Real estate, alternative real assets and other diversions

Can UAE emerge as an aircraft leasing hub? Plus my thoughts on Central Europe and the dollar

The Macro View

Sunlight coming through high rise buildings

I was stunned to read a Boeing report that forecasts that the global passenger jet fleet will more than double to 45,250 by 2035. Given that almost 20,000 of the world’s in-service aircraft will be retired or converted to freighters in the next decade, Boeing forecasts at least $3 trillion in financing for 40,000 odd new aircraft deliveries in the next eighteen years. This makes aircraft leasing one of the few growth niches in global finance. While Tony Ryan and Guinness Peat Aviation pioneered the industry’s growth in the late 1970s, putting Dublin on the world map as he epicenter of global aviation finance, I see no reason why Dubai and Abu Dhabi should not take advantage of the sheer scale of the secular growth in the industry to nurture an ecosystem in aviation leasing and finance: a new Dublin is in the desert. After all, even new, 8000 of the 20,000 odd passenger jets in service even now are leased, not owned, by airlines. The global aircraft leasing markets enable Emirates and Etihad airlines to finance new aircraft orders, manage their balance sheets and manage their global route networks more efficiently.

Chinese banks have emerged as major players in global aircraft leasing, as symbolised by the IPO of Bank of China (BOC) Aviation and CDB Financial Leasing’s initial public assets in Hong Kong while investors as varied as Tony Fernandez’s Air Asia and Li Ka Shing have actively acquired aircraft leasing assets.

The world’s top two aircraft lessors now are General Electric’s Capital Aviation Services (GECAS) and Dublin’s Aer Cap, with over 1000 aircraft each leased to the world’s leading airlines. Chinese megabanks ICBC, Bank of China and CDB own three of the world’s largest operating lessors. Since Chinese demand for new passenger jets will shape the future of aviation in the next decade, it does not surprise me that Chinese banks, conglomerates and even Hong Kong taipans have scrambled to invest in aircraft leasing assets. There is surely a lesson here for the GCC’s sovereign wealth funds, merchant banks, Islamic banks, insurance companies and family offices. As an investor, I find this sector interesting because it is possible to earn 6–8% on senior debt and as much as 15% in a diverse portfolio of aircraft leased to the leading airlines in the US, Europe and Asia. The Middle East and Africa are 10% of the global leased aircraft market even now. Emirates Airlines has a lessee fleet of 122 aircraft, though global airlines like American, Air France KLM, IAG (British Airways, Aer Lingus, Iberia) boast three times as many leased aircraft.

It is no coincidence that 60% of passenger jets owned by lessors are narrow body aircraft that are more cost efficient to operators and can be rerouted easily compared to wide body aircraft while also in great demand by Asia, Europe, GCC and Latin America’s low cost carriers. Budget airlines use fleet expansion to launch short to mid haul routes. This makes the narrow bodied jet leasing segment highly liquid, particular to the white hot regional budget airline operating in the Pacific Basin and even India. It is no coincidence that both General Electric GECAS and Air Capso dominate the global narrow body passenger jet leased fleet market.

The age of a leased aircraft is critical as older aircraft have significant residual value and maintenance cost risks which can gut their credit rating in an economic slump even as borrowing costs in the capital markets spike higher, as the airline bankruptcies in the 2008 and 2009 global recession demonstrate. This is the reason Chinese bank lessors tend to prefer aircraft fleets whose age ranges between three and five years.

I believe investing in aircraft lessors, not airlines, is the optimal play on the secular growth in global air travel. It is imperative that aircraft lessors must own young narrow body fleets, have stable cash flows, and the lowest cost bank funding possible scale is mission critical because there are 160 aircraft lessors operating worldwide and only the biggest firms can diversify jet type, fleet age, lease duration and client concentration risk. Of course, EPS growth, rising operating margins, free cash flow, cheap valuations and high ROE are the holy grail for investors in the global aircraft leasing market.

Macro Ideas – central Europe and the GCC investor

Central Europe has been one of the more neglected areas of investment for Gulf private clients, even though UAE sovereign wealth funds have invested in Austria’s state oil firm, Serbian property projects, Polish banks and Romanian oil drilling and exploration companies. I have traveled extensively in the region in a quest to analyse its economic and financial potential. This region, the former Habsburg empire, later the Warsaw Pact satellites of the USSR, suffered terribly from the Balkan wars of the 1990s, the wars in Croatia, Bosnia and Kosovo. The election of populist, nationalist governments in Budapest and Warsaw is also a deterrent to foreign capital inflows. However, the region boasts fabulous property investment opportunities, some of the highest economic growth rates and literate populations in Europe and some of the best managed blue chip growth companies in the emerging markets – all within the protective umbrella of EU membership.

The most compelling reason to invest in central Europe is the evolution of vibrant consumer economics in places like the Czech Republic and Poland, historically beneficiaries of the German industrial colossus. It is possible to earn double the yield in Grade A office buildings in Prague let out to multinational tenants than it is possible to earn in Munich or Berlin. The fall in crude oil prices makes central Europe a valuable hedge for GCC based investors who have significant exposure in India or Southeast Asia. Croatia, ‘the Mediterranean as it once was’, is one of the most hauntingly beautiful places on earth, its Adriatic coast a playground for Roman emperors and post-Soviet Russian oligarchs. A Dubai investment bank has even invested in a Croatian yacht and marina resort.

I do not want to gloss over the significant risk of investing in central Europe, as in any other province of emerging markets. The region’s capital markets and banking systems are dominated by Austrian, Italian and French banks who contract cross-border flows in times of banking stress, as in 2008-9. The Law and Justice Party in Poland and Fidesz government of Viktor Orbán in Hungary have embraced economic nationalism as state policy, a clear threat to the interests of foreign investors. The war in Ukraine’s Donbass, the highly unstable (and uninvestable) western Balkan states of Macedonia and Albania, Russian influence in corporate boardrooms and occasionally xenophobic economic policies are, unfortunately, also risks to Gulf investors. For instance, it is pointless to invest in Hungarian energy, telecom and banks since Viktor Orbán seeks to do a Putin and exert state control on companies ostensibly privatised in the 1990s post-communist transition. Poland’s banking tax or coal industry protectionism is another example of a Warsaw government that defies the norms of pro-market economic policies. Yet Poland is largest economy in the region with wage rates that are just about one third German levels, making it a leveraged play on German auto/industrial growth. Poland’s stock market has also provided amazing opportunities in 2015 and 2016, mainly in the midcap sector.

Although Hungary is a highly-developed economy in the heart of central Europe and Budapest was once the twin capital of the Austrian Empire, this nation’s investment potential has been crippled by Viktor Orbán’s statist and even autocratic policies. In any case, the Hungarian government has clashed with the EU and Berlin over political reform, privatisation and immigration, a red flag for global investors.

The Macro View

About Matein Khalid

Matein Khalid

Matein Khalid is Chief Investment Officer of Asas Capital in the DIFC; he is responsible for global investment strategy and the development of the multi family office platform. He has worked in Wall Street money centre banks, securities firms and hedge funds in New York, London, Chicago and Geneva. In addition, he has been an advisor for royal investment offices in the Gulf for 8 years. Mr Khalid has four degrees in finance, economics, banking and international relations from the Wharton School, University of Pennsylvania. He is a director at the American College of Dubai and has taught MBA level courses in commercial/investment banking at the American University of Sharjah and British University of Dubai. He writes the Global Investing columns for Khaleej Times, Gulf Business and Oman Economic Review.

Articles by Matein Khalid

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