Insight: Wednesday 22 April 2020: The Other Side – Part 9: the MAX overhang

The coronavirus impact on our industry has hit both airlines and OEMs at the same time. As airline demand was falling, factories around the world have been closing and re-opening to different time tables, resulting in the inability to produce aircraft in the short term. That is probably a good thing, as the impact on the demand side and supply side are relatively in balance.

In past economic downturns, aircraft and engine OEMs continued to produce airplanes at planned levels until they were forced to make cuts to match demand. Typically, a large oversupply of aircraft resulted in the resulting market displacement in terms of values and oversupply. In this case, supply cuts occurred concurrently with the reduction in demand, resulting in a situation that is more in balance, albeit economically more painful for the economy.

The net result, when we come out on the other side, might have had values returning more quickly to normal as demand returns and older aircraft are purged from the market. The substantial negative impact on demand in this downturn, while much worse than the recession of 2008, might not have had a proportional impact on values had the supply-demand balance remained more aligned.

The MAX factor

In the narrow-body sector, Airbus is reducing production by 1/3rd, from 60 A320 family aircraft per month to 40 per month once production is fully able to resume. That is a substantial drop, but will likely be in line with the demand drop seen by airlines once flights are once again cleared and social distancing can be achieved at airports and on-board. While demand will be lower, so will supply, keeping things in balance.

But for Boeing, life isn’t that simple. A fleet of 371 existing MAX airplanes is grounded, with 422 more completed and awaiting delivery at Boeing facilities. With 793 aircraft potentially returning to service, or about 65 per month if they were all delivered within a year of being re-certified, it is clear that the market cannot absorb that level of capacity today. Boeing could cut its new production to zero and still have too many MAX aircraft for what the market will bear.

Of course, since Boeing can’t get paid for the existing grounded fleet, it will need to produce additional aircraft and deliver the 422 completed aircraft to its customers generate cash, with an emphasis on the latter that remain subject to performance penalties. But the demand for those aircraft may not be there, as demonstrated by the rash of cancellations and deferrals of orders this month. It is notable that several of these orders were from leasing companies, who understand market trends better than other players.

The net result will be an oversupply of aircraft, particularly 737 MAX aircraft. Airlines would prefer to defer delivery, especially given that oil prices have dropped to record low levels and fuel economy, one of the key reasons for acquiring new aircraft, is no longer a primary concern. With airlines unwilling to take delivery and what appears to be about two years of demand in aircraft on the ground, the MAX overhang has tipped the supply-demand balance for narrow-body aircraft into a strong oversupply position.

An oversupply position will, of course, result in lower values for narrow-body aircraft. With Boeing desperate for sales and deliveries to generate cash, we can expect low prices for the MAX and a slightly lower impact on A320neo values. The MAX overhang is exactly what the market does not need, and will impede recovery in the narrow-body market for the next four years. As a result, we expect Boeing to produce a minimal level of new production aircraft in 2020 and 2021 as it recovers from the market overhang caused by the grounding.

The Bottom Line:

Boeing is no longer in the driver’s seat when it comes to the MAX. Given the delivery delays, airlines now have the right to cancel MAX orders without penalties, and in recent weeks we’ve seen a rash of order cancellations that have left Boeing’s net orders negative for the year. The on-going rash of MAX cancellations isn’t over.

The delays with the MAX will come back to haunt Boeing over the next two years as reduced demand will make it impossible to produce new aircraft in quantity without destroying market pricing for new aircraft, which would also destroy cash flow. The worst possible scenario has played out for Boeing, which may not be able to produce more than 12-16 MAX aircraft per month over the next two years without killing cash flow from lower values. There are simply too many aircraft on the ground that will satisfy the demand for too few customers in the near term.

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