Engine ValuationAnyone who has been following Doric for the past few months and years should by now have a very good understanding of what the investment is all about; the potential future rewards and the potential risks.
The following analysis and views are very much detail oriented and are provided for interest. It should not really affect an investors decision to buy/hold/sell Doric shares because its impact on the rationale for investing is minimal.
This is an attempt to look at likely engine valuations for the Doric A380's. However I am having to use the Rolls-Royce Trent 900 valuations as a proxy for the Engine Alliance GP7000 as fitted to the Doric A380's aircraft. This is because I cannot find sufficient data for the EA engine.
Given that both the Trent 900 and GP7000's are unique to the A380's, share very very few parts with other engine types and the overall economics are pretty much the same plus the A380 market share is roughly equal (although within Emirates the ratio of EA/RR is 3:1) I would expect there to be minimal differences between the two engines in terms of valuations although the EA engines may be worth a tad more to Emirates because they have more EA engines than RR.
Using data supplied from the reputable
http://www.airfinancejournal.com/magazine (Which I suspect gets a lot of its data from iba.aero) I have compiled the following data.
Code: Select all
Year Fair Market Base Value QEC
2017 14.9 14.9 0.6
2018 14.5 14.9 0.6
2019 11.5 12.25 0.6
2021 5.7 8.55 0.6
2022 3.8 3.8 0.6
What can be seen is the engine valuations were in free-fall from 2018 and a significant divergence between base and fair values occurred during the pandemic. Interesting to note that the Base and Fair market values have converged and the QEC valuation has remained the same for many years. The 2022 data was published mid-year just as the A380's were returning to service so I would hope the decline in valuations has halted, if not possibly reversed by the time 2023 data is published. Fair market valuation fell from $14.9m in 2017 to $3.8m in 2022.
It should be noted that these valuations are of serviceable engines; not scrap. I would expect scrap value to be around 50% of the current $3.8m i.e. around $2m
However the QEC items (Quick Engine Change Items which are the hardware and components needed to quickly build up a provisioned spare engine to a service-ready condition, typically air start motors, Hydraulic pumps, Generators etc which are high value items that can be transferred between unserviceable and serviceable spare engines) are valued at $0.6m and even in a scrap situation will be worth say 75% of the QEC value, say $0.45m
That totals somewhere around $9.4m per ship set.
Additionally, landing gear, Auxiliary Power Unit and Line Replaceable Units will also have some value although largely dependent upon the general market at the time.
Maintenance CostsSome other numbers that might be of interest are maintenance costs. This would be a key cost input into what drives Emirates decisions as to which aircraft to lease, buy and scrap
As the engines get older and accumulate flights (cycles) the Life Limited Parts (LLP's) need to be changed, these are mostly the big heavy rotating discs that the blades attach to. Currently new LLP's cost $11.15m per engine. This is on top of average overhaul costs of $8.1m per shop visit per engine.
The Mean time between overhaul is 30,000 hours and with a cycle ratio of 8.8 hours that equates to about 3400 flights. Unfortunately I do not have Emirates flight data including utilisation at hand but as a guess I reckon that equates to a planned engine change every 6-7 years or so with a complete LLP change every 10-12 years. (It's a little more complicated than that because its advisable to stagger engine times across the wing and LLP lives relate to multiple parts with several of those parts having different life cycles declared and many engine repairs/overhauls are unscheduled due to various reasons such as modification upgrades, quality issues, performance deterioration etc).
Anyway, bottom line is that under the terms of the lease agreement the engines must have at least the bulk of one shop visit life remaining on them. That means an expenditure of $8m-$15m per engine (say $50m for a shipset).
However there are a couple of wrinkles in this. All the above is based on what is called "Time and Material' and whilst its the traditional way of operating an airline it's not how modern airlines work. They will have entered into a side agreement with the engine manufacturers whereby Emirates would have been paying a monthly fee from day one to the engine supplier with a guarantee that no matter how many shop visits are made Emirates will only pay the same flat rate per month (or hour). These payments are often broadly split into two parts. One is to cover the 'ordinary' shop visits and the other is to pay for the LLP's. Due to the high cost of LLP's airlines will often not pay the LLP portion of the monthly rate because a) damned expensive and b) by their very nature the payments can be planned for years ahead so may as well use the cash flow for immediate operations where they will get a return on the cash.
The other wrinkle in all of this is the fact that there are no second-hand customers for the A380. So even if DNA hold Emirates feet to the fire and insist of full return conditions - which could cost Emirates $100m or more, all that would happen is that Doric get a pristine aircraft that is effectively worthless on the open market.
Hence these 'half life' + cash return conditions are equitable for all concerned; including to some extent the engine manufacturers who may have been paid for LLPs (although no doubt Emirates would negotiate to get some or all of that cash back one way or another).
Without knowing the specifics of what the engine life remaining is for all Doric aircraft at end of lease, whether engine ownership can be transferred between Doric airframes it is impossible to accurately assess the value of each airframe. For example if one airframe at end of lease has pristine overhauled engines versus another with end of life engines then the former will be worth more.
We also do not know the contents of the Doric side letter it terms of its breadth and conditions.
So apart from awaiting further news from Doric (and possibly other Lessors) regarding the fate of the next A380's coming off lease, the
http://www.airfinancejournal.com mid year edition should provide some further valuation data points. Am cautiously optimistic we may have reached the valuation bottom and may see valuations experience some modest increases although that may not be reflected until the Doric March 2024 revaluations for A380.