Airplane makers gamble on growth, market expansion

At its annual general meeting this month in Singapore, the International Air Transport Association lowered its forecast for profits this year of its member airlines by more than 50 per cent, to $4 billion from $8.6 billion predicted as recently as March 2.

Although it raised its estimate for earnings last year to $18 billion from an earlier estimate of $16 billion, the forecast of an even steeper than expected fall in airline profitability makes a gloomy backdrop for the 49th Paris air show at Le Bourget airfield this week.

The carriers are being squeezed between high oil prices – expected to average $110 per barrel this year, against $96 in 2010 – and an overly rapid expansion of capacity relative to demand. Global airline capacity this year is slated to rise by 5.8 per cent, while demand is expected to expand by only 4.7 per cent.

“But with a dismal 0.7 per cent margin, there is little buffer left against further shocks,” IATA’s director general, Giovanni Bisignani, said at the annual meeting, referring to the $4 billion profit on projected revenue of $598 billion. In the US market in particular, unemployment data and consumer sentiment indicators suggest that a bigger buffer might be welcome.

Positioning themselves for a slackening market, JetBlue and AirTran airways, focused on budget-sensitive personal travel, have already announced promotional low-fare programmes for the September post-holiday season, offers not usually made until late July or early August, according to Helane Becker, airline analyst at the investment bank Dahlman Rose.

Yet even as airlines face the prospect of excess capacity, Airbus and Boeing say they are increasing production of their A320 and 737 airliners to meet an expected wave of new orders. Boeing is also stepping up production of its wide-bodied 777.

Even taking into account strong growth in emerging markets and the attraction for the carriers of fuel-efficient offerings such as the A320 New Engine Option or Bombardier’s C Series – which has just notched up its 100th order – are the manufacturers at risk of getting out of sync with the economic cycle?

Michael J Richter, co-head of aerospace business at the investment bank Lazard in Los Angeles, says he takes a relatively optimistic view of the outlook for the manufacturers.
“The aerospace industry is in a better position than last year at the time of Farnborough,” Richter said, referring to the British air show that alternates annually with Le Bourget. “Paris this year should be a vibrant deal-making environment.”

Mergers and acquisitions business has been fairly active this year and is likely to continue, reflecting a greater availability of financing, he said. “While the aerospace industry remains vulnerable to economic cycles, there are numerous hot spots globally at present.”

While “ultimately, consumer demand drives air traffic,” Richter said, “Asia-Pacific retains bright prospects, although the Japanese earthquake/tsunami/nuclear meltdown has naturally caused problems and disruptions. Private equity has re-emerged in the aerospace industry to finance strategic acquisitions, while buyers already in aerospace are executing fill-in purchases to cover gaps in their structures or product lines.”

Lazard’s forecasts show commercial aircraft production rising this year over 2010 and rising again in 2012, then holding steady into 2013.

James F Albaugh, chief executive of Boeing’s commercial airplane unit, said his company would raise the production rate of the 737 model to 35 aircraft per month from 31.5 early next year, to 38 in the second quarter of 2013 and finally to 42 in the first half of 2014, to service a backlog of 2,100 orders.

Raising output

Together with increases of the much larger 777 family, Boeing is raising its overall aircraft output rate by 40 per cent in the next three years.

Airbus similarly announced in May it was stepping up production of its A320 family. Looking ahead over the next 20 years, Albaugh forecast global demand for 33,500 new commercial aircraft, worth nearly $4 trillion, of which $1.7 trillion worth would be in the 100- to 200-passenger 737/A320 size range.

“Now is the time for us to commit to a new programme,” Albaugh said. “We are leaning toward the New Small Airplane, to be in service by 2019 or 2020 with 20 percent better fuel efficiency than today’s 737.” Alternatively, the current model 737 could be re-engined. A decision between the two options should come this year.

After a series of embarrassing production and testing delays, meanwhile, Boeing’s 787, seating between 230 and 296 passengers, is at last scheduled for delivery to All Nippon Airways in August or September. The original delivery date was to have been May 2008.

Boeing is planning a larger version of the 787, to carry 320 passengers to a range of 7,000 nautical miles, or 12,800 km. The company is also assessing how to improve its long-range, wide-bodied 777 family, but Albaugh insists that the company will never again start two new programs simultaneously, as it did with the 787 and the 747-8 model.

Airbus, meanwhile, says that it will deliver its first extra-wide-bodied A350 XWB, its competitor to the 787, in the second half of 2013 although it has announced an 18-month delay in the largest version of the plane to allow the development of a more powerful engine.

Airline mergers – like United with Continental, Delta with Northwest, Air France with KLM and British Airways with Iberia – mean that fewer decision makers will be controlling larger purchases as the combined fleets are renewed or expanded. This has major potential consequences for both the large manufacturers in cases where the existing fleets include both Boeing (Continental, British Airways) and Airbus (United, Northwest and Iberia) planes.

Near-term, this may offer Airbus an edge in orders for its A320 New Engine Option, or A320neo, which could cut average fuel consumption immediately while allowing airline managers more time to evaluate the eventual Boeing response. At mid-June, A320 new orders totaled 362, with Airbus’s sales and marketing chief John Leahy targeting 500 by the end of the air show.

On the sidelines of a recent meeting of the chief executives of Star Alliance airlines, Harry Hohmeister, chairman and director general of Swiss, said the flexibility of engine choice offered by Airbus, between Pratt & Whitney’s 1100B and CFM International’s Leap-X, made it easier for him to opt for the A320 neo.

Among the smaller airliner makers, Bombardier of Canada has sold more than 100 of its C Series – formally introduced in 2008 and due to come into service in 2013 – of which the largest version, the 130-seat CS300 stretches into seat capacity jealously guarded by Airbus and Boeing. Evidence that challenging the giants may be worth the risk comes from Vueling, the low-cost airline based in Barcelona, which recently said it would ask all three manufacturers for fleet renewal proposals, with deliveries to start around 2016 or 2017.

Embraer, of Brazil, says it faces a strategic dilemma similar to Boeing’s. After selling 1,000 of its E series small jetliners in the last seven years, it must now decide whether to re-engine, or develop a new, larger airliner to join the dogfight in the mid-size market segment.

“We are not in a hurry and must assess carefully how to play our cards,” said Luis Carlos Affonso, the executive in charge of Embraer’s new programmes.