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:: November 2001 Newsletter ::

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Dear Aircraft-Minded Shoppers,

It’s that time of year again—time to go to the mall. You might remember my last report from the mall. I forget when it was, but suffice to say that things were grim. No one was buying anything, save the occasional lump of Pottery Barn designer coal. Well, things were different this time. People were buying carloads of stuff. Good news? Hardly. Checked the price tags. Wow. Cheap as hell. Everything seemed like a good deal to me, and I’m a hopeless cheapskate. Replaced my TV (stolen when my lamebrain contractor left the back door open) with a better one, which cost about $100 less than the old one that I bought three years ago.

Yep, things are a bargain these days. We’re refinancing the house at some absurdly low interest rate. The NY Times reports that gas is now 25% cheaper than in June. There’s lots of unused industrial capacity and demand was waning, so prices have dropped. Across the board, we’re staring deflation in the face.

Needless to say, the airlines have it worst of all. September 11 and that AMR A300 crash added fear to recession, a uniquely potent mix. Yet a funny thing has happened to pricing. Even though ticket prices are falling, airlines are still trying to keep vestiges of the old pricing structure intact. Business fares remain outrageously high (even for economy class), while leisure travel prices have dropped. Even those idiotic $2,000 economy no-Saturday-stayover fares (which fellow analyst John Walsh calls “mad pricing disease”) are in place. To shore up ticket prices and keep things from entering a discount freefall, airlines have been cutting capacity and costs (they’re helped by oil prices, which, again, have fallen well below $20 per barrel).

To a certain extent, these airlines might be right—pricing might be salvageable. After all, commodity and manufactured goods prices have fallen drastically, but service economy prices have not (you’re still paying exactly the same price for your Teal Aircraft Binder subscription service, right?). But then there’s that small matter of Southwest. The much-loved (and consistently profitable) Texas discount carrier seems to be saying “forget pricing. It’s broken and you can’t fix it.” They aren’t cutting capacity. They’ve hinted that they might actually expand. And most of all, they’re offering steep discounts to keep America flying (exactly like GM, with its “keep America rolling” discounts). They seem to be doing well enough. Unlike the other guys, at least, they aren’t hemorrhaging cash.

At this point you might be thinking, “Richard, you are absolutely not an airline analyst, nor are you an economist. Why are you pretending?” Good question. I’m trying to get my hands around this complex issue (of which I admittedly know little) because more than ever, airline health has a huge effect on what happens next in jetliner manufacturing. Which, last time I checked my job description in the help-wanted ads, I cover.

So back to the airlines. Those guys choosing to cut costs and capacity? They ain’t taking planes. Southwest and the other semi-healthy discounters? Neither are they. Southwest’s post-September 11 strategy may keep its system and business volume intact, but their profits are falling. When Southwest and friends do start taking planes, they’ll be demanding lower prices and other concessions. Airbus and Boeing, of course, will pass these low prices down to their subcontractors (“Ask about our ‘share the pain’ program”).

Obviously, the jetliner guys are in a world of hurt. There may be good survival strategies for the airlines to follow in a time of low demand and overcapacity, but none of these strategies will benefit the manufacturers. And again, there are some extremely dark spots. Look at Airbus’s narrowbody backlog—it’s heavily North American, and not exactly high end North American. Does anybody think America West, Northwest, or US Airways will take any A319/320s in 2002 or 2003? (Incidentally, once again, feel free to ask anytime for the latest jetliner spreadsheet—it changes weekly).

This leads to the question of whether the manufacturers will want to help the airlines take delivery of planes (or, more correctly, convince them to take un-needed planes) by getting more involved in financing. Until the recent disaster, finance was seen as a major new business area for aerospace manufacturers. Following GE’s model, Boeing was rapidly growing its finance portfolio, for profit, not necessity. Even Airbus was slowly getting the message. Yet now, finance might become a new place to hide bad news. Superficially, airlines could take planes, and pricing could remain stable. But finance packages would hide myriad horrors, and these wouldn’t be discovered until a year or more later. By then, things in the market might be better. If they aren’t, watch the companies involved feel some serious pain.

In short, Airbus and Boeing are going to have to decide how much of their own balance sheet to risk to keep the market from collapsing. And it might be better than copying the “please buy our merchandise at 40% off” scene at the mall.

Regarding this supplement, it features our first Lockheed Martin F-35 report. The plane that won JSF looks a lot like a single engine F-22, and is in fairly good shape, compared with a year ago. A model of the losing contender, Boeing’s X-32, sits on my desk, reminding me of the high price of failure (like I need yet another reminder). I hope the prototypes, which resemble some weird frog/bat hybrid, find their way to testing facilities and lead productive, if orphaned, lives.

For December, we’ll take a good hard critical look at the A380 program. I allowed for a one-year delay in October’s Commercial Jet overview; I think it might slip some more. Rumors and news about EADS and Airbus arrive hourly, and it’s clear the A380’s fate has as much to do with industrial politics as market demand. There’ll be an epitaph update for BAE’s long-running 146/RJ/RJX, which is in the process of dying as this is written. We’ll also update the F/A-18E/F, F-14, AH-64, E-3/E-737 AWACS, Dassault’s Falcon, and other key programs. Call or e-mail with requests, and have an excellent holiday season.

Yours, ‘Til We Cut The Price Of This Binder,

Richard Aboulafia
 

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