Boeing and Airbus see order delays as demand cools

Orders for both narrow-body and wide-body aircraft have slowed dramatically in 2016 after several years of record orders for the industry. Global economic growth is waning, and carriers have begun to push delivery dates backwards or cancel order for aircraft that are no longer perceived to be needed in the same time frame. Recent examples include Delta Air Lines pushing back A350 and A330neo deliveries, and LATAM, who from the merger of LAN and TAM have large 787 and A350 orders on the books, respectively, and now deferring deliveries of each type. Now Southwest is deferring deliveries of 67 Boeing 787 MAX8 aircraft as it rationalizes its fleet plan. Airbus net orders in the first quarter were for only 17 aircraft, a fraction of the 700 net orders projected for this year. Airbus reported its "priority for 2016 is to continue its market leadership role, targeting a book-to-bill ratio [the ratio of orders received to the units delivered and billed] of at least 1 during the year". While the second quarter has picked up a bit, the writing is on the wall. The great rush to acquire aircraft appears to be over, and the prospect of economic change and unpredictability, combined with low fuel prices that enable existing aircraft to remain profitable, are changing the landscape as well as delivery skylines at the OEMs. What’s behind this? There are several factors. The first is global economic growth, which has slowed. China’s growth has slowed measurably, and the Baltic Dry Index measuring shipping is at or near record lows. The US economy continues to struggle, and it now appears Obama will be the first president in US history not to experience economic growth of more than 3% in any single year in office, an abysmal record. Brazil is in a tailspin, causing LATAM to defer orders. The only bright spot for potential orders seems to be Iran, as sanctions are lifted and pent-up demand is satisfied. The second is oil prices. New aircraft are costly, and when fuel prices are low, the differential between a high lease payment and a small increment in fuel is quite telling. Today, aircraft are typically replaced when they are economically obsolete, not when they are physically obsolete. The Arizona desert is full of aircraft that could fly, but are fuel inefficient. But in a low fuel cost environment, some legacy aircraft can continue to be as profitable as new aircraft, as the capital cost differential absorbs purchases a lot of fuel. While most analysts think prices will rise, few believe we will have the spike seen previously, as additional capacity can quickly be brought on line when prices increase, providing a supply-demand balance to keep prices steady. We don’t foresee prices above $50 per barrel in the next five years. The third is right-sizing aircraft. Most of the orders for new aircraft are larger than their predecessors, with many 737-700 models being replaced by MAX8, such as at Southwest. But not all of those routes can sustain the traffic required to profitably require a larger sized aircraft. A good many routes that Southwest began, and later abandoned for lack of profitability with low traffic, would be better served by a C Series or E2 Jet, right sized for those routes. We’re seeing a trend towards right sizing, with Air Canada and Delta orders for C Series being a prime example. This is good news for Bombardier and Embraer because neither the A319neo nor 737MAX7 are competitive with their new models economically. Have the airlines over-ordered larger narrow-bodies, and when will the market adjustment occur? The fourth is industry cyclicality. Our industry has been cyclical for quite some time, with economics slowdowns and exogenous events putting the industry into recessionary periods that are typically followed by growth. While these impacts can be clearly seen on charts, when taken over the long-term they are minor blips on an overall growth path. But those blips often result in orders being deferred, and picked up by airlines later as traffic increases. We’re seeing that this year as airlines have begun to reschedule deliveries. The orders are deferred, and not cancelled, but will impact short-term production schedules. The fifth is the supply chain. Suppliers are often loathe to add capacity until they are certain that it is needed. Before investing capital in new facilities to provide increased output, they want to see an order backlog from the OEMs to ensure that an appropriate return is made on their investments. But as OEMs find aircraft deferred, they will have more difficulty convincing the supply chain that their planned production rate increase will really occur. Could we see more situations like Zodiac in which one supplier holds up deliveries? Without firm commitment to suppliers by OEMs, this becomes not only possible, but likely. The sixth is that the order bubble is bursting. We do not foresee Airbus and Boeing meeting their goals of 60 narrow-body aircraft per month by 2020, as the market simply isn’t there. Over the longer-term, 60 aircraft per month from the big two, when combined with Bombardier, Embraer, COMAC and Irkut, would generate more capacity than either Airbus or Boeing’s 20 year forecast. And since that 20 year period typically starts from a smaller base and grows, 60 per month provides a considerable supply imbalance in early years of the forecast. We don’t believe that the current neo and MAX skylines will be delivered as currently scheduled, and project increasing deferrals over the next two years. Fortunately, there are plenty of customers to take up some of the slack in the near term. On the wide-body side, orders for new wide-bodies have also slowed, and Boeing’s aggressive two plant production of the 787 may burn their backlog more quickly than though should additional deferrals occur. With production rate adjustments already forthcoming for A330 and 777 as the neo and -X replacements come into play, wide-body deliveries are likely to remain relatively flat for the remainder of the decade. The Bottom Line Production rates depend upon demand for aircraft. We foresee a drop-off in demand that will result in more limited growth for narrow-body production and flat production of wide-body aircraft in the short term. Neither Airbus nor Boeing will likely reach their target narrow-body production rates of 60 per month by 2020, and until the new wide-body programs are in place, a decline in deliveries is likely for both OEMs, even with Iran taking up some of the slack.

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