FOMO to FOMD - Premium 2018.6 Supply Chain Strains

In recent years, we’ve seen a surge in aircraft orders, particularly for the re-engined narrow-body models from Airbus and Boeing. Backlogs remain near all-time record highs, and the two large OEMs are each talking about producing more than 60 narrow-bodies per month, numbers that were unheard of only a few years ago. The industry is experiencing continued growth, and the impact of 5% annual growth has the industry doubling its output about every twelve years. In that process, during the introductions of new technology aircraft, we’ve seen a rush to obtain delivery positions that is substantially higher than in previous generations of aircraft. New models do spike interest in orders, but it appears we have a new factor in play, FOMO or the Fear of Missing Out. Air travel is essentially a commodity industry, and at least half of the market is price sensitive, moving to the lowest price option. Offering the lowest prices and maintaining margin requires having the lowest costs, and when a new more fuel-efficient model hits the market, particularly during periods of rising fuel prices, demand soars. But at the same time, new aircraft programs never seem to be on time. Airbus A380 and A350 experienced delays, Boeing’s 787 had multiple delays, Bombardier’s CSeries also had multiple delays, and even engine programs like the Pratt & Whitney GTF is well behind schedule and struggling to catch up as new problems have emerged. Airlines understand that OEMs have been conservative in increasing capacity, and are not only dealing with new materials but new manufacturing processes as well. Understanding the cyclicality of the industry, we can see why OEMs are conservative. But the result is when a new technology model is introduced with improved economics, orders now come more quickly than they did traditionally. The question is whether, after that initial spike, they settle back to more normal levels. The following chart shows narrow-body orders from 2000-2017. It is quite clear when the A320neo and Boeing 737 MAX were introduced in 2011 and 2012 respectively, given the spike in orders. We believe, to some degree, that fear of missing out influenced the substantial number of orders, which went far beyond what would normally be expected for growth. Examining the data in another way, we’ve charted orders by year since the initial order for a model. Because many models are introduced at mid-year air shows, the first year is often only half a year, with the second year showing the impact as customers finalize orders. In the narrow-body segment, we’ve seen unusual resilience in order levels staying high in recent aircraft, including the 737 MAX, buoyed by the introduction of the -10, and A321, buoyed by the new LR variant. The following chart shows orders by year since the initial order for the two main narrow-body families. The levels remain consistently upward and haven’t fallen as we’ve seen with other programs. Let’s contrast this with the wide-body market, in which the Boeing 787 and Airbus A350 generated substantial interest upon their introduction. That initial surge was followed by years with smaller order volumes, a more normal process historically for the industry. While the 787 delays resulted in substantial order cancellations, the order book did not grow at the same rate after the initial surge, despite the introduction of additional models. The A350 did not see the same initial rush as the 787, with a later spike resulting from a major order. The following chart shows data for wide-bodies by year. The growth rates for narrow-bodies has not slowed to the same degree as wide-bodies. They are well above the levels of two decades ago, and should be, given industry growth rates. Fear of Missing Deliveries Today, airline fears are changing, from fear of missing out to fear of missing delivery dates. With nearly 10,000 new technology narrow-bodies on order, those who are going to order for the most part have already decided their direction. Now the question is fill-in orders and changing the mix of models. But with the rush to increase production rates, the supply chain seems to have been left behind. Pratt & Whitney fell well behind in GTF production, and CFM is slightly late with its LEAP engine, causing delivery delays at both Airbus and Boeing. The OEMs are both looking to increase production rates, while the supply chain is unable to smoothly maintain current levels that are about 20% lower. As a result, for narrow-bodies, orders have remained strong, as nobody wants to give up their delivery positions in fear of future delays. Plus, with fuel prices low, receiving penalties for late deliveries and continuing to operate the last generation of aircraft isn’t a bad economic equation. Top-up orders and executing options appears to be happening a bit quicker than in the past, which may be a result of the fear of missing deliveries and having a well thought out fleet plan altered by production delays. The net impact, for narrow-bodies, is the same - a continuing strong order book at record levels. For wide-bodies, however, the rush is over, as there appears to be plenty of capacity and options to choose from with reasonable prospects of a near-term delivery. The Bottom Line OEMs are changing their focus from building order books to execution - building up production rates to a level that will meet demand and work off steep backlogs. While the OEMs are on board, planning to raise their rates to 60+ narrow-body aircraft per month, the supply chain has not necessarily reached the same conclusion. Without OEM guarantees of volume, some suppliers are loathe to invest in additional infrastructure, and it only takes one part out of several million to bring an aircraft program to a grinding halt. The more aggressive stance by OEMs with respect to the aftermarket has some suppliers worried about long-term cash flow. Programs like Boeing’s Partnering for Success were not matched to the same degree by Airbus, begging the question of their necessity in the minds of some suppliers. The net result is that a handful of suppliers are not ready for the ramp-up, and that could delay the ramp-ups to rate 60 and force OEMs to find second sources for various components. Boeing’s recent acquisition of a seat company is an example of bringing a problem area in-house to solve. Execution is now the industry watchword, with the supply chain a crucial element in that process. But bringing them on board, while pressing their margins and aftermarket, is a challenge akin to herding cats.

US Flight Planner	Airbus vs Boeing
US Airline Schedule Performance	Daily Production & Deliveries

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