RichardAboulafia.com 

:: July 2014 Letter ::

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Dear Fellow Air Show Shirkers,

Last week, I had some extra time to catch up on newspapers, supervise our helpful interns, and return emails to old pals. In other words, I didnít go to Farnborough for the first time in over a decade. But I got the gist of the show in one helpful New York Times article, which doesnít mention air shows or jets at all. Itís called, Welcome to the Everything Boom, or Maybe the Everything Bubble, and you can find it at tinyurl.com/o36ywqm. I recommend reading it, but here are two key takeaways:

1. Thereís lots of cash sloshing around out there, in part because companies (and investors and banks) donít see much worthwhile to spend it on. As a result, thereís ďa shortage of good investment opportunities to deploy that savingsĒ and booming demand for safe assets.

2. There arenít a lot of new investment opportunities (industrial projects, plant expansions, etc.) out there, even though thereís plenty of cash. This lack of investment opportunities, along with central banksí loose monetary policies and a high global savings levels, is contributing to all the cash sloshing around out there.

These two points are essential to understanding the jetliner industry and the air show that just finished. The first point (plentiful cash at low interest rates) was one of two key factors driving the jetliner market to massively outperform the rest of the world economy during the Great Recession (expensive fuel was the other factor). Jetliners, after all, are safe assets: theyíre mobile, long-lived, revenue-producing, with relatively predictable values.

But even with the recession largely over, lots of cash is still pouring into jetliner finance, piling onto a trillion dollar backlog. Thus, demand for jets continues to be quite strong, but mostly from money people, not airlines. In all, of the large jetliner orders at Farnborough, 65% came from lessors and financiers, which might be an air show record.

Not all of this money is smart money. In fact, thereís talk that the smart money is starting to move away from jetliners. Hopefully, the OEMs will remain sober about production rates, but weíre raising our forecast to reflect the inevitable exuberance that comes from ongoing record order numbers. Sure, raising rates means damage to aircraft longevity and therefore aftermarket revenue, but as the OEMs say, ďpeople want jets now; we donít want to tell them they canít have them.Ē

The second point, a lack of new investment opportunities, is more intriguing. On this one, our industry isnít diverging from the global economy. Rather, weíre belatedly following it. Weíre moving away from new planes and towards derivatives, because the large companies that drive this market no longer see the value proposition of clean sheet designs. Consider the following evidence:

1. The A330neo. Launched at Farnborough, it represents a belated recognition that the A350-800 was a foolish idea, and that re-engining the A330 was Airbusís only way to stay in the 250/300-seat market. You can count on Airbus to launch the right productÖafter theyíve exhausted all of the alternatives. But for customers who donít need the 787ís range, an A330neo is a good option. We expect a market for at least 600 jets.

2. Almost all those other Farnborough orders were suffixed by Neo, MAX, X, or E2. This was a show almost completely dominated by major derivatives, which clearly sell well.

3. Consider the last round of new clean-sheet designs. The A380 was just a bad idea. Bombardierís CSeries has put the company in dire straits, and itís in danger of being crushed between two derivatives, the A320neo and Embraerís E2. The 787 is a great plane, and may, one day, even be profitable. But then again, some say that if Boeing had gone with a 767neo, it might have gotten 75% of the success at 10% of the nonrecurring cost. As for the A350XWB, after the A330neo was launched, there were plenty of voices saying that Airbus was merely reverting back to the first version of the A350, and that the A350XWB was merely an expensive mis-step. Thatís not my view, but it is being said.

4. The OEMs say so. Earlier this year, Airbusís Tom Enders said he didnít see the company introducing a new clean-sheet jet until 2030. He told Bloomberg last year, ďWhy should we spend large amounts of money when we can make significant incremental improvements?Ē Thatís a decade-long new jet vacation. As for Boeing, in May Jim McNerney told investors that ďthe more-for-less world will not let you pursue moonshots,Ē his term for all-new jets, and his way of further implying that Boeing was no longer an engineering company. Clearly, these adversaries have found something to agree about.

Now, a few thoughts on the consequences of these two mega-trends:

1. The large jet duopoly is secure for decades to come. Airbus and Boeing now have 11,000 jets on backlog. Combined output is headed north of 1,400 jets. Volumes like these give a tremendous pricing advantage to incumbents (thatís the key factor working against the CSeries). As if that isnít de-motivational enough, that lack of new investment opportunities extends to newcomers too. How would they find incumbent product line gaps large enough to justify a new product, and what new proprietary technologies could they discover to justify a new product? It isnít just the CSeries. The MS-21, C919, and ARJ21 are in an even worse position.

2. Engine OEMs are in the driverís seat. New jet engines are the only new technology thatís guaranteed to pay its way on new aircraft models. That should give the engine primes stronger market power than theyíve had in the past. But they will also suffer from shorter product lifetimes and diminished aftermarket expectations. The days of 40-year engine programs and 30-year engines with aftermarket parts appetites like the JT8D are over, and these numbers will further decrease.

3. Iím not sure Airbus and Boeing are correct. Yes, large derivatives are in vogue. But Airbus may have a real problem responding to the 777-9X without a clean-sheet design. And Boeing may need a clean-sheet 757 replacement, both because itís a good opportunity and because of the A321neoís success. In short, the pendulum could swing back towards new jets in a few years.

So, I spent Farnborough week staycationing in a Barcalounger, catching up on newspapers, and taking notes with an envelope and a pen. But I think better in air conditioning, and thatís something that Britain simply doesnít have. And I had more time to supervise Tealís July Aircraft reports. In addition to the annual Jetliner overview, weíve updated the UH-60, SH/MH-60, and the jetliner inventory. Have a great month.

Yours, ĎTil My Air Show Hiatus Ends,
Richard Aboulafia
 

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