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SMBC Aviation eyes opportunities as airlines come under stress

CEO expects to sign more leases for new planes as industry profits decline

SMBC Aviation Capital is investing in new fuel-efficient jets, with Boeing 737 Max and Airbus A320neo models accounting for most of its outstanding orders.   © Reuters

HONG KONG -- Airline profitability is coming under pressure, opening up opportunities for aircraft leasing companies, according to SMBC Aviation Capital, the world's fourth-largest jet lessor.

"Fuel prices are higher, interest rates are higher, [exchanges rates] are more volatile," Peter Barrett, SMBC chief executive, told the Nikkei Asian Review in a recent interview. "Airlines are going to be less profitable probably and going to face some challenges ... But I think we are very well-positioned to both manage the challenges that might come and also take advantage of any opportunities that [this] will bring up."

His Dublin-based company, which was acquired in 2012 by Sumitomo Mitsui Financial Group and Sumitomo Corp. from Royal Bank of Scotland, focuses on the leasing and trading of new narrow-body jets from Airbus and Boeing. Aircraft of that size account for the bulk of global commercial flights.

"We think that gives us a very good protection against the challenges that might come on the market because these airplanes are the airplanes that people are going to want to fly even in tough times because they are more fuel efficient," Barrett said. "They are going to give them that extra little bit of margin in what will be a more competitive environment."

The International Air Transport Association, the global airline trade group, has forecast that industry profits will fall 11.1% to $33.8 billion this year due to rising fuel, labor and interest costs. Asia-Pacific airline profits are seen falling 18.8%. Regional carriers including Japan Airlines and Air China have already reported year-on-year declines in quarterly profits in recent days.

"The last four or five years has been a great period for airlines," Barrett said. "They have had low capital costs, low fuel costs, generally good demand [and] generally benign labor costs. Those things are all changing. It will certainly be a more challenging environment going forward."

SMBC's fleet consists of 419 jets that it owns or manages. It has another 246 jets on order, mostly Boeing 737 Max or Airbus A320neo models. The company's Japanese shareholders have pledged to inject a further $1 billion into the business by next March to support its fleet expansion.

"We focus on the most modern and the most in-demand aircraft," Barrett said. "We have an order book for the newest technology aircraft."

While SMBC has not been a leading participant in the leasing sector's mergers and acquisitions, Barrett foresees the coming period bringing opportunities to buy fleets of aircraft from other owners; some of these would be deals with airlines under which they would sell their planes to SMBC then lease them back.

SMBC Aviation Capital Chief Executive Peter Barrett

"Some of our customers will probably want to use leasing more, because it will be more advantageous financially in a more challenging market," he said.

SMBC generated $288.74 million of net profit in the year ended March 31 on revenue of $975.45 million. Both figures were down slightly from a year earlier, with earnings slipping 8.4%.

So far, the dozens of airlines that SMBC works with have mostly been able to keep current on their lease payments, Barrett said, adding that delinquencies are "no more so than normal" so far.

Though the numbers remain small, amounts at least a month overdue rose to $6.8 million as of March from $1.06 million a year earlier, according to the company's annual report.

SMBC's clients include seven airlines belonging to China's troubled HNA Group.

"Obviously the broader HNA Group has had its challenges and that's something we are keeping a close eye on," Barrett said. "They have had some arrears. But [the airlines] are generally performing reasonably well. They continue to be good customers of ours. I don't see that changing."

HNA sold 30% of Avolon Holdings, the third-biggest aircraft lessor, to Japan's Orix in August for $2.2 billion. While HNA has signaled its intent to hold onto its remaining 70% stake, Barrett said he expects some of the Chinese companies that have piled into aircraft leasing in recent years to exit.

"There has been a wave of Chinese investment in this industry. I don't think it is going to be realistic to expect it to continue at that pace," he said. "There's going to be a natural tempering of that as [Chinese players] reach a critical mass in this space. Some of them will probably do it for a while and decide it's not for them."

Asia now makes up about 40% of SMBC's business, up from around 30% before the company's 2012 purchase by the Sumitomo companies. Eyeing further growth, SMBC in late October set up its first Asian operating company subsidiary in Hong Kong. The move will allow SMBC to sign leases in Hong Kong to take advantage of new tax incentives offered by the city's government for aircraft lessors.

The jet leasing arm of Industrial & Commercial Bank of China and Ireland's Aergo Capital have also both set up operations this year in Hong Kong.

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