The huge backlogs Airbus and Boeing have for single aisle aircraft are well known. Both firms have backlogs of about seven years at current production levels. Both firms are talking about and planning to increase their production rates to bring down the backlogs. We think this bubble keeps building.
As readers know, we have been of the view that an order bubble exists and we are not alone in this view. But this view is not held by the two big OEMs; they are confident that ordered aircraft will be delivered and production increases are justified.
What evidence can we offer to support our bubble thesis? Take a look at the next two charts. Start with the blue lines showing deliveries and then consider the orange lines showing retirements. You would likely agree; retirements are relatively low compared to deliveries.
To graphically illustrate this order vs retirement issue take a look at this next chart. It seems to us self-evident that retirements are not coming nearly fast enough. After all, average annual retirements for the A320 fleet is 21% between 2000 and 2015 and for the 737 it was 5%. While the 737 has a second life as a freighter, this could explain some of the difference, but not that much. The difference between the two does invite the question whether operators get more life out of a 737 than an A320, but that is not the focus here.
How many aircraft are we talking about? There have not been as many retirements as one might have expected. Both these aircraft are well made and last a long time. There were 1,164 A320s retired between 2000 and 2015, while 8,971 were ordered. For the 737 the respective numbers were 242 retired and 7,048 ordered.
So why are the A320 and 737 fleets seeing such large orders? The biggest driver in fleet growth has to be demand. As the next chart illustrates, looking at IATA and US DoT data compared to A320 and 737 fleet sizes, it would appear airlines and lessors have basically got it right with orders. The US DoT data suggests slower growth than IATA’s which make sense, as the US market is mature whereas IATA includes faster growing global markets.
Aircraft fleets of both types have grown as low cost airlines have multiplied, and this has helped older aircraft stay in service too. But as air travel has evolved, aircraft size has barely changed. The following chart comes from Boeing’s 2015-2034 Outlook. As Boeing points out: “As the LCC business model continues to grow, more point-to-point flying is occurring. In 1994, LCCs provided less than 10 percent of all short-haul flights (less than 3,000 miles), the majority of which Southwest flew. Today, LCCs fly almost 30 percent of short-haul flights. There are regions of the world—such as Europe, Southeast Asia, and North America—where this trend is more common.”
This could explain the growing popularity of the A320 and 737s. These aircraft carry the bulk of the traffic, and are especially suited to LCC operations.
This may partly explain the backlog – both OEMs have big backlogs as airlines want to keep growing. But are they retiring older aircraft fast enough to justify the order levels and backlog?
Last year was not as great for orders and this year, so far, looks even worse than last. Even with the traffic growth and robust LCC model working well, it may be that the airlines and lessors are reaching a point of saturation for the A320 and 737. At least until markets grow to a point where more new aircraft are needed and older ones are retired faster.
Retirements have slowed because of two issues: cheaper fuel and inability to get new aircraft fast enough. The second point is what drives Airbus and Boeing to increase production.
Is this production increase warranted? Only if the orders recover quickly to earlier levels and retirements accelerate. The evidence we see shows slow retirements continuing and a significant softening in orders.
Nothing on the horizon looks like changing this. This next table shows 737 deliveries from 2013 through April 2016 for the top 20 markets. The number of blanks for 2016 are eye opening. Look at the drop-offs in key markets like China, Indonesia and India. Even if we triple the numbers for a full year estimate, the US looks robust, but China looks anemic. Ireland (lessors and Ryanair) is likely to stay strong. Is the party over?
The evidence is mixed. One can choose to infer which data better argues a point of view, either there is a bubble or there isn’t one.
Our view is that despite traffic growth, we see production of A320s and 737s exceeding market ability to deploy the aircraft.
- Not only do we think that order levels are higher than market growth, we notice that some orders are being deferred (despite talk of faster production).
- Oil prices are down and emerging markets that were big aircraft buyers are out of steam. These are factors that do not support huge backlogs.
- Airlines like Southwest, Allegiant and Delta, with money to afford new planes, are cherry picking the second hand market and they are not unique – again not supportive of the backlog.
- Lessors are like a canary in the coal mine:
- In 2015 Air Lease Corp. earned 22.6% of its revenue in China, up from 22.1% in 2014 and 15.1% in 2013. In their 2015 annual report the company states: “We are indirectly subject to many of the economic and political risks associated with emerging markets, including China, which could negatively affect our financial condition, cash flow and results of operations.”
- Aircastle reported in its 2015 annual report: “There is also risk of oversupply in the future driven by large outstanding order books of some Asian airlines. Demand weaknesses, due to slowing economic growth in the region, could adversely affect the Asian airlines industry.”
- AerCap reported in its 2015 annual report: “Specifically, the debt crisis in certain European countries could cause the value of the Euro to deteriorate, thus reducing the purchasing power of our European customers. Concerns have also recently developed regarding the sovereign debt of Russia and certain Latin American countries, including Argentina and Venezuela.”
- The 2015 Singapore air show saw orders down 75% on the previous show – and this is Asia’s biggest aero-event. Asian air travel growth is supposed to be the industry’s next growth engine.
- Finally, Goldman Sachs reported: “There are 1,552 narrow body leases expiring through 2020, 54% of which will be 12 years old or less. Separately, lessors are taking delivery of 1,671 narrow body aircraft over the same time frame, of which Ascend data shows only 44% are placed with an airline (the rest are still speculative). Over 900 narrow body aircraft are scheduled to be delivered to lessors over the next five years that are unplaced. This creates the possibility of double-counting and a lot of potential competition with new orders. Many lessors have spoken out against the latest narrow body production rate hikes from Boeing and Airbus, saying it will drive oversupply. Lessors make up 20% of the 10,000 unit narrow body backlog.”
Our view on this bubble is apparently in good company.
Co-Founder AirInsight. My previous life includes stints at Shell South Africa, CIC Research, and PA Consulting. Got bitten by the aviation bug and ended up an Avgeek. Then the data bug got me, making me a curious Avgeek seeking data-driven logic. Also, I appreciate conversations with smart people from whom I learn so much. Summary: I am very fortunate to work with and converse with great people.
All it will take is another 9-11 attack and or a fuel spike and the bubble will burst. Too many planes parked in the desert that are still useful and the majors are still buying used frames. The current narrow body production numbers will be unsustainable in the near future.
Boeing forecasts demand for 26,730 single-aisles over the next 20 years.
Airbus forecasts demand for 22,900 single-aisles over the next 20 years.
The two of them together are planning to actually build about 26,300 single aisles in that time. Bombardier and Embraer are planning on producing somewhere in the range of 2,000-4,000. China wants to produce 2200 C919’s and Russia has stated an expectation to sell 1000+ MS-21’s. So the planned production exceeds expected demand by at least 5,000 units.
Worse, the expected 20 year aircraft demand comes from effectively an extrapolation of the air-traffic growth rates of the last 20 years, which has been on an exponential trajectory that surpasses population growth, and is therefore not a long term sustainable demand. Yes, they try to factor more into their demand models than that, yet the final forecasts always have a remarkable tendency to closely match a simple extrapolation. The reality is that while emerging markets are still catching up to the developed markets, and the developed markets are still growing, the growth rates in both are slowing, and there’s little reason to expect any recovery in growth rates to be as high as their recently meteoric past.
So I agree. There’s a bubble. It’s large, but not huge (~20-25%). So either an unexpectedly large economic surge has to occur to fill that bubble, or there’s going to be a pull back in production rates as the current backlogs are dealt with. Fortunately, the size of the backlogs should give the manufacturers time to prepare for rate cuts cost-effectively, but I’m not confident all of them will still be building 100+ seat aircraft in 20 years. I’m pretty sure at least 3 will (two well-established enough they’re going nowhere that fast, one that is a government pet project). The other three will have tougher challenges.