Vietnam Airlines plans to send used passenger planes to Air Transport Services Group for conversion into cargo jets as it prepares to create a freighter division and capture more intra-Asia freight growth, the U.S.-based company disclosed Friday.
The small deal is noteworthy on two levels. It is another example of passenger airlines moving more aggressively to take advantage of cargo opportunities triggered by the pandemic. And it reinforces how ATSG, the largest lessor of freighter aircraft, is rapidly expanding its customer base beyond U.S. shores due to demand from express delivery providers with strong e-commerce business.
Vietnam Airlines will remove two Airbus A321 narrowbody jets from its passenger fleet and sell them to Air Transport Services Group (NASDAQ: ATSG), which will send them to a specialty facility for conversion into pure freighters capable of carrying large containers on the main deck. Once modifications are completed, ATSG will lease the planes back to Vietnam Airlines, CEO Rich Corrado said on the company’s earnings call with analysts.
The sale-leaseback arrangement is similar to one last year between Air Canada and ATSG’s leasing arm, Cargo Aircraft Management. Air Canada is also building an all-cargo airline from scratch, initially using eight Boeing 767 medium widebody jets it retired from passenger service. CAM bought the first two aircraft, outsourced the retrofit work to Israel Aircraft Industries and is leasing the planes back to Air Canada. Those 767 converted freighters entered service in the past eight months.
For the Vietnam Airlines reconfigurations, ATSG will use a government-certified design and installation kit developed by a joint venture between ATSG and Precision Aircraft Solutions in Beaverton, Oregon. The company has five production lines in the U.S. and China operated by airframe overhaulers, but no decision on a conversion location has been made yet, according to ATSG spokesperson Kym Parks.
ATSG will likely deliver the A321s to Vietnam Airlines in 2023, said Mike Berger, ATSG’s chief commercial officer.
New combination carriers
More passenger airlines are realizing the value of dedicated freight transportation after successfully operating cargo-only passenger flights during the pandemic when travel shriveled. Freighters enable them to capture more business and diversify revenues as shipping demand rises. Other airlines that have recently become combination carriers include WestJet in Canada, Indigo in India and Gol in Brazil.
“Some of these passenger carriers . . . when they faced the pandemic had to pull down a number of resources but they could have stayed engaged on the cargo side more efficiently if they had freighters,” Corrado said. “And so they want to now get into the freighter market. And we’ve been the beneficiary of that.”
The Vietnam Airlines deal underscores how ATSG is expanding its international reach as it broadens its fleet beyond Boeing 767 freighters.
Wilmington, Ohio-based ATSG, which also operates two cargo airlines and a charter passenger airline, currently has 121 aircraft in service, including 103 cargo jets. It achieved second-quarter adjusted operating profit of $158 million, a 23% gain from the same period last year.
Of 10 new aircraft scheduled for placement this year, eight are going to customers in Asia, Europe and Canada that are expanding their networks to support e-commerce fulfillment. The majority of ATSG’s 2023 lease deliveries will be headed overseas, as well, Corrado told analysts.
Many of the new international contracts are for Airbus aircraft that ATSG is adopting for the first time. Dublin-based ASL Aviation Holdings, which owns several airlines that provide airlift for Amazon (NASDAQ: AMZN) and integrated transportation providers such as FedEx (NYSE: FDX) and DHL, is poised to receive ATSG’s first two A321-200 narrowbody freighters before the end of the year.
The A321 converted freighter is a new aircraft type that has only been on the market two years. It is quickly gaining adherents as a formidable competitor to the Boeing 737-800 and a replacement for older 757s in the standard-body segment. Airbus affiliate Elbe Flugzeugwerke (EFW) also has an A321 passenger-to-freighter conversion program and a year head start in sales.
CAM is outsourcing the ASL retrofit work to Pemco, a sister overhaul company and one of the facilities used by joint venture 321 Precision Conversions.
The lessor plans to convert and lease at least three more A321s next year. Malaysia-based Raya Airways, which operates in the Asia-Pacific region, has secured two of the next conversion slots.
ASL has also ordered two Airbus A330-300 widebody freighters, which are comparable to the 767. ATSG says it has customer orders for the first 20 of 29 A330s that it will start to convert next year and begin to deliver in 2024. The A330 conversions are being outsourced to EFW.
ATSG, which is mostly using cash flow to fund its substantial growth, holds options to buy more A330, 767-300 and A321 passenger aircraft as feedstock for freighter conversions.
E-commerce business resilient
E-commerce continues to be a huge tailwind for ATSG and other cargo carriers aligned with the express package industry.
“Consumers still prefer buying online and not just for convenience. They are also looking for lower prices they often find online to stretch their own budgets to cover inflation. We remain direct beneficiaries of the rapid delivery that online shopping requires, and we’ll keep reinvesting the majority of our strong cash flow to meet this demand,” Corrado said.
His comments echoed those of Cargojet’s leader, Ajay Virmani, who said a week earlier that consumers may be trading down in value but have not reduced the quantity of goods purchased.
Cross-border e-commerce is especially robust, as demonstrated by double-digit international growth in FedEx’s and UPS’ most recent earnings.
ATSG’s Berger noted that e-commerce is still in the early stage in many large economies and has a huge upside.
Online sales in Brazil, for example, are only 5% of total retail sales. The ratio in India is under 10%. And in Mexico, e-commerce represents 11% of the retail sales total, compared with more than 14% in the U.S. and nearly 20% for the global share, according to the U.S. Census Bureau and other research.
Forecasts indicate that by 2025, the online segment will make up close to a quarter of total global retail sales
“So the engine is still great as we look out over the next few years,” the chief commercial officer said. “We’ve got everything in place with diversification in terms of conversion houses as well as feedstock to meet that demand from customers.”
Despite uncertain economic conditions and an easing in consumer spending, analysts agree with management that investing in more equipment is low because the bulk of business comes from express carriers, or subcontractors, that run daily shuttle networks with time-definite requirements and utilization commitments regardless of whether volumes soften. ATSG has minimal exposure to general air cargo, which tends to be more cyclical and difficult for carriers that depend on short-term charters.
The air services conglomerate holds deposits for most of the 18 freighters it expects to deploy in 2023 and commitments from long-standing customers for the others. Of the more than 80 passenger-to-freighter conversion slots CAM holds for production from 2022 through 2026, more than 50 are already reserved by customers.
“We have not seen any weakness in demand really at all. We’ve talked at length about the order book not only for this year but the upcoming years. And we haven’t seen any indication from any of our existing customers that there is any hesitancy at all,” said Berger. “In fact, all have communicated quite clearly that if it’s possible to take the new aircraft, new deliveries early, they certainly would.”
Boeing (NYSE: BA) and Airbus last month slightly raised their 20-year outlook for the freighter market. Boeing forecast the global freighter fleet will be 80% larger in 2041 than today and that the market will grow at a solid 4.1% compound annual rate. Airbus’ overall estimate of 3.2% demand growth was lower, but it said express cargo would grow at a 4.7% clip and that the express share of global cargo volume would increase to 25% from 17% before the pandemic.
Berger noted that two-thirds of the freighter fleet growth will belong to the five major integrators — Amazon, DHL, FedEx, UPS (NYSE: UPS) and SF Express — and partners that supplement their regional networks.
“Either those folks are our direct customers or they’re our customers’ customers,” he said. “We’re extremely bullish about it and we’re certainly poised with feedstock to meet that demand.”
If demand or growth did decline, ATSG could pull back on acquiring aircraft and use the cash for stock buybacks or other activities, executives said.