Premium #183 – Are We Headed for an Aviation Downturn?

There is good and bad news as we take a look at the near future in commercial aviation. The good news is that most programs have large backlogs that provide steady deliveries for the foreseeable future. The bad news is that some economic warning signs are on the horizon, which could signal a downturn that could impact the markets. We begin with some of the leading indicators - orders for large business jets. This sector has led the recovery in business jets in recent years, but appears to be slowing. While Gulfstream and its new G650 have remained strong, sales for Bombardier and Dassault appear weak. That weakness is coming from Asian markets, which when combined with continued weakness in the small and medium sectors that are recovering slowly from the 2007 recession, is indicative of economic turbulence ahead. If economic turbulence hits the Asian market, it will impact orders for narrow-body aircraft in particularly. Examining the backlogs for Airbus and Boeing for their A320 and 737 families, we find that around half of the orders come from the Asia-Pacific region, many from carriers that might be not survive a recession. We believe that 25% of the orders could be vulnerable to cancellation when the next Asian economic correction arrives. We’ve seen already this year a major rise in Chinese stocks, a bubble created, and that bubble begin to burst. Looking at the 5 year chart for the Shanghai Shenzhen CSI 300 Index, there has been a meteoric recent rise, then a major correction. The question is whether a further correction will be necessary, and what that will mean for the Chinese economy. A level between 2,500 and 3,000, rather than near 4,000 would seem logical here, and another downturn would not be surprising. Most bubbles end up bursting - sooner or later. Does this appear to be a bubble? Our view is yes. The relevant question, therefore is not if, but when, and to what degree. As markets reflect economies, and economic growth, we would expect an Asian slowdown led by the Chinese market. With the Chinese economy already showing weakness, and outsourced jobs formerly done in China now being exported to Vietnam and even emerging Myanmar, will the downturn have a major impact? We believe it could. The Implications for Commercial Aviation We all recognize that air traffic is closely related to GDP. If China enters a recession, the impact on Asian markets could be significant. With slowing traffic, airlines will either defer or cancel orders for new aircraft, forcing OEMs to juggle their backlogs. Of course, should such a correction come later this year or early next year, could it have an impact on the expansion plans at Airbus and Boeing? It seems that the timing for those production increases match closely the historic patterns of a recession for the airline industry every 8-10 years. We believe the next recession will result from corrections in the Chinese economy, which appears to be faltering. With a seven year backlog, on the surface, there appears to be little risk to Airbus and Boeing for current narrow-body production. But with each considering massive production increases to more than 50 aircraft per month, a downturn in demand that begins next year could exacerbate the supply-demand balance for aircraft, resulting in a weakening market for new aircraft orders. Each of the big two is relying on cash flow from narrow-bodies to cover weaknesses in key wide-body programs -- in particularly the 787 at Boeing that is still not breaking even, and at Airbus the A380, which Airbus says will finally break even at the end of this year. A pan-Asian downturn, starting in China, could impact a number of large aircraft orders. Lion Air in Indonesia has a massive order book, with nearly 500 aircraft. Will they be able to take delivery of them all? We believe it is doubtful. Will other Asian LCCs remain successful as leisure markets fall? Doubtful as well. The backlog of narrow-body airliners for Asian carriers is significant. For just the new models, A320neo and 737MAX families, there are currently commitments for more than 1,540 from Airbus (about 40% of firm orders) and 644 from Boeing (about 23% of firm orders). Even if only 1 in 5 were cancelled or deferred, it would have a significant impact on the industry. The Bottom Line Cash flow for the Big Two aircraft OEMs is increasingly reliant on Asia. Asian markets appear headed for some trouble, with a weakening Chinese economy leading the way. Is this really the right time to increase supply, when the region with the most orders on the books appears to be significantly weakening? While time will tell, the planned narrow-body production increases at Boeing and Airbus may be coming at exactly the wrong time.

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