Premium #151: 2014 in Review

2014 was an interesting year in aviation, with the launch of the A330neo and first delivery of the 787-9, continued high demand for the A320neo and 737MAX narrow-body families, and a return to record profitability for the major US airlines, particularly as fuel prices decreased in the fourth quarter. Let’s revisit some of the key events in 2014, player by player. AIRBUS The major news at Airbus in 2014 included the launch of the A330neo at Farnborough, and the certification and first delivery of the A350XWB to Qatar Airways yesterday. The A330neo will be available in -800 and -900 models that correspond to the current A330-200 and -300 in size. These new aircraft promise a substantial fuel burn improvement over the A330ceo. While not as fuel-efficient as the Boeing 787, the A330neo will be priced significantly lower, and is strategically positioned to erode margins from 787-9 and -10 sales. Being offered alongside the new technology A350, Airbus now has both economy and premium options in the medium size twin marketplace. With a recent order from AirAsia X, the A330neo appears to be gaining traction. The big question is how long demand for the existing A330ceo model will continue before additional production cuts, beyond those already announced, will be needed. The A330ceo, and at Boeing the 777-300ER, face a similar challenge of filling production slots in the wake of new and more efficient variants being offered. That will require significant discounting. The A350 delivery to Qatar is Airbus' answer to the high technology 787, and has very competitive operating economics. The smoother introduction of this high technology airplane, with only minor schedule delays when contrasted against the A380 and 787, is a major accomplishment for Airbus. We expect strong success for the A350. The A320neo is moving forward, with its first flight featuring PW 1100G GTF engines, to soon be followed by the CFM LEAP engine in 2015. The neo is about 2 years ahead of the 737MAX in development, and is reflected as such in its backlog of 3,436 firm orders and 4,938 commitments (orders, options and MOUs). Market share for engines on the neo program are fairly even, with 35% CFM, 29% PW, and 37% undecided. We expect a 50/50 share long-term on the A320 model, and a bit higher market share for PW on the A321 due to its higher thrust. Within the A320 family, the A321 appears to be the most popular choice to replace Boeing 757s, and is selling much better than the 737-9MAX, which has not garnered significant orders. We expect that trend to continue. The A319neo has not generated many orders, and we believe Airbus may drop the program, similar to the A350-800 model, transitioning customers to the A320neo. The A380 has been controversial, with conflicting signals being sent by Airbus management at last week’s investor conference. Airbus indicated that the program will be profitable by 2018 and pass break-even point. Airbus is now considering both a re-engining and stretch of the A380, with pressure from Rolls-Royce (which has an alternative engine based on the Trent XWB that could readily be available) and Emirates, which stated that they would purchase an A380neo. The question is how large is the market for an A380neo or stretch. Engine Alliance, a joint venture of GE and PW, which makes the competing A380 engine, GP7200, is the best selling engine on the A380. It may have a more difficult time developing an alternative engine within the time frame as Rolls-Royce. We believe that the A380 EIS was a decade before its time, and with a new engine option, will now come into its own as traffic congestion increases at key hub airports. BOEING The major news at Boeing in 2014 is stability, with no major problems and a return to normalcy after a rocky 2013. The highlight of the year is the first delivery of the 787-9, which entered service with Air New Zealand. The good news at Boeing is that the 787 aircraft program appears to have finally reached its intended objectives. The 787-9 production ramped-up without the problems that the previous 787-8 had, and the 787-8, despite a rocky development program and terrible EIS, including a grounding of the aircraft in 2013, is operating smoothly. Those problems now appear largely in the rear-view mirror, and delivery schedules are now being met on time, with the aircraft performing well. The 777X has had strong demand since its launch in late 2013 at the Dubai Air Show, and has generated 220 orders to date in 2014. Meanwhile the 777-300ER has generated only 39 orders during the same period. With six years of backlog to fill until the new model arrives, and only about 3 years worth of orders in backlog, there is a significant gap that Boeing will need to fill in order to maintain existing production rates in Everett. Interestingly, the 777X has a new set of key vendors for many components, including Heroux-Devtek rather than UTAS for the landing gear, and GE rather than Honeywell for the electronics bus that integrates avionics and flight controls for the aircraft. Boeing’s partnering for success program is having an impact, as they tighten margins for component suppliers on new aircraft programs. The 737MAX continues to generate strong order volume, with 2,558 firm orders and 3,734 commitments. The aircraft is essentially sold out through 2020 based on production schedules ramping up from the current 42 to 47 per month by 2017 and 52 by 2018. Even with the increased production levels of 620 aircraft per year in 2018, the commitments represent a seven year backlog. The bulk of MAX orders are for the -8, with the -7 not selling well at all, and the -9 finding it difficult to compete with the more capable A321neo. If Airbus drops the A319neo, the -7MAX may not be far behind. The 747-8 is not selling well as a passenger aircraft, and freighter demand, expected to be the mainstay of this program, is also weak. As a result, Boeing has reduced the production schedule to a little over one per month, and appears to be waiting for the Air Force One replacement RFP in 2017 before dropping the 747-8 program. The 777X accommodates roughly the same number of passengers with better efficiency, rendering the 747-8 economically obsolete. BOMBARDIER Bombardier had a rocky 2014, with the grounding of the CSeries test fleet due to an oil seal issue with the PW1000 GTF engine during flight testing, resulting in a partially contained engine failure. This delayed EIS from early 2015 to the second half of 2015. The good news from Mirabel is that after the disruption from the engine, the test program has resumed with positive results. Virtually all of the “showstopper” tests, wing bending, flutter, and fly by wire have passed the critical elements, and there is a new confidence that the program, which is now over 660 flight hours, will be completed on schedule. The CSeries is an interesting aircraft, and has now achieved 263 firm orders and more than 500 commitments, including an order from Macquarie leasing for 50 aircraft this summer. While Bombardier will not yet confirm economics, their senior executives indicated that they expect to be smiling while delivering economic results from FTV4 early next year. While demand in that segment has been slower than desired, the CSeries is outselling the 737-7MAX and A319neo combined. The CRJ program experienced a resurgence, with a major order from American. The cabin for the CRJ remains cramped, but the seat-mile economics within its class remain compelling. The question is how airlines will balance economics and passenger experience in their fleet planning decisions. The larger CSeries offers both. The Q400 introduced two new variants, a 50-seat passenger/freight combi model for the developing world, and an 86 seat high density variant for LCCs. With an 86 seat Q400, it is unlikely that we will see the development of a new 90-seat turboprop from Bombardier in the near future. EMBRAER Embraer launched the E2 series, a re-engining of its existing EJets, at Paris in 2013 and revealed additional information on the program in 2014. Much like A330neo and 777X, Embraer faces the problem of filling the production lines in the near term with the existing models prior to the EIS of the E2 in 2018, 2019, and 2020. From 2010-2013, Embraer averaged 100.5 deliveries annually. With a firm backlog of 266 EJets the company can sustain a production rate of 66.5 annual aircraft before the new models are introduced, leaving a gap of about 1/3rd of production capacity to fill, the same dilemma as A330neo and 777X. The E2 jets had 210 orders at the end of the third quarter. The E2 Jets, with improved economics from the Pratt & Whitney GTF engines and other improvements, will be economically competitive with other new aircraft, including CSeries, Mitsubishi RJ, and Sukhoi Superjet. MITSUBISHI Mitsubishi rolled out the first flight test aircraft earlier this year, and now appear to be making significant progress after some program delays. The MRJ, with the PW GTF engine, should be quite competitive in the marketplace. To date, MRJ has received orders from ANA, Trans States, SkyWest, wew Eastern, Air Mandalay, and JAL, with 223 orders and 184 options. After two delays, the question facing the program is similar to any other new program after the A380 and 787 -- will it be on time? SUKHOI The Superjet program has been quite successful in its North American debut at Mexico's Interjet, with reports of 7% better fuel burn than forecast being reported. That said, the limited production capacity for the program is likely slowing potential growth. The Superjet is a modern aircraft with western suppliers for key components, and should be selling better than it is. However, the current political environment and financial sanctions against Russia continue to negatively impact the program, despite no “official” sanctions against aviation. COMAC After years of delays, the ARJ-21 is finally close to EIS. Vice-chief designer Zhao Keliang recently admitted that COMAC’s inexperience in aircraft development, supply chain management and certification led to the long delay in the program, which started in 2002. This aircraft is already outdated, and will be severely so compared with the Embraer E2 and Mitsubishi MRJ. Given the primary focus being sales within China, we suspect that Chinese airlines might have a tough time placing orders for these competing aircraft in order to COMAC. In terms of the C-919, we see this a follow on to the ARJ-21. It is a more ambitious project but will likely suffer the same fate. Although it is an order of magnitude more advanced than the ARJ-21, it is still far behind its competitors. The C-919 competes with the 737 and A320. COMAC today does not have the people and IP to compete with the established OEMs in the segment. Even with next generations engines (LEAP), the C-919 will not be anywhere near a threat to the 737MAX or A320neo. Chinese airlines may be "encouraged" to buy local. This will possibly hurt Boeing more than Airbus, which has an A320 FAL in China. Of some interest is the potential cooperation between China and Russia on a twin aisle aircraft, ostensibly to be called C-929. China will need two decades of learning, failing and improving to possibly reach the level to compete effectively with Airbus and Boeing. China has the financial capital to get there and its ambitions should not be underestimated. ATR ATR had a very good year - in November ATR and Indonesia's Lion Group signed a $1bn purchase agreement for 40 additional ATR 72-600s, marking a milestone in ATR's history, as Lion Group became ATR's largest customer ever. ATR announced 155 firm orders in 2014. This almost matches their best year in 2011 with 157 firm orders. As air travel becomes more cost effective in southeast Asia, especially Indonesia with over 1,000 islands needing air service, ATR should continue to see order growth. UAC While UAC is typically associated with the forthcoming MC-21 (also known as MS-21), it is also able to claim success with the Sukhoi Superjet (SSJ). The SSJ has been a surprise - it has proven to be a better aircraft than many expected. Interjet is exercising options and recently Dutch carrier VLM placed an order. With this foundation, UAC is moving forward with plans on its MC-21. The aircraft follows SSJ ideas - western avionics and engines. This should ensure the aircraft attracts attention from airlines beyond the CIS. The MC-21 is expected to be certified and have EIS in 2016. Given the current situation in Russia that may be delayed. The Russian Industry and Trade Ministry has reduced budget spending program for 2016 and 2017 by 2%. The overall 2015-2017 investment program was reduced to $2.7bn from $2.8bn. Spending will be cut for projects which have not been initiated so far, including the development of several models of helicopters and planes for regional flights, the ministry said. Although the MC-21 is well advanced, as a state funded company in the midst of high spending on the program, we expect the program to be slowed. CFM INTERNATIONAL CFM International, a joint venture of GE and SNECMA (part of SAFRAN) will continue its leadership position in the narrow-body engine market, largely due to its exclusive position on the 737MAX, and as a competitive option on the A320neo family. The current market share leader on A320 and exclusive engine on 737NG, CFM has a strong customer base that makes it easy for existing customers to select the LEAP. We foresee continued growth for CFM International as the market leader in narrow-body engines. ENGINE ALLIANCE Engine alliance, a joint venture of GE Aircraft Engines and Pratt & Whitney, makes the GP7200, which has the leading market share on the Airbus A380. Discussions of an A380neo are underway, with Rolls Royce offering a new Trent variant. The strange bedfellows syndrome may impact EA’s ability to compete for a new A380 engine, as GE and PW must each independently validate the business case for an A380neo, and agree to move forward. That situation is complicated by the increased competition between the partners on A320 family. It appears doubtful that Engine Alliance will have a new alternative for the A380neo program in the near term. GE AIRCRAFT ENGINES GE and Boeing appear to be moving closer together, with exclusivity on the 777X matching the exclusivity on 737MAX and 747-8. Only the 787 series remains competitive at Boeing, and GE engines are now available on all Boeing products. GE’s participation at Airbus remains strong, with half of the A320 and A320neo family, and a portion of A330ceo. We understand that GE was asked to consider its GEnx from the 747-8 for the A330neo, but demurred. The outlook remains positive for GE Aircraft Engines, which has a strong market share and backlogs for the foreseeable future. PRATT & WHITNEY Pratt & Whitney will be introducing six new GTF engine models on 13 different aircraft with five manufacturers on four continents within the next five years. The success of the GTF engine has returned PW to major player status in the market after a period of decline, with commitments for more than 7,000 engines in place. With the GTF now in production for CSeries and being readied for A320neo, PW is in a growth mode for the next five years. As a result, it has its hands full, and we don’t expect to see a PW GTF engine for a wide-body application in the near future, as their internal capacity is focused on executing the multiple programs they have acquired within a very short time frame. The outlook is positive for PW, and the task going forward is execution. PW's selection of a geared technology has now been also selected by Rolls-Royce for its future Ultrafan engine. ROLLS-ROYCE Much like GE and Boeing, Rolls-Royce is developing a strong relationship with Airbus, becoming exclusive on the A350, A330neo, and potentially the A380neo. Rolls-Royce is currently not competitive in the narrow-body market, having sold their share of International Aero Engines to Pratt & Whitney. Nonetheless, they are developing a new geared concept that would appear appropriate for a 757 replacement sized aircraft. Rolls-Royce appears to have a solid position in the wide-body marketplace, including a competitive offering for the 787. The outlook for Rolls-Royce is also positive. THE MAJOR AIRLINES In the domestic US market, the three major legacy carriers and LCC Southwest achieved record profitability, perhaps reflecting the new oligopoly nature of the industry and lack of true competition in many markets. Unlike years past, when one airline would block fare increases, 2014 saw several increases go through uncontested, increasing profitability. The decrease in fuel prices in the fourth quarter should enhance profitability to record levels, as they have not adjusted fares downward in response. We expect the US domestic airlines to remain profitable in 2015, with steady yields. Internationally, market conditions vary by region, with mediocre financial performance in Europe, and strong performance in Middle Eastern and Asian carriers. The center of gravity internationally has shifting to the south and east, with traffic growth and capacity, and European carriers are no longer the dominant force they once were. AIRINSIGHT AirInsight has had a wonderful 2014, and we look forward to an even better 2015. Thank you and Happy Holidays to all of our subscribers and friends in this industry in which we are most fortunate to work.

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