Premium #129 Farnborough: Behind the Headlines

The A330neo launch and its implications The biggest headline from Farnborough 2014 was the launch of the A330neo, which will be a more effective direct competitor to the Boeing 787. The new competition will be a classic case of trading operating efficiency for lower capital costs, as the 787, with similar engine technology, advanced systems and composite construction, will be more fuel efficient than the A330neo. But Airbus has fully amortized A330 program costs, and can provide an A330neo at a much lower price than Boeing 787. Does the launch of the A330neo program kill the A350-800? We believe so. Airbus will likely formally drop the smallest version of the A350 family once orders are transitioned either to A330neo or A350-900 models. There are only a handful of orders remaining for the poor-selling -800 model, despite the success of the A350-900 and -1000 in what appears to be the “sweet spot” of the twin aisle market. The introduction of the A330neo introduces pricing pressure into the market for Boeing, which needs to recover the large cost overruns on the 787-8 program to bring the program into profitability. We expect that the competition from A330neo could negatively impact Boeing margins on future 787 sales, and that airlines will be the beneficiary of renewed competition between the airframe manufacturers. This could push the break-even point for the 787 program further out to the right. However, we don’t expect Boeing to price 787s at a loss to gain market share against the less expensive A330neo. Besides Boeing has a very big 787 backlog. How do the economics stack-up? Our independent assessment of operating economics indicates that that A330neo will be somewhat competitive with the 787 on a 4,000nm segment, with the 787 holding a slight advantage. When capital costs are included, the A330neo is quite competitive, depending on pricing assumptions. We have not yet completed analysis of the A330neo on all routes, and there are some indications that performance improvements may degrade for shorter stage lengths. As we obtain additional data from Airbus and other industry sources, we will incorporate that data into future analyses. The following chart shows our comparative analysis of Cash Operating Costs for a 4,000NM segment for competing aircraft. Data underlying the chart are shown in the following table: Our assumptions for the A330neo include an additional six seats for the -800 over the -200, and ten for the -900 over the -300. The seating increases will be gained through relocation of lavatories and more compact galleys, and we will more closely examine the Airbus LOPA (Layout of Passenger Accommodations) as we refine our analysis to reflect typical airline configurations. The cost per seat mile for the A330-900neo are close to those for the 787-9, but cannot catch the 787-10, which competes with the A350-1000 in size. A total cost comparison, including capital costs represented by a typical lease rate, shows how the lower pricing for the A330neo versus Boeing 787 narrows the economic gap. The following chart incorporates estimated lease rates for each model based on data on current market pricing, and our assumptions regarding A330neo pricing.The key question for Airbus and its suppliers is will the A330neo cannibalize the A350 program, or are these separate markets? The following table compares the maximum range of each model, with a full passenger load.The A350-1000 remains a unique offering in terms of size and range, but the A330-900neo is quite close to the A350-900 in seating, with a difference of only 10 seats. The range differential of 1,550NM is significant for airlines requiring long-range, but flights utilizing that much range are limited. The A330neo looks like an ideal trans-Atlantic replacement for 767s and A330ceos, and could be an effective aircraft on Middle-East and India routes to Europe, as well as inter-Asian routes. Airbus cannot discount the A330 to the point that it threatens the A350 in the marketplace, as it would like to continue to increase the sales of its new aircraft. Thus, despite the threat of excessive discounting against Boeing, Airbus must also worry about protecting its own pricing for A350. The key for Airbus is to maintain demand for both its A330 and A350 in the same size range, one with shorter-range and one with longer range. We believe this will be a difficult task, resulting in some potential A350-900 sales being cannibalized by the A330neo in the near term. However we are confident that Boeing will find the arrival of the A330neo disruptive. Already after announcement, the A330neo has more orders than the A350-800 ever had. Many airlines are wary of the long range, high-tech 787 or A350 and for them the cheaper A330neo is likely to be irresistible. The CSeries Gains Momentum Bombardier, after goose-eggs at the last two major air shows, finally began to gain momentum for the CSeries, which because of recent engine difficulties was not able to fly to Farnborough. Despite that, Bombardier received 5 firm orders plus 66 LOIs for 71 CSeries aircraft at the show. Bombardier set out two market goals for CSeries prior to entry into service -- 300 firm orders and 20 customers. It achieved the latter at Farnborough, and moved the total firm orders to 203 and program commitments to 513 at the air show. Because most LOIs will convert into firm orders, a couple of additional orders in 2014 could push the program above its 300 goal. Flight Global published a story that Australian leasing company Macquarie may soon place an order for 50 CSeries. While neither Macquarie or Bombardier would comment, such an order would provide an additional program boost to ensure momentum as the program moves closer to its EIS. Bombardier also passed a milestone for the Q400 of 500 orders, while introducing a new Combi model with 50 seats and 1,153 cubic feet of cargo space. This model could be very successful in developing countries, particularly in Africa, where airfreight is an important element of airline operations. This provides an interesting alternative to the ATR-42 for some customers that have significant demand for air cargo in the 50 seat turboprop category. There were commitments for 10 Q400s, with five firm. Bombardier brought an American Airlines CRJ900 to the show. This aircraft has also seen a spate of orders. The CRJ now boats 5.5% better fuel burn than the original model. It is also being made lighter and therefore provides compelling competition for Embraer. However Bombardier appears almost shy about some of its improvements; the outward sloping winglets now being used on the enhanced EJets and the "conical" fix on the engine that means no more chevrons but better fuel burn. GE and Boeing made a big fuss about doing this for the 777X with the GE9X. Yet Bombardier did it first. Pratt & Whitney’s Engine Troubles Overshadow Announcements The recent engine failures on CSeries and F-35, both produced by Pratt & Whitney, couldn’t have come at a worse time, just prior to the aircraft expected to be stars of the air show. With neither engine flying, the media focus was on problems, rather than news. P&W announced an improved version of the GTF engine for the A320neo, offering an extra 2% improvement in fuel burn beginning in 2019. This brings the fuel burn advantage over today’s engines to 18%, and provides the PW-1110G-JM Advantage a 3% margin over the competing LEAP 1-A from CFM, which has not yet announced a competing performance improvement package. This GTF performance improvement was largely overshadowed by engine failure news, which attracted much more press. P&W, albeit suffering from unfortunate timing, raised its order book from 3,500 GTF engines at Paris last year to more than 6,000 after Farnborough. While most press seemed to ignore the GTF Improvement news, airline customers did not. Embraer Continues Momentum Embraer received commitments for 85 EJets and E2Jets at the show. The E2 orders included 30 firm +20 options from Azul and 50+50 from Trans States. The interior for the E2 Jet was shown at the show, with positive reviews, particularly for its new overhead bins providing capacity for one small roller-bag per passenger. Embraer also showed a novel staggered premium seating layout. The largest E2Jet order came from TransStates, which also has orders with Mitsubishi for the same sized MRJ. Moreover, at 92,000 pounds the E2-175 ordered is way outside the scope clause and this would have to change substantially to allow for the E2-175 to be deployed. The TransStates orders, however, are conditional and can be easily cancelled. We understand that Embraer has not added the TransStates order for 50 plus 50 E2Jets into its official backlog as a result of the "cancel-able" nature of the contract. Nonetheless, the E2 had a positive show with the major order from Azul. Boeing Stabilizes 787 Program with 787-9 After a tumultuous start with the 787-8, Boeing has introduced the 787-9 without a hitch, indicating that the program has now reached maturity. Boeing can now focus on improving dispatch reliability for the 787 series and continue improvements to its production operations and lower costs. Boeing entered the air show with a large lead in orders over Airbus, and while Airbus outsold Boeing during the show, Boeing retained its overall lead in 2014 orders when all was said and done. The show was relatively uneventful for Boeing, indicating that things are back on track in Seattle.

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