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:: October 2001 Newsletter ::

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Dear Fellow Returnees To Normality,

Let’s start this letter on a note of hope. As I write this, the Bush Administration has begun bombing Afghanistan. There could be a sustained campaign to wipe out terrorists, followed by a rebuilding of the country with aid. This inevitable move could well result in victory—the Brits are on our side, which for some reason makes me feel better. There is of course the prospect of retaliatory terror, but let’s hope that it ends here. I hope that by the time this letter reaches you, we are living in peace.

Once again, back to my job. If a relatively peaceful resolution is indeed in sight, this is good news for the aviation industry. We can start forecasting on the basis of economics and psychology, rather than waiting for the next round of violence. But the next few years look very bad. I’ve taken a first stab at the commercial jetliner numbers, with an updated overview included in this supplement. I’ve allowed for a repeat of the Gulf War effect, with a cyclical down cycle exacerbated by political events. The resulting numbers, sad to say, look a lot like 1995. Like the chart says, the coming down cycle was supposed to be painless. Other updates, by the way, include the Rafale, C-5, Beech 1900, Citation, and CL-215

This recession makes the outlook for new aircraft uncertain. It isn’t just the depressed demand side; the supply side is hurt too. Airbus claims that it will use $5.1 billion of its own funds on A380, but there’s no denying that revenue will fall as 2002/2003 production drops well below expectations. This means EADS will have to fund the A380 with cash that will come straight from anticipated profits. Our new forecast has a one-year slip in the A380 program, but it could easily slip further as EADS’s stock price gets hit. Boeing, of course, will have similar problems with Sonic Cruiser, although this is a less well-defined program, and it still doesn’t appear in our forecast.

The administration’s economic stimulus/bailout package will play a tangential role. An up front package of $15 billion in cash and loan guarantees for the airlines is merely a down payment, and the total economy will get hundreds of billions in aid, loan guarantees, and increased defense spending. This money should keep most of the airlines in business, but relatively little will trickle down to the manufacturers (even financially healthy Southwest is rumored to be backing away from order commitments). Ironically, this US Government rescue/subsidy program could do the most for the seriously beleaguered airlines—US Airways, Northwest, America West—that happen to be Airbus’s biggest US customers. However, the latest word is that the money could be provided on the basis of creditworthiness, not size. This would reward competent management.

Speaking of government support, the attacks appear to have resulted in a shift of power from the private to the public sector. Until recently, the role of government in economic life was increasingly restricted to interest rates and monetary policy. All of the sudden, the market is powerless, and government is looked to for salvation. Even Swissair looks set for a bailout of some kind—it could become the first Swiss company to be bailed out by the Swiss government since World War Two. Right now, the aviation part of the bailout seems necessary, but this increasing government economic role is not necessarily a good thing, and could become a Faustian Bargain. After all, lawmakers have a history of making all kinds of loopy demands in exchange for cash. Look for more protectionism and interventionism of all kinds, starting with “essential air service” demands on airlines.

Business aircraft are another trickier issue. There has been a lot of talk about how the attacks will increase the appeal of private jets, as travelers look for safety and try to avoid congested public infrastructure. Yet the reality could be somewhat different. In the short to medium run, we are in a serious recession, which means reduced travel and capital spending by businesses. This is never good for business jets, no matter what. There are also safety-related capacity constraints to be dealt with. But there is no denying the appeal of private aviation now. The bottom line: I’m sticking with my current numbers until something changes my mind (feel free to get in touch and ask for the latest spreadsheet, but it isn’t too different than the numbers in the May overview).

On the military aircraft front, we’re looking at a much safer market, with a higher potential upside. Depending on what happens next, we could have a $450 billion defense budget by FY 2004. The C-17 and V-22 will benefit heavily. On the fighter front, I expect the USN to rediscover its long-dormant stealth envy. Even though Afghan air space isn’t difficult to penetrate, it would be useful to fly over some neighboring countries with reduced risk of detection. This means good news for JSF, which could be accelerated.

To facilitate this, the Navy might push for a fast ramp-up of Hornet E/F (I’ve heard talk of 72, or even 96, per year). This would effectively “buy down” the program and finish it quickly, allowing for a faster transition to JSF. The Air Force might try the same thing with F-22, and given support for an F-22E stealth attack version, they might just get it.

Meanwhile, the JSF decision is scheduled for later this month. Time for a reiteration of my long-held opinion: Lockheed Martin will win. The reasons—industrial base, Air Force preference, etc—are fully outlined in my JSF report (just ask for a copy if you don’t have the latest). However, politicians are angling to ensure a large workshare for St. Louis, and if Lockheed Martin is smart, they will grant it. Hopefully, this will be a private sector solution. A DoD-mandated solution would be messy and expensive. Also, I have a strong feeling that Boeing will benefit from a Korean F-15 purchase in the next month. Korea may want to make a statement about its independence from the US some time by purchasing a foreign fighter. But now would not be a good time.

Anyway, I can make these predictions relatively fearlessly—I won’t be here to face the consequences. In the midst of some difficult times, I’m off on my honeymoon. I leave on October 17, and will return on November 5. If you need anything while I’m gone, you can either ask our Director of Corporate Analysis, Phil Finnegan (ext. 105) or Director of Operations Tim Storey (ext. 102).

When I return, I’ll update the JSF and F-15 reports. I’ll also update the EH 101 and NH-90, which have benefited from victories in the recent semi-unified Nordic helicopter buy. Other updates will include the Su-27, F-2, MD-11, and Lynx. Have a good fall, and let’s hope for the best.

Yours, ‘Til The Right Guys Win,

Richard Aboulafia
 

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