Much of the demand for new aircraft has been driven by the rapidly growing Asian economies, including China. But economic conditions in Asia appear to be slowing, and this could impact both future orders and potential deferrals of existing orders should market weakness continue over the next 2-3 years.
A report in China Aviation Daily entitled Overcapacity Hits Top Chinese Airlines on Rapid Expansion (link) should send a shock wave through the industry. While the weakness in international trade is not unexpected, given the Baltic Dry Index is at record low levels, the secondary impacts into the global economy hadn’t yet been felt, primarily due to low energy prices. While those prices have enabled the top Chinese airlines to post strong financial performance, despite traffic falling, they cannot of themselves solve the overcapacity problem that is brewing in Asian markets.
And then we also are getting bad news on air freight. Air cargo volumes were down 5.6% through in February according to IATA’s latest release. The numbers were skewed by the US port strikes in early 2015, which caused air freight to spike and drove the comparison with this year. Results were also affected by the Lunar New Year falling in February this year. Asia-Pacific carriers, which carry ~40% of total freight, saw FTKs contract by 12.4%. Europe, Latin America and North America saw declines between 2% and 4%, and Middle Eastern carriers continued their growth at 3.7%, although the major Mideast carriers cut route expansion. Combined January and February 2016 performance compared to the same period two years ago reveals 6.3% volume growth, or 3.1% annual growth, well below the ~6% passenger traffic figures.
In China, the massive jumps in ASM growth we’ve seen from rapid expansion is slowing, which also means a slowing of new aircraft orders. China Southern grew 30% year over year in available seat miles in 2015, while China Eastern and Air China posted 25% and 20% increases. But those massive increases in capacity resulted in only 10% revenue growth. The good news is that growth remains positive. The bad news is that load factors are falling, and that the supply/demand balance has shifted from over-demand to over-supply in aircraft.
Domestically, China has overcapacity on air routes. Professor Li Xiaojin, at China’s Civil Aviation University, said that “the supply of domestic air routes exceeded the demand, due to the growth of high-speed trains. Airlines can only expand their international air routes, as a result of the growing demand for overseas traveling and the frequent flow of domestic and foreign personnel.” High speed rail has been an item worrying China’s airlines for a long time.
International markets are competitive. Xing Xiong, from CTrip.com International, the largest on-line travel agency in China, indicated that “compared with some well-known foreign airlines, domestic airlines have a weak branding impact on the international market. Chinese consumers have started to care more about services, branding, and comfort of airlines, in addition to air ticket prices.” He went on to indicate that Chinese carriers need to up their game competitively.
The Bottom Line: The large backlogs at Airbus and Boeing are about to shrink, as new orders continue to dry up, and deliveries are likely to slide out to the right. We don’t expect massive orders this year at the Farnborough Air Show, continuing the trend we saw last year at Paris. As a result, the OEMs will eat into backlog this year again, as the order bubble may have burst. We expect a aircraft market correction that will result in 2-3 years of spare orders, particularly for wide-body aircraft as Asian markets slow.
The positive news is that aircraft orders from Iran to replace an ancient fleet may provide a temporary and small boost during the down cycle. Whether that will be enough to carry the industry to the next upturn is the unknown question. While it is not time to short Boeing or Airbus yet, we expect growing market weakness through 2020.