Dear Fellow Old Economy Metal Benders,
Happy New Year, and (doesn’t it get irritating?) Happy New Millennium! As tradition demands, the first supplement of the year includes our annual macro overview of the industry, the World Aircraft Overview. If you want one e-mailed (for a color version), just let me know. There are also updates of the Comanche (still not good, I’m afraid), MiG-29 (much, much worse), B-2 (lots of upgrade money, and the faint glimmer of more planes), E-8 JSTARS (still popular, at least in the US), and S-92, among others. Also, I am removing the unsustainable contractor appendix; please replace it with the updated Pentagon contracts appendix.
I spent the day before Christmas in a popular Washington-area shopping mall. As my fiancé, Casey, and I wandered around looking for gifts, I reflected that visiting the mall was rather like watching a car crash in slow motion. The place was dead. Consumers were outnumbered by aggressive signs that trumpeted things like “40% off,” “SALE,” and “Bankruptcy Liquidation”. Demoralized shoppers, no doubt anecdote-rich victims of the NASDAQ crash, occasionally purchased lumps of designer coal from Pottery Barn.
I’m sure you’d like to hear more about my trip to the mall. But actually, I’m just using it to illustrate my perception of our economic times. I’m supposed to take economics into account when forecasting aircraft demand, which makes me even guiltier of malpractice than usual. But at the very least, let me try to relate our current economic direction to our industry.
For the most part, America’s economy has been in stellar shape over the past eight years. We’ve had an excellent combination of low inflation and rising wealth and strong demand. Greater use of information technology and supply chain management techniques reduced the danger of a premature and sudden fall off in demand at the supplier level, which meant that there was less danger of a recession. Most of all, our economy became extremely good at producing useful things at low cost. But right now, confidence is waning, due mostly to oil prices, politics, and a fear that corporate profits (and the stock market) are declining. In December, manufacturing activity in the US hit its lowest point since April 1991. Businesses and people are getting conservative. And after all, since everyone has spent the last eight years in acquisition mode, they kind of have all they really need anyway.
There’s really no better example of this than jetliners. Airbus, Boeing, and the regional guys have done an admirable job, from the consumer’s standpoint. The manufacturers produced large numbers of planes that everyone wanted, and sold them at market share war prices. They convinced airlines to replace older, fully amortized planes at a faster than expected rate. The builders kind of put the cart before the horse, and sold a lot of planes before they cut their manufacturing costs, which meant profits took a hit, but they have started to make money again.
So, what do I think about the civil aircraft market in the coming year? A potent combination of overinvestment in recent years, and a well-founded concern about profitability, may well lead airlines to defer many orders. I’m particularly concerned about narrowbodies, which are heavily dependent on US orders, and have been the biggest beneficiary of the orders boom.
That leads us to the much-vaunted backlog. Still near a record high, eh? Well, not really. Over 35% of it belongs to lessors. As I have written before, these guys are enjoying a risk-free ride here. They are well prepared to take advantage of a growth market, but in the event of a downturn (i.e., what will probably happen next) they can basically cancel or defer orders at their convenience. And, as ever, a certain percentage of the backlog is permafrost—planes that will never be delivered, but remain on the books. All told, about half the backlog is less than firm. And even the truly firm orders can be deferred, with no real cost to the buyer.
Right now, I’m cautiously optimistic. Assuming the recession stays mild, we should see a relatively soft landing for airlines and manufacturers. The narrowbody segment is going to shrink, but this will not be 1995 all over again. One complication to all of this is the sudden round of airline consolidation. The UAL/USAir/AMR/TWA mergers could lead to others, which might lead to some cancellations. I’m convinced the AMR/TWA merger will get rid of about half the 717 order book. Incidentally, if you want the latest jetliner numbers, just send me an e-mail.
As for the manufacturers, Boeing has done the best job of preparing itself for a downturn. First, they have indeed made progress on profitability—commercial margins are back near 10%, and there appears to be room for improvement. The emphasis on developing new service initiatives will lead to a few miss-steps, but for the most part, it’s a good way to add value, and develop counter-cyclical businesses. As for Airbus, well, we can’t really tell. Maybe AIC will become more transparent.
Next month: F-16, B-1, 777, A330, and the Fighter and Special Mission overviews. Have a great month, and try not to get snowed in at any of our nation’s airports.
See You In Cattle Class,
Richard Aboulafia
(703) 385-1992 ext. 103—Office
raboulafia@tealgroup.com