Premium #220 – How big is the duopoly clash zone?

Over the past week a number of media outlets have focused on the "arrival" of Bombardier in the big duopoly's space. This past week also saw the first flight of the 106 seat E-190E2. The first C Series is about to be delivered to its first customer, Swiss. Clearly, the small duopoly is coming on strong. Last week we shared this chart demonstrating the rising influence Bombardier and Embraer have below 130 seats. We called this the clash zone and we think the new entrants are winning, based on the data we have. How big is this market? Compared to the 150-200 seat market, this one is much smaller. For Airbus and Boeing this segment is becoming less attractive, but for Bombardier and Embraer, this is a very attractive segment. This market was dominated by Airbus and Boeing until 2008, when orders dropped off considerably - Airbus took a negative net order position as a number of A319 orders were cancelled. Embraer was doing well and started to outsell everyone in the segment. Bombardier had less luck initially in selling the C Series. Looking at deliveries, 2008 was clearly a watershed year. Even as Embraer had strong deliveries, Airbus and Boeing were exiting the market. Bombardier's CRJ1000 had a few deliveries while the C Series was in development. Boeing was particularly inactive during this time frame. Both Airbus and Boeing were busy up-selling their customers to the 150+ seat models. The industry’s high load factors appeared to support this because the larger aircraft offer better revenue potential. However, this has led to some airlines seeing load factors soften (see next chart). This chart comes from the US DoT and shows seasonally adjusted load factors have dropped from their peak. Load factors remain high (>80%) but as load factors soften there going to be more empty seats. For Boeing 737-800 operators this has been an issue, since the aircraft typically has 162 seats compared to 150 on the Airbus A320. Right sizing is making a comeback as we have seen so far in 2016. Air Canada and Delta have both selected the C Series this year - our charts are focusing up to year end 2015. The fleet of 100-130 seat aircraft in passenger service was 5,336 at year end 2015. As the next chart shows, after 2008, and the start of the exodus by Airbus and Boeing, the market growth slowed. Does this suggest the market is shrinking? Airbus and Boeing say so, and since 2011, they are correct. But that will not stay the same for long, as six new aircraft are entering that market – the A319neo, 737 MAX7, CS100, CS300, E2-190 and E2-195. None have yet been delivered. Our evidence is based on the recent (2016) orders from United, Air Canada and Delta. These three orders alone are worth 265 (including options) aircraft and would be one of the top years for orders in the chart above. The evidence suggests that the 100-130 seat segment is more robust than Airbus and Boeing suggest. Indeed, the United order for 65 737-700s supports our evidence. United was not interested in up-sizing, as it needed the right-size aircraft for certain routes that would not support a 162 seat model. Delta selected the CS100 to fill the gap from 76 seats on its regional fleets (subjected to scope clause limits). Air Canada looks to replace its E-Jets and A319s with CS300s. So while the curve has dipped and appears to be a softer market, we believe this dip is part of the new product cycle and is also influenced by the sea change taking place. Airbus and Boeing have effectively left the segment, as their designs are less efficient, and the new entrants aircraft, which have not started delivering yet, will surpass the economically. Once the C Series starts delivering this year and the E2 comes on line in 2018, the segment will begin to recover in terms of deliveries. The segment still has many older aircraft from companies that have left the industry, such as BAe/Avro and Fokker. The average number of retirements in the segment has been around 2.5% per year between 2000 and 2015. The retirements have accelerated in the past four years to approximately 200 aircraft per year. Just over half these retirements come from aircraft firms that have left the industry. Spares become more expensive for older aircraft as support starts to drop off. Consequently the 100-130 seat segment should see approximately 100 orders per year for some time just for replacements, if only half the replacements are equally sized. Between 2000 and 2015, the market grew 23%, even with the slowing in growth. The past is never a prologue as any forecaster can tell you. But if we take a logarithmic trend line to the data we see the following chart. By 2034 it looks like a potential market of just over 6,000 aircraft. There are several elements to consider that will impact the market size -- existing aircraft, retirements, replacements and growth. Embraer forecasts the market for 70-130 seat aircraft at 6,350 by 2034. Bombardier forecasts 7,000 aircraft by 2034 between 100-150 seats. Airbus forecasts the single aisle market by 2034 at 22,927 while Boeing forecasts 26,730 single aisle aircraft by 2034. The Japan Aircraft Development Corp. (JADC) in its 2034 detailed forecast estimates 17,408 single aisle (100-169 seats) aircraft. JADC estimates that 89.3% of these will be in the 120-169 seat category. They go on to say: "With regard to airplanes with 100 to 119 seats, the demand will be mainly for the CS100 and EMBRAER 195, amounting to 1,793 units." JADC also state: "...there will be deliveries of 6,806 units in the 100-149 seat class." That means 10,602 in the 149-169 seat class. But with more than half of those aircraft already on order, that seems a bit conservative. We believe that up sizing will continue as airlines continue to focus on cost per seat mile rather than cost per aircraft mile in fleet planning. Airbus and Boeing are selling larger aircraft at low prices to keep Bombardier out of their market, and will likely continue to do so for the foreseeable future. Larger aircraft that provide equivalent seat-mile costs with additional revenue capacity for growth make a compelling argument, particularly when fleet compatibility issues are added to the equation. With many forecasts to choose from, it would seem reasonable to settle on 5,500 as a reasonable number. The growth from the trend line does not look so aggressive then, does it? Indeed, if we assume a fleet of 5,500 by 2034, this will be a growth of 50% from 2000. That does not seem unreasonable, even with a substantial portion of replacement aircraft being up sized. Dividing the 2034 market by OEM is the bigger challenge. Are Airbus and Boeing going to vacate this market permanently? Or are they making a tactical withdrawal while they develop a new aircraft? One cannot be certain what they are up to, although we are certain both are working on new designs. Are these designs going to focus on 150+ seats and higher? We suspect they are. But will their technology enable a shrink model to be more cost-effective than today’s aircraft? A lot can happen in 15 years. As a consequence, we think the 5,500 market size will be split approximately big duopoly 25% and 75% for the small duopoly. Breaking it down further, we think it is plausible that the 75% is divided evenly between Bombardier and Embraer, with 2,060 aircraft each.

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