OPINION: DVB’s (pre)view from the City

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Bert van Leeuwen is managing director of aviation research at DVB Bank. Here, he offers his take on what the Farnborough air show might hold in store

Many of us will shortly gather in the English countryside to enjoy the 2014 Farnborough air show. What the weather will bring, nobody can tell, except maybe our industry guru Adam Pilarski. Let’s hope for the best for everyone making this biannual pilgrimage, but just make sure to pack an umbrella as well as a pair of sunglasses.

In terms of business and actual hardware, what to expect is becoming a little clearer now, but not much.

What follows is a bit of speculation about some of the expected trends, mostly written from the perspective of the impact on aircraft deal volume and residual values. After all, while we all enjoy the sight of these aircraft flying high in the sky, in the city the thing we really love is the money in our pockets. Last year brought a record number of new orders of commercial jets and it will be difficult to surpass that volume this year.

What is the score so far? Flightglobal’s Ascend Fleets database shows that between January and June 2013, a total of 1,171 Western-built commercial jets were ordered. This year, the counter reached 853 over the same period. Last year, during July the month of the Paris air show the order total had shot up to 1,859. If the same order flurry would occur this year, the order total would shoot up to over 1,500, but this seems highly unlikely from the current perspective. The manufacturer’s orderbooks today are already bulging and there were several exciting new programmes launched at last year’s show, including the Embraer E-Jet E2, Boeing 787-10 and the 777X. Of course there was the “close-out sale” of 175 737-800s to Ryanair. But which “new and improved” aircraft could trigger another flood of orders? Let’s see.

At the regional end of the market, I have not seen anything that would indicate a huge number of new orders. The 50-seat regional jets are out anyhow and most of the 70-seat orders for the current-generation aircraft have already been placed by mainly North American carriers. Regional aircraft that could draw additional orders include the Superjet, the Mitsubishi MRJ, the E-Jet E1 and E2 and of course the Bombardier CSeries.

It seems the MRJ has not made any spectacular progress during the past year and, given the technical uncertainties of any new aircraft programme, potential customers may want to wait a little longer before committing. Embraer will have to sell the remaining slots for the E-Jet E1, while the significantly more efficient E2 generation is on the horizon. Maybe some financial incentives could trigger more orders for the E1s, but the type has become less attractive for investors, financiers and operators since the announcement of the E2s, if only from the residual-value perspective.

Then there is Bombardier. With a bit of luck, the CSeries could have become the star of the show. The widely reported engine problem has unfortunately spoiled the party for the CSeries. This must be a bitter pill to swallow for Bombardier as its new baby could certainly use some positive publicity. Will we get a little more insight into what actually happened to the engine? Will it have any impact on other Pratt & Whitney GTF-powered aircraft and what will be the “slight design modification” to the engine referred to in the press? These questions will be asked many times as the majority of new regional jet designs rely on the Pratt engine design.

Moving on to the mainstream single-aisles, the battle between Airbus’s A320neo and Boeing’s 737 Max will certainly continue, with both claiming design superiority. Order-wise, the A320neo is still in the lead and has the advantage of spreading the technology risk over two alternative engine designs. Generally financiers don’t like multiple engine options as this splits the market in cases of remarketing, but in the case of the A320 the sub-fleets are large enough to take away much of this concern.

Effectively, the technology risk for these re-engined aircraft is mainly in the engines, as the airframes are well proven. With delivery dates for new orders now stretching out many years into the future, are airlines still eager to order additional Neos and Max jets? There will probably still be a significant order volume in this market segment, but as a financier or investor, one hates to think what the escalation clauses will do to final delivery prices seven years from now. While the price premium for the Neo and the Max was supposed to be modest (50% of the fuel savings), escalation may actually open a significant price gap between the old and new generations.

As long as financing is available to allow airlines to take delivery of all these aircraft, which have huge backlogs, Airbus and Boeing should maintain enormous pricing power. However, the value dynamics of aircraft could change if in the obsessive battle for market share these manufacturers use price discounting as a means for winning orders.

Since the launch of the A320 in the late ‘80s (and the same goes for the 737NG), prices for this type have not increased significantly. Initially projected production volume for the Airbus single-aisle has been exceeded by a multiple.

Production efficiencies and the amortisation of the nonrecurring cost must have left enough room for the manufacturer to book healthy profits while keeping prices more or less stable during the years. With the relatively modest cost of a re-engining project, this situation should continue, but will it? With the Neo and Max, there should be an opportunity for the manufacturers to increase margins and – again from a financier’s point of view – in a way this is actually a good thing.

Perverse as it may sound, the best protection of the residual value of an older-generation aircraft portfolio is a significant increase in the price of the new aircraft. The fuel-burn savings can be offset against the higher capital cost (as long as interest rates are positive) for the new kit, keeping the old assets relatively competitive. What the financial community doesn’t like is the introduction of non-retrofittable upgrades. Already the OEMs have indicated that in the near future additional enhancements or “PIPs” (performance improvement packages) may be implemented. From the Lockheed L-1011 “lead sleds” to the Boeing 787 “teenagers”, financiers utterly dislike early oddball aircraft. While it is understood that manufacturers need to improve their products to remain competitive, the interests of financiers and investors (now close to 40% of the global jet fleet) have to be taken into account as well and the option to economically retrofit any improvement is essential.

Probably the most interesting event at Farnbourgh this year could be in the medium and large twin-aisle jet segment.

Let’s cut to the chase: will Airbus confirm the re-engined A330neo? Some of the most respected industry experts claim a huge market for this aircraft, were it to be launched. Ironically, the A330neo seems to be the phoenix rising from the ashes of the original A350 design, which was rejected by many of us remember ISTAT 2006? Maybe Airbus wasn’t so wrong with the “warmed-up A330” years ago?

If launched, in honor of its maligned predecessor, maybe the aircraft should be called the A350 “Classic”. If the A330neo will be launched, what engines will it have? Airlines seem to love the Rolls-Royce powerplants, investors and lessors often are less enthusiastic because of residual-value considerations. Would a two-engine option of Rolls-Royce and General Electric powerplants be an alternative? Sales volume probably won’t allow this. The best solution would be to select engines that can be used on other aircraft types as well, so as to optimise residual values. For technical reasons this will probably be impossible. John Leahy reportedly mentioned that a re-engined A330 – while somewhat range-limited - would come close to the fuel efficiency of the new generation of aircraft (such as the 787) but that it would have a decisive advantage in capital costs, plus there would not be the technology risks associated with a brand-new design. As a re-engined aircraft, the A330neo probably does have lower production cost, if only for the limited nonrecurring element. Again, reading this as member of the financial community, lower capital cost could mean bad news. Lower capital costs imply lower prices, and this means potentially more pressure on the residual value of the current A330 fleet and, yes, potentially even on the pricing of new-generation twin-aisles. Boeing has been relatively successful in cranking up the price of the 787 between the launch orders and today. I seem to remember the “7E7” was supposed to cost as much as its predecessor, the 767-300ER, but this certainly is no longer is the case. If the re-engined A330 were significantly lower-priced, Boeing would probably have to respond in a similar way, and the much-needed price gap between current-generation aircraft and the new technology planes could be reduced.

In term of new orders, the smaller twin-aisles are no longer flavour of the month. Within the 787 family, the focus seems to shift away from the -8 in favour of the 787-9 and maybe a little less so to the 787-10. Probably we will see some orders for those two variants.

The view from Toulouse is that reports of the death of the A350-800 have been greatly exaggerated, but the orderbook certainly doesn’t look healthy. The question is when will the aircraft be put out of its misery? The commercial discussions between Airbus and the remaining -800 customers probably play a role in this. The A350XWB could pull in additional orders for the well-established -900, but more interesting is the question of what will happen with the -1000? While as such a very good competitor compared with the 777-300ER, it is now confronted with the new, more capable Boeing 777X. While both types probably could coexist in the bigger fleets, the move by Emirates to cancel its A350-900/-1000 order and reopen the competition leaves ample room for speculation. The generation change from the Boeing 777-300ER to the 777-8X and 9X has a lot of similarity to what we already saw for the Embraer E-Jets E1 moving to the E2. The new 777 design is announced but there are still plenty of -300ER production slots to be filled. No doubt the -300ER will still be an excellent aircraft for the airlines for many years to come; the concern is once more about the future residual value.

While the 777-9X will almost certainly be priced at a significant premium over the -300ER, any short-term discounting of the -300ER to fill slots and maybe spoil A350-1000 sales campaigns could undermine values of existing -300ERs. Let’s hope this scenario will not become reality.

So, apart from an A330neo bombshell, anything else? Maybe some tweaks to the A350-1000 and in particular its engines to enhance competitiveness compared with the 777X? Let’s see.

Given the state of the cargo market, it is unlikely we will see much news regarding the freighter side of the business, unless finally some decisive action to kick-start the A330 P2F conversion is taken. Given the track record of this project and Airbus freighter programmes in general we at DVB fear the worst.

To finish, what is to be expected in the top end of the market or the jumbo segment? The 747-8I may pick up one or two orders, but nothing spectacular. With respect to the A380, it seems Emirates has enough of those on order and despite some rumours about a new lessee the attempted boost to market the A380 together with partner Amedeo has yet to bear fruit. Will there be any announcements about a re-engined or even a stretched A380? The latter seems far-fetched, but some engine tweaks can’t be excluded, especially as this seems to be high on the wish list of the all-mighty Middle Eastern carriers. Interestingly enough, some airlines seem to have bitten off a little more they can chew in this segment. Will we see some deferrals or cancellations? Probably the PR machines will not allow any such news to surface in Farnborough.

In conclusion, DVB doesn’t expect any industry-shaking product announcements, apart from an A330 re-engining, and even that one is probably going to be postponed until later in the year. Most likely, there will be a few hundred orders for the E-Jets, A320 family and 737. The A330, 787, 777 and A350 could pick up a few orders as well. Will Airbus be able to sell the slots freed up by the Emirates cancellation? Press releases indicate this should not be a problem at all, so we’ll see.

So let’s have a good show, and don’t forget your umbrella; in the meantime, I’ll start thinking of excuses why all the above predictions turned out to be completely wrong.