or retire the aircraft. For lessors, this investment decision is made with an assessment of the lessee’s credit worthiness. The alternative could be to pocket maintenance reserves and part-out the aircraft, an option which becomes very real if the asset’s book value has been depreciated appropriately.

Transition multipliers result in three or more transitions for the delivery of one new-technology twin-aisle. The operator that takes delivery of a new-technology type (transition #1) returns a current-generation type to a lessor or re-delivers it to another airline (transition #2) that in turn scraps a second generation twin-aisle (transition #3). One new delivery may replace one retired aircraft, but the resulting transitions cascade through the global market. The costs involved in each transition and the limited number of operators with experience integrating used twin-aisles into their fleet results in transition friction.

Transition friction creates an opportunity for service providers to grow their business by offering innovative solutions that lower costs and shorten lead-times. Engine OEMs are contemplating portable power-by-the-hour agreements that will facilitate transitions between operators without the need for large cash outlays to buy into maintenance programs. Interior providers are focused on reducing lead-times and using refurbished components as viable alternatives to new. OEMs are developing modular designs that standardize configurations, reducing re-engineering work required during transitions.

Abundant OpportunityWith generation shift comes opportunity. Airlines are evolving their business model, increasing travel options for passengers. New operators and changing business models will generate a vibrant secondary market that will benefit sophisticated owners of twin-aisle aircraft.

Network carriers are expanding their international presence, opening new routes and new markets. International opportunities shield network carriers from intense competition in their home markets, positioning their short-haul networks to feed long-haul growth. Serving different origin-destination markets than more agile, lower cost competitors allows network carriers to protect yields and grow passenger numbers. Air Canada grew its international traffic by 10% in 2015, deploying 787s on new routes and increasing sixth freedom connections through its hubs. International Airlines Group (United Kingdom) and Delta Air Lines (United States) are interested in acquiring used current generation twin-aisles to supplement their new-technology order books, enabling them to capture international growth opportunities with lower capital costs. It has been reported that Virgin Atlantic (United Kingdom) plans to replace its 747 fleet with A350-1000s.

Re-fleeting network carriers can re-deploy aged aircraft to grow market share with price sensitive leisure passengers. Air Canada Rouge operates 767-300ERs transitioned from the mainline fleet. High density seating, lower capital costs and productivity improvements have enabled Rouge to compete in the vacation package market. Lufthansa (Germany) is shifting A330 flying to Eurowings, leveraging its lower cost structure attained through its joint-venture with Turkish Airlines, SunExpress. Qantas (Australia) has used its Jetstar subsidiary to improve the profitability of its international network.

Low cost carriers (LCCs) with international ambitions have new opportunities to expand their reach. Traditionally, LCCs have favored continuous growth of short-haul flying with a single fleet type of highly reliable aircraft. As LCCs have matured, their ability to stimulate new passenger demand in saturated markets has waned, forcing the evolution of their business model. Penetrating markets dominated by network carriers has enabled LCCs to continue to grow, overcoming cost creep by accommodating higher yielding passengers. Mature LCCs now have such scale

Figure 3: Growth markets require twin-aisles suited to shorter stage lengths. Twin-aisle average stage length in 2015 and cumulative % seat growth from 2010 to 2015 by continent of origin (Innovata)

The Airbus 330neo and Boeing 787 are examples of the evolution in twin-aisle aircraft.

The Twin Aisle Evolution

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that twin-aisles may offer greater growth opportunities than continuing operations with a single fleet type.

New-technology twin-aisles offer low operating costs that favor high utilization to spread capital costs. LCCs deploy capacity to leisure focused markets beyond the range of single aisles. Flexible work rules, high density seating and quick turn-times generate a cost advantage. Norwegian Air Shuttle is deploying 787s across the Atlantic and to Southeast Asia. AirAsia X (Malaysia) has committed to expand its network with the A330neo.

Current generation twin-aisles offer a lower risk opportunity for LCCs to enter new markets. Lower capital cost, current generation aircraft are available now and reduce the need for high utilization, enabling LCCs to use their home market network to feed long-haul flights. Proven designs have high reliability. Higher density seating and a favorable fuel price environment is enabling LCCs to experiment with used twin-aisle expansion. WestJet (Canada) has taken ex-Qantas 767-300ERs to launch direct service to Hawaii and the United Kingdom. WOW Air (Iceland) is deploying A330-300s to enter U.S. markets out of single aisle range. Twin-aisle seats flown by LCCs have grown 12.4% per annum since 2010 compared to 3.8% industry-wide. A330s supplied 39% of LCC twin-aisle seats in 2015, while 787 seats have been growing rapidly. 767s continue to play an important role in LCCs twin-aisle ambitions.

LCCs focused on their home markets have growth opportunities feeding long-haul carriers. Ryanair (Ireland) and easyJet (United Kingdom) have both publicly mused about using their short-haul cost advantage to feed long-haul carriers. Long-haul feed adds cost and complexity to the LCC business model, requiring investment in IT infrastructure and passenger accommodation when connections are missed. Innovative airports may attract connecting passenger flows by taking on the risk of missed connections and facilitating baggage handling, such as Gatwick Airport (United Kingdom) which is experimenting with its GatwickConnects service offering.

This is not a zero-sum game. Instead of siphoning travelers from established carriers, new airline business models will open international travel for a new class of passengers. A diversity of airlines experimenting with an array of business models will expand the operator base, increasing demand for both new-technology and current generation aircraft. Sophisticated owners will be well positioned to generate returns from a growing market for twin-aisle aircraft.

The End ResultPassengers will be the beneficiaries of the twin-aisle evolution. A diversity of carriers will offer improved global links at competitive fares with passenger experiences tailored to a variety of price points.

Network carriers, LCCs with international ambition and LCCs with a home market focus will all have growth opportunities in an expanding market. Right-sized, small and intermediate twin-aisles that are both new-technology and current generation will be critical to the development of these airlines’ networks. Inevitably, some carriers will fail. Agile airlines that adapt to changing market conditions will succeed.

A variety of aircraft financing sources will be required to fund both new entrants and established carriers. Sophisticated owners of twin-aisle aircraft will leverage connections and technical expertise to create value in transitioning current generation aircraft and placing new-technology types, bundling win-win-win deals across multiple parties to overcome transition friction.

Figure 4: Twin-aisle seats flown by LCCs segmented by equipment type (Innovata)

1 CIT Analysis based on $2.00 USG, 549 flights per year, 4,000nm ESAD, used aircraft.

Steve Mason is Vice President of Aircraft Evaluation and Strategy at CIT Aerospace. Steve joined CIT in 2012 after 12 years spent working with Rolls-Royce PLC and International Aero Engines, where he was responsible for aircraft engine sales for Western Europe and leasing markets. In his current role, Steve is responsible for aircraft investment analysis, new aircraft strategy, airline market assessment and aircraft valuations.

About the Authors

James K.D. Morrison is an Assistant Vice President at CIT Aerospace. Jim is a Professional Engineer licensed in the Province of Ontario and holds a Master’s of Science in Technology and Policy from the Massachusetts Institute of Technology (MIT). Prior to joining CIT in 2015, Jim was a Research Assistant at MIT’s International Center for Air Transportation and held marketing and strategy roles with Bombardier Commercial Aircraft.