Engine teardown: When's the right time?

Engine teardown is a complex issue. Owners must consider the value of the engine, its parts, and the market for each. Choosing when to tear down an engine can feel like playing Russian roulette. Neelam Mathews reports.

The decision whether to tear down an engine is a tough one as teardowns come at a price; labour and skills are the same as required in an overhaul.

How does one decide to do a complete overhaul if the engine is over halfway towards its time between overhaul (TBO)? Among the many considerations, the owner must look at the availability of that aircraft type and its parts, and whether repair would be more cost-effective than reaping gains from serviceable parts.

There is no generic answer to determine the right time for engine teardown, as each engine must be treated on its individual merits Jon Sharp, president and CEO of Engine Lease Finance Corporation (ELFC), explains his company's ‘hold or sell’ analysis: "On the one hand, we take into account the engine or host airframe lifecycle and current and forecast demand for leasing, whereas on the other we consider the specific condition of the engine in question. For example, does it need an expensive shop visit anytime soon? What is the life limited parts [LLP] status like? And what are the current market conditions for selling?"

Simple mathematics

Rudiger Heinrich-De Stefano is the VP of material management for MTU's Maintenance Lease Service, an 80 per cent joint venture with Sumitomo Corp. It handles lease and material management, including teardown for MTU Maintenance. According to Heinrich-De Stefano, the decision for a lessor with a lease contract that's soon to expire is "simple mathematics".

The lessor will compare the forecasted income from the engine sale or teardown against what it could make from continuing to lease under a new contract. The time is right "if the engine is nearing a heavy shop visit and is obsolete. Or, if the investment to lease-in an engine is lower than the targeted overhaul costs", says Heinrich-De Stefano.

Lessors should evaluate the current lease market and prospective lease fees in comparison with the cost of performance restoration. "This should be compared with the prospective value of the engine in parts. Owners, if they are a financial institution, can make the same calculations," explains Heinrich-De Stefano.

According to a study by Monaco-based financial advisory, Stratos, the cost of maintaining engines is heavily stacked towards the second decade of an engine's life, so investors are very sensitive to the cost burden of maintaining mature engines. Operators need to consider their flight operations and fleet management plan. "If the engine is coming near to a heavy shop visit, it might make sense to teardown or sell the engine for parts and lease-in an engine for the remaining lifetime or operation of the aircraft," adds Heinrich-De Stefano.

According to Gary Fitzgerald, MD of Stratos; "The forecast of intrinsic maintenance value is a key element in investors’ evaluation of residual values during the life of the aircraft."

Siemens product lifecycle management (PLM) software, for example, enables engine suppliers to seamlessly manage an aircraft engine programme from concept to disposal, using a single source of knowledge, creating sustainable business value.

Trends in teardown

A recent forecast by MTU Maintenance estimates that while shop visits for commercial jets above 100 seats will grow around two per cent per annum over the next 10 years, engine MRO revenue should grow at a rate of 7.4 per cent. However, the sector is in a period of transition; more MRO-intensive engines are being replaced by new ones with less need for maintenance.

There is presently an over-proportional growth in demand for engines, such as the V2500, CFM56-5 and -7. "Let's hope that there is no return to times of irrational exuberance," says Sharp.

"Particularly now, with significant new money flooding the market, encouraging new entrants tending to ‘follow the leader’, I am concerned the bubble will burst."

"Luckily, we entered into these growth platforms years ago," says Katia Diebold-Widmer, head of marketing at MTU Maintenance in Hannover. She explains that, on the negative side, struggling MRO providers that are focused on ageing engine types are now looking for ways to compensate their decreasing workload on older models by increasing their market penetration on newer models. This is leading to a plethora of shops offering CFM56-5B and -7 services at very low prices.

According to Auvinash Narayen, VP of sales and marketing at AerFin: "The market remains volatile and opportunistic, with few large-scale transactions."

Airlines often restructure their fleets following major events such as the financial crisis, SARS and 9/11. During such times, operators often phase out older aircraft, creating opportunities for traders, Narayen explains. "While we don't know when the next major event might happen, we are seeing a reduced economic life on aircraft due to the high volumes of new aircraft going into the market, [which are] driving down the residual values of older aircraft and [causing the] premature retirement of younger aircraft."

"Over-capacity is certainly strongest with older engine types," says Diebold-Widmer. "At the same time, we estimate there is currently under-capacity for certain engine types, such as the GE90 Growth."

Typically, most entrants will invest in new narrowbodies as they are the safest bet for future demand. But other business models involve lessors investing in older equipment. " If you know how to manage the market supply and demand pattems, you can tap into this niche," says Sharp.

While traditional traders look at narrowbody engines that need volumes to sustain material supply, UK-based AerFm focuses on a niche of distressed assets for higher risk adjusted returns. “Most businesses chase volume to sense the mass market and to deploy capital. AerFin is not constrained by credit line facilities and we are therefore able to focus on innovation and deploy a far higher degree of technical resources to achieve higher retums from smaller markets," say Narayen.

Adding to its portfolio, Aerfin is planning to implement EASA through accreditation; this will enable it to recertify parts under a scope that will complement its engine disassembly facility. The present 45,000 sq ft facility in Cardiff, UK, has a warehouse devoted to engine inventory that has been sent for repair: the company manages the distribution supply chain to 0EMs, MROs, airlines and parts traders.

The amount of parts an owner can retrieve is often based on how the engine has been operated. " If the lease market is weak and the parts market is strong, there will be more teardowns. Additionally, if major carriers are exchanging their fleet and these assets will not be absorbed as flyers, the amount of engines for teardown increases as well," explains Heinrich-De Stefano.

More specifically, different geographical regions may also present a risk to those involved in buying equipment for disassembly. The amount of parts that can be retrieved depends on how and where the engine has been operated. For example, engines that have been operated in harsh environmental conditions will have a different business model to most.

A concentration of ageing aircraft in certain locations may appear to provide opportunities; however, this is only the case if such regions have stringent maintenance procedures.

Inconsistent record keeping or historical maintenance standards may adversely affect component values and environmental conditions may increase the need for maintenance. This represents a risk for traders buying equipment from certain operations, Narayen points out.

Breaking down an engine

The cost to break down an engine can reach tens of thousands of dollars and varies depending upon the amount of parts to be retrieved, but typically the cost is minimal in relation to the value of the parts.

MTU says it is prepared to give customers a fixed price for teardown, enabling them to make a quick decision. Technically obsolete parts, as well as consumables and parts that are glued in, cannot be repaired or re-used. "But other than that, it is more a question of ‘is there demand for the part and is the repair economical‘/‘ says Heinrich-De Stefano. 

Those that can be recycled are handed over to a company that will extract the precious metals. Netherlands-based Aircraft End-of-Life Solutions (AELS), for instance, dismantles engines for high-alloy metals. According to Dark-Jan van Heerden, deputy director of AELS, the price of an alloy could be $20-$25 per kg as against $1.2 per kg for aluminium. 

"However, the cost of destruction is also much higher. Engines are made to last so taking them apart requires time, effort and skilI."

Engine OEMs are often blamed for adopting strategies that limit the surplus parts market, which is worth around $3.5bn.

In the long-term, this could have an adverse effect on residual values as fewer MROs will be able to compete, and buyers of surplus material become reliant upon OEMs and their affiliated engine service agreements, says Narayen.

The various care packages all use OEM-controlled shops that exclude any PMA or DER parts and use as little as possible teardown parts from third parties, said an engine lessor.

"These OEM strategies will cause certain lessors — likely starting with those that focus on older equipment — to fall into bed with non-OEM MROs and teardown specialists, so welcoming DER in particular. This would secure a lower cost of ownership and a teardown exit. The OEMs may yet shoot themselves in the foot."

Sharp says existing engines will not be dumped in favour of MAX and NEO types, because the backlog for the current powerplants is huge. "Airlines are not going to retire the aircraft unless there is a significant hike in oil prices," he argues.

"As far as the MR1 and Embraer's new aircraft types [the E2 aircraft] go, we have no idea how the new engine types will perform. Once the honeymoon period for OEM support is over and the fleets are growing, we can make the investment decision. Which means we'll have to wait for five years from EIS [entry into service] to see how the market will look."