Premium #126 – The Regional Jet Market Evolves

The regional jet market continues to live in the shadow of the mainline aircraft segment. However changes are taking place that seem to be redefining both the single-aisle mainline segment and the regional jet segment. Typically thought of as the sub-100 seat segment, regional jets are starting to cross this barrier. Looking back, we’ve seen the 19-seat aircraft disappear, then 34-seat aircraft disappear, now the 50-seaters are disappearing. What constitutes a regional jet nowadays? Last week we discussed the implications of the higher seating capacity being added to single-aisle aircraft by Airbus and Boeing. It appears that the two big OEMs are moving their focus upward in capacity terms. Does this leave the sub-150 seat market with a gap? Does it look like regional jets can move into this space? The following chart illustrates how the global regional fleet is rapidly evolving away from older aircraft. The solid lines show the 50-seat aircraft from the two main OEMs in the segment. The dashed lines show the 70+-seat aircraft from the same firms. As the chart shows, the largest aircraft, the Embraer E-Jet is the most popular. Size matters. Airlines constantly seek lowest costs and the evidence is that larger aircraft, all things being equal, provide this. When fuel was cheaper, the idea of a 50-seat jet was novel and embraced by both passengers and airlines alike. It was especially attractive in the United States where many small communities could be connected to a hub. Speed between the outlying communities and the hub made regional jets attractive. It also extended the size of the one-hour regional catchment area from 250 miles using turboprops to 500 miles using a jet, offering more small cities the opportunity to connect through more distant hubs. The following chart illustrates the steady growth in regional jet seating capacity. From 2011 the industry appears to have settled on a standard just below 70 seats, and within the US-scope clause. The following chart illustrates the significant changes Embraer has seen in its fleet deployment in Europe. The smaller ERJs have seen a decline in use while the largest of Embraer’s aircraft have seen wide acceptance. The Embraer experience is not unique – Bombardier has seen the same thing, as the following chart illustrates. European regional airlines do not suffer from scope clause constraints as do regional airlines in the United States. This means they are more likely to seek larger aircraft. For example as of 1Q14, 64% of the world’s CRJ-1000s were deployed in Europe. Embraer’s E-190 has 17.8% and of the E-195 has 51.5% of the fleet deployed in Europe. Even as regional airlines move to larger jets, the operational impacts on their business are changing as well. The following charts from the US-based Regional Airlines Association illustrate the changing seat capacity and stage lengths. Whereas mainline aircraft hover around an average of 160 seats, regional aircraft seating is growing. Mainline airlines are also evolving fleets – moving from A319s to A320s, and A320s to A321s, and similarly from 737-700s to 737-800s. So what does this evolution portend? Industry consolidation has played a role obviously - but this is mostly in the United States. However the United States has been a leader in deployment of regional jets and therefore acts like a canary in the coalmine. Fortunately the biggest and most significant US consolidation steps are complete. In a way, the worst has happened. The US-regionals which survived may continue to exist. Outside the United States regional airlines never saw as much growth potential, and did not have that far to fall when times went bad. Regional jet operators in Europe are typically major airlines feeding their own networks, such as KLM and Lufthansa. KLM, for example, selected the E-190 to replace its Fokkers after that company closed. KLM selected the E-190 because of its cargo capacity which is greater than that of the CRJ. Another competitive force facing regional jets is improved turboprops. An example is Bombardier’s Q400NG, with near jet speed capability at substantially better fuel burn. On routes under 500 miles the Q400 is a more economical aircraft and seats 74, which puts it right at the bottom of the newer larger regional jets in capacity terms. ATR and Bombardier have been trying to make sense of developing a 90-seater turboprop. Regional jets are seeing the floor being cut away under them by ever improving turboprops on routes, possibly up to 750 miles. The newest turboprops have noise and vibration cancellation technologies that make flights much more “jet-like”. US-based regional airlines face predictable revenue streams once they have landed a contract to fly for a major. But bidding for that service is tough. It is being made tougher as majors also evolve their business models. An example is American Airlines buying E-175s and then getting Compass, a regional airline, to fly them on its behalf. With each additional step taken by a major, the regional has less room to find efficiencies. A successful regional has to live off its margin – truly a game of survival. Scope clause is an issue that makes the United States a unique market. Almost all of the US-based airline pilot union contracts — Alaska Airlines is a notable exception — forbids them from outsourcing flying to any aircraft certificated in the U.S. with an MTOW exceeding 86,000lb. Essentially, the scope clause provides job security for pilots governed by the provisions of a collective bargaining agreement. This is a complicated issue. Airlines continually chip away at scope, but with each chip they end up negotiating an offsetting benefit for pilots. Pilots are well placed among organized airline employee groups to protect their benefits. Absent scope clauses, we would see US-regionals flying even larger aircraft. Seat-mile economics would ensure this and are the primary driver for chipping away at scope clause restrictions. Outside the United States regional airlines do not face scope clause restrictions. In these markets there is a clear drive to seek better economics. By reducing frequencies that larger aircraft allow, an airline can carry the same traffic at lower cost. Of course in some markets such as China and the EU, high speed rail acts as an effective competitor. Russia has attracted some retired western 50-seater regional jets. Since 50-seater aircraft are now trading at low capital costs, the operating economics are attractive. The next chart illustrates how values for 50 seat RJs have fallen. Clearly for certain markets, smaller and older regional aircraft can be put to good economic use. That said, even within the tough United States market, many 50-seater regional jets are still hard at work. Bottom Line The regional jet market faces ongoing evolutionary forces. Within the United States these are playing out of the consolidation and labor contracts. Outside the United States it is much more a game of economics and capital costs. Evolving technology in terms of high speed trains and better turboprops serve to keep the pressure on. But as we see it, the market for regional jets will respond by also deploying technologies such as better engines (better fuel burn, lower noise) and refining winglets and fuselage drag reduction. We also expect to regional airlines outside the United States acquiring larger regional jets as budgets allow. Regional jets are growing – just like mainline jets. There are artificial constraints restricting this segment of the US market. These include scope clauses, and capital availability for regional airlines. The next generation aircraft from Embraer and Bombardier are even larger – 100-130-150 seat aircraft. These are likely to be attractive options to unconstrained regional airlines. We’ve seen regional aircraft disappear – 19-seat and 34-seat turboprops are virtually gone. The 50-seat regional jet is going through a natural demise with no new replacements, and today’s market is between 70-100 seats for pure regional jets (CRJ, MRJ, SSJ, E175, E190) and emerging into the 100-130 seat market (CS, E2). Plus, turboprops are growing in capabilities. We come down to a key question - what is a regional jet? Are the CSeries and E2 regional or a mainline aircraft? In the US it is mainline (albeit a regional is the largest CSeries customer). In the rest of the world, it fits both – Malmo is a regional, but Gulf Air and Air Baltic are both mainline carriers. The lines are blurring between regional and mainline with the new generation that will replace older 737-700 and A319 models, as well as smaller regional jets. And because they are “tweeners”, they are harder to position for and market to airlines. The new generation of aircraft can be both regional and mainline, depending on markets. The CS300 and E2-195 will be A319/737-700 sized aircraft, traditionally the territory of the majors. But because they come from the manufacturers of regional jets, are they the logical “step-up” for regional airlines as well? Probably not, because there is still a watershed at the 100-seat level, where other newcomers such as Mitsubishi and Superjet are focusing. What it means is that the market from 100-150 seats is still being re-defined, and new aircraft could address both segments. Figuring out who the buyers are is the challenge, as Bombardier and Embraer are learning.

No results