:: June 2009 Letter ::
Ask any auto company crash test dummy. The only thing worse than crashing in a car without an air bag is crashing without an air bag while under the illusion that you do actually have one. The jetliner industry finds itself in a serious air transport market downturn. For years now we've heard exhortations not to worry; no matter what happens, the large backlog would insulate us from anything bad that happens. It's increasingly clear that it won't.
I had this thought at Le Bourget this year. There were people at the show - otherwise smart, rational people - who actually cared about new orders. You can see how the industry got the jetliner orders monkey on its back. Check out the chest-thumping headlines from air shows over the past six years (2003-2008). Monster orders, outlandish market share claims, and the promise of eternal growth all got people hooked. By Le Bourget 2009, there was little to work with by way of potential orders. Airbus scored with an MoU from Wizz Air, a recycled A350XWB order from Air Asia X, and some anti-Boeing/anti-Bombardier bloviation from Qatar's Akbar Al Baker. Boeing scored with some UAV buzz, a few F-15 sales rumors, and not much else. As an aside, at the last Paris we expected the big stars this time around to be the A400M, 787, and F-22. All were conspicuously absent.
Unfortunately, all those glorious headlines from recent shows heralded an illusory backlog. Anyone searching for orders at the show need merely look at the Airbus and Boeing web sites. The two big primes alone have 7,200 jets - seven years of production at current rates - on backlog. If the backlog mattered at all, how would new orders be even remotely consequential? Instead of orders, we need traffic, and aside from show attendees, you weren't going to find it at Le Bourget. It's a simple and timeless equation. When airlines make money, they order planes. If they keep making money, they take delivery of those planes.
The air transport industry most certainly isn't making money. Sure, the main indicators are stabilizing, but they are still grim, and there are no signs of the kind of growth drivers needed to get us back to first half 2008 traffic any time in the next few years. In a business desperate for hope, May's 17.4% cargo drop (FTKs) is practically a green shoot compared with the apocalyptic twentysomething percent drops we'd seen during the previous six months. Passenger traffic, down 9.3% year over year in May, shows no signs of improvement. Even the Mideast backlog kings face a miserable traffic environment. IATA's numbers are far from comprehensive, but there's absolutely no way to sugarcoat their expectation of $9 billion in airline industry losses this year.
That brings us to the main debate at Paris. Airbus and Boeing insisted that current jetliner production rates will hold, plus or minus a few percent. Much of the supplier base thinks they're nuts, and that further jetliner production rate cuts are inevitable. Airbus CEO Tom Enders said at the show that even if 1,000 jet orders were cancelled, Airbus would still have years of production at current rates. To quote George Stephanopolous, "Like all good spin, it was a hope dressed up as an observation." The backlog, like the market, tends to behave as a surprisingly cohesive entity. For example, at the last market peak (January 2001) there were 3,200 jets on backlog. At the bottom of the last market trough (January 2003) there were 2,700 jets on backlog. That modest reduction was more than accounted for by deliveries. Only 80 cancellations were recorded in 2002/2003, so the core backlog remained intact. Yet production rates fell by 30%. People deferred en masse, and the backlog did nothing to protect the industry.
For a worst case scenario, look at business jets. That aviation market has been hit harder than any other by the present downturn, and Cessna and Gulfstream were both absent from Le Bourget. Cessna provides the best illustration of backlog weakness. Up until the fourth quarter of last year the company planned to build 525 Citations in 2009, up from 467 in 2008. In November, it cut the number slightly, to 495. In late January it cut 2009 production to 375 jets, and in April this number was cut again to 290-300. Of these, about one-third are $3 million Mustang VLJs, so the drop in value was even greater than the drop in units.
Yet Cessna's backlog didn't change much with these announcements. In late 2008 the company said it had a $14.5 billion backlog. At the end of the first quarter of 2009, the company announced a $13 billion backlog. Orders had slowed to a trickle, so as with the 2002/2003 jetliner market the only changes were due to deliveries of existing orders and a small number of cancellations (92 net in the quarter). Those massive production rate reductions are almost completely due to deferrals, against which backlog announcements are meaningless. It's the same dynamic as in the airline industry. If corporations and high net worth individuals make money, they order business jets. If they keep making money, they take delivery of those jets.
You see a similar phenomenon in other segments of the manufacturing economy. During the 2003-2008 boom, backlogs were touted by everyone from luxury yacht builders to luxury home builders as proof that their fortunes would hold up even if demand softened and new sales collapsed. Harley-Davidson even put buyers on a waiting list. Yet just after the bad times hit, abandoned yachts started clogging the coast, and the less said about houses the better. If you'd like a Harley, there are many available, at a discount. UBS motorcycle analyst Robin Farley says sales have "hit a wall" and thinks production will fall about 20% this year.
The jetliner guys aren't completely in denial about the hard times. Rather, jet production is a lagging economic indicator, and if something miraculous happens and world economic growth resumes this year, we could see the current production rates continue. Airbus and Boeing are actually being rational. Inadequate supply chain capacity can suppress jet production in good times, and if they think we'll snap back fast, it makes sense to stay the course. They don't want suppliers to cut capacity. From the suppliers' perspective, there's little hope of that fast recovery, and much to be lost from having inventory, workforce, and plant that's suddenly idle. They too are being quite rational.
In conclusion, this business remains every bit as cyclical as the outside world. So, backlogs are a lot like your 401K. In good times they produce good feelings and a false sense of security. In bad times, they're completely unreliable. Assuming that the economy doesn't recover until late 2010, delivery rates will fall by 30%, with a trough year in 2012.
I had expected that the 787 ramp-up would insulate Boeing and the aircraft's suppliers from the worst of this. That doesn't look like it will happen. But that's the subject of another letter. This month, we've updated the Trainer and Military Transport market overviews, as well as India's LCA and ALH, the Learjet family, the Tornado, AMX, MD-80, and Rooivalk. Have a good month.
Yours, 'Til Teal Gets Through Its Firm $475 Million Consulting Backlog,
© Richard Aboulafia 1997-2006, All rights reserved.