Premium #152 – LOOKING AHEAD TO 2015

It is that crystal ball time of year, when we look forward and attempt to discern how next year will be different and what events will shape the industry in the coming year. Let’s begin with a look at the external factors impacting the industry, and then expectations for each of the major industry players. Economics The global economy will continue in an overall slow growth mode, as recessionary influences pervade Europe, Asian growth is slowing, while the United States is showing some preliminary signs of a potential recovery. Lower fuel prices will negatively impact the Gulf region, but the impact on air traffic will pale compared to the impact on national budgets that were bloated when oil revenues were high, and could cause new difficulties for the UAE and other countries in the Middle East. Oil prices have dropped; I recently paid $1.99 per gallon for gasoline in Michigan, with prices still falling. The question is whether this drop is sustainable. We believe it is possible, as the US has become a major producer from shale, and can do so at reasonably competitive prices. We foresee a swing in oil prices, with the pendulum swinging lower than many anticipate (into the $50 per barrel range) prior to swinging back to settle in the $60-$70 range by year-end 2015. Low oil prices will begin changing the economic relationship of new and used aircraft, placing more price pressure on the former and increasing the economic lives of the latter. While we don’t anticipate a let-up in demand for aircraft in the near term, we believe a bubble is building in narrow-body aircraft that will likely burst in 2019-2020, just as Boeing and Airbus complete massive increases in capacity. Technology Engine technology continues to drive aircraft economics. The PW GTF, recently certified for the A320neo, has several more variants on tap for certification. The competing LEAP is in ground test and will enter test flight in 2015, and remains about a year behind in terms of schedule. There are no new narrow body programs in development yet at the engine selection stage, although it appears Boeing may accelerate the development of a 757 replacement, given the Airbus 2-1 plus lead in orders for A321neo over 737-9, as it is simply a more effective aircraft for those missions. For that application, the PW GTF and RR Advantage geared turbofans appear to be the leading candidates. There are no new wide-body programs without engine selection currently on the books, but Airbus is considering an A380neo. Rolls-Royce is ready to roll out an updated version of its Trent XWB, possibly to be named the 9000, for an A380neo. Engine Alliance, a joint venture of GE and Pratt & Whitney, does not have as clear a growth path for a new alternative, but both parties are researching the opportunity. With engine selection in place for A330neo and A350, and 787 and 777X, this will likely be the last wide-body opportunity to be decided this decade. 2015 could also become the year of breakthroughs in batteries. We’ve seen a prototype of a replacement for the 787 battery; it provides equivalent output using low volatility chemistries in the same packaging as the initial battery. The design eliminates the need for the exhaust system and should save weight. Rapidly changing battery technology could bring new chemistry lithium-ion batteries into the aviation arena quite quickly, with enhanced safety. E-enablement and cyber security will reach the forefront in 2015, particularly with Boeing’s decision to utilize an open architecture for 777-X to save weight by combining computing capacity on a network. While efficiencies can be gained with the new architecture, any penetration of that architecture could result in the ability for aircraft systems to be hacked. As an open system it may be easier to accomplish. While industry participants prefer to keep incidents close to the vest in order not to alarm the public, several cyber security issues have been thwarted, and others resulted in potentially dangerous situations that fortunately have, to date, not resulted in the loss of aircraft. Cyber-security will become a significant issue for the industry to address this year. New Aircraft There are only a few “all new” programs in process, in addition to the several re-engined and derivative programs set to reach the market this decade. The question is whether or not they will make their planned EIS dates: We do not foresee any major "new" program announcements in 2015, with the possible exception of an A380neo and a stretched A380-900 model to further improve seat-mile economics. Either, or both, of these are possibilities as Airbus (under pressure from Emirates and Rolls Royce) evaluates the potential for its VLA over the longer term. Airbus Airbus is celebrating the first A350-900 delivery and will celebrate the A320neo EIS in 2015. The key decision of 2015 will be on the direction for the future of the A380. We’re betting that the neo is launched, along with a stretch, ensuring that the program will continue for the foreseeable future. There may yet even be interest in developing an A350-1100 before 2025. Boeing Boeing will continue current development programs in 2015, with no new programs coming on line. Work will continue on 737MAX, 787-10, and 777X. While Boeing is examining a 757 replacement, no firm decision is expected in the coming year. Bombardier Bombardier will celebrate the first delivery of the CSeries in late 2015, which will provide a needed turnaround in cash flow. The CRJ will remain viable with lower fuel prices and heavy discounting in the near term, and will achieve multiple orders in 2015. The Q-400 remains the only turboprop in the market close to the 90-seat goal some have been looking at. Embraer Embraer will be working hard to fill the production gap between the current EJets and the E2, not scheduled until 2018, 2019 and 2020 for EIS. Irkut /UAC Development continues on the MS-21, as there are technically no sanctions on commercial aircraft in the current rift with Russia. Nonetheless, sanctions on banks could delay the program past 2017, something key to watch in 2015. Sukhoi is talking of increasing production of the SSJ to 80 per year. The recent win at VLM gives the SSJ program a boost in Europe. COMAC COMAC continues to struggle, while purchasing expertise by acquiring companies in general aviation around the world. The ARJ-21 and C919 programs appear to remain well behind schedule, as China has yet to learn the complicated process of building a new technology aircraft. We expect further delays to both programs in 2015. But there is growing talk of cooperation with Russia on a twin aisle aircraft. China can afford this program, but we don't see the Russians being able to match this. Mitsubishi With the MRJ roll-out in 2014, the MRJ appears now poised for flight testing in 2015 for EIS in 2017. However, we’ve seen roll-outs before that have led to further delays at Airbus, Boeing and Bombardier, and we expect Mitsubishi might face similar challenges. We’re currently 50/50 as to whether the MRJ will meet its revised 2017 target for EIS. Engines Pratt & Whitney has now certified 2 of its 6 planned GTF engine variants for five programs on four continents. We expect the GTF to be on schedule for its remaining applications. The market eagerly awaits the news of the CSeries testing - we understand that Bombardier will announce their results early in 2015. Certainly before the end of 1Q15. GE has begun activity for the GE-9X for the 777X program, and there is still adequate time for technology substitution and improvement before the expected 2020 EIS. Rolls-Royce has delivered on the Trent XWB for the -900, and is working on a variant for the -1000, as well as developing a new engine for A330neo. The key question for Rolls-Royce is whether an A380neo engine will be defined by Airbus in 2015. Rolls-Royce has only 30 more A380s to engine on current announced engine selections. Consolidation The industry supply chain continues to consolidate, with fewer players obtaining a larger share of the pie. While some new entrants have emerged as a result of the 'Boeing Partnering for Success' program, such a Montreal-based Heroux-Devtek for landing gear on the 777-X. Consolidation among major players is expected to continue. United Technologies will likely make a major acquisition in 2015, potentially of similar size to the Goodrich acquisition. We believe at least one, and potentially two, blockbuster mergers will occur in the aviation supply chain in 2015. Our Crystal Ball We expect lower fuel prices to result in more higher airline profits. Better personal income levels from lower fuel bills could fuel demand for airline seats, but that those additional seats will be provided by existing aircraft that will be retired later than planned, rather than additional new aircraft in the short-term. We also expect continued success for Airbus and Boeing, but for new orders to be at lower levels than the past couple of years, reflecting the current large backlogs at each manufacturer. The sheer size of these backlogs could be an advantage for Bombardier and Embraer in the sub-150 seat market. Equity values in aerospace will continue strong in the short-term, and most industry OEMs and suppliers will have strong performance and multiples. In short, 2015 will look at lot like a continuation of 2014, with companies focused on executing the programs already in place and delivering their products to market on time. We wish all of our readers a happy and prosperous 2015.

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