Small Duopoly Faces Big Challenge in North America's Market

Do the prospects for Bombardier and Embraer look good in the North American market? Or has the market up-sized from the 110 to 130 seats category to 140 to 180 seats? We’ve taken a look at the fleets of airlines in North America, which represents the largest narrow-body market in the world and where the small duopoly needs market penetration to achieve critical mass. The Current Fleet We took a look at aircraft defined as narrow-bodies used by airlines in Mexico, Canada and the United States as of the end of the first half of 2015. The market segments breakdown as follows: narrow body segment (single aisle) 54.2%, the regional segment 28.5%, turboprops 8% and widebodies (twin aisles) 9.2%. North America has more narrow-body aircraft in service than any other region, and Airbus/Boeing forecast a requirement of 4,626/6,048 narrow-bodies in North America in 2033. There are not many aircraft in this segment that are parked. Of the 296 current parked narrow bodies, 130 (43.9%) are 757s. Looking at the smaller end of the market, specifically the regionals and singles aisle markets we note the following. There are 4,941 in-service passenger aircraft in North America up to 165 seats. The sub-70 seat segment consists of 953 or 19.3% of this market. Between 71 and 100 seats we have 1,002 or 20.3% of the market. From 101-130 seats we have 1,271 or 25.7% of the market. The largest segment is from 131-165 seats and consists of 1,715 aircraft and is 34.7% of the market. In terms of Airbus and Boeing's forecast they count from 100 seats up and the market in 2Q15 was 2,986 and therefore offers significant growth per their forecasts. The small duopoly is focusing its new aircraft on the 100-160 seat segment. What does this look like? First, the fleet's age is an important factor. Only 17% is over 20 years old, meaning the current fleet has a lot of life left. Replacement sales will not be easy for the small duopoly. Airbus and Boeing have been successful in keeping their customers loyal. This implies then that the small duopoly must seek growth opportunities. Airbus and Boeing's forecast suggests there should be a lot of growth. While North America is the most important to provide the breakthrough, it is the USA that is the most influential since its by far the largest in North America. (As of this writing, recent talk about Air Canada ordering C Series is still a rumor.) If we tighten the market opportunity even further, using 100-130 seats, and review what the North American market looks like, we derive the following table for in service passenger aircraft. The in service fleet consists of 1,271. Of these we highlighted the best looking replacement opportunities, and these add to 238. Which reinforces our point made above. So the replacement market looks like slim pickings. But there is more to this. For the USA alone there are 1,065 aircraft in service within the 100-130 seat segment. Looking at the big four US carriers in the chart below we can see how significant the 100-130 seat category is. Southwest has 697 737s and of these, 133 are 737-500s and -300s with an these average 24 years old. The -300 and -500s will be replaced by -700s and -800s, or perhaps by similarly sized MAX models Southwest has ordered, depending on timing. After 2010 Southwest started converting 737-300s from 137 seaters to 143 seaters. So while this airline might have at first been thought of as being 130-seat friendly, it is not. Delta is trying to obtain more 717s, which it likes for its smaller city operations. (Another happy operator is Hawaiian.) With 88 in service, Delta's 717s are going to be utilized for a number of years before being replaced. Delta could operate these aircraft for another decade. Delta also has a significant part of its fleet in this segment. American (plus US Airways) and United have virtually the identical fleet profile in this segment. Finally, looking at what these airlines are projecting in terms of fleet planning by way of orders, we get another clue as to how this segment will evolve. The result is eye popping. Southwest has ordered 30 MAX7s. Bear in mind this is only 22% of its aging -300s and -500s. Clearly the issue is not entirely settled, since the airline has been only taking new deliveries of the -800NG. Frontier has 18 A319neos on order. WestJet has 25 MAX7s on order. Overall out of roughly 1,000 aircraft, only 73 of the next generation Airbus and Boeing are on order. In conclusion, it appears that the market opportunities in North America, especially the United States, are slim. Low fuel costs ensure cheaper A319s and 737s stay in service longer. Plus there 717 is finding a second life. While fuel prices will not remain low forever and higher MRO costs will catch up and make newer aircraft attractive, that won't happen for some time. When this happens only the small duopoly will have cost-effective aircraft to offer. When this happens, we can see the market in the US alone is worth over 1,000 aircraft, but it may be 10 years away. The Bottom Line The North American market will be extremely difficult for the small duopoly to break into. If there were to be a change of vision at Southwest, for example, both Bombardier and Embraer could see huge opportunities. The likelihood of this happening, however, is extremely unlikely. However there is one item that could open the market considerably. In the USA we have a market distortion called the Scope Clause that limits the size of aircraft that can be flown by regional airlines that feed the majors. Recent changes in FAA regulations have resulted in regional airlines being unable to find a sufficient number of pilots. This has dislocated the industry on a minor scale so far, but that problem appears to be exacerbating. If regional carriers are unable to find pilots, the majors may well have to acquire their own aircraft in the 100 seat segment. Such a move would delight Bombardier and Embraer. Even so, it still wouldn’t do much for the E2-195 and CS300 which compete with the A319neo and 737MAX7. Airbus and Boeing have production volumes so high for their narrow-body series that they are able to incrementally price aircraft at levels at which Embraer and Bombardier cannot effectively compete. They can easily price to the point of economic indifference, and move the market to larger aircraft, which they have already been effectively doing. Will arguments for "right sizing" of aircraft succeed? We believe so, but only with the next replacement cycle in the mid 2020s.

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