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Aviation Industry Leaders Report 2019

Aircraft Market

Aircraft Market

Technology has long been at the forefront of aviation. Technological advancement for commercial airliners is ongoing but takes time to develop. The latest airframe and engine technologies are impacting the aviation industry in many ways. Furthermore, digital technology is disrupting the market in terms of airline and aircraft operations as well as financial technology development.

Equipment

Aviation technology is forging ahead with new airframes and engines now coming on line that promise lower fuel burn, less noise and more efficient flying. Designing and producing new commercial aircraft, however, is expensive and takes a long time to come to fruition, from design through to the lengthy regulatory approval stage. The A320 Neo narrowbody aircraft program, for example, was launched in 2010, but the first commercial delivery did not occur until January 2016, with deliveries only now ramping up. The Neo and the Boeing 737Max are only re-engined airframes and as such came to market in a shorter timeframe.

The Boeing 787 Dreamliner and the Airbus A350 aircraft, however, are both designed from a clean sheet and are considered to be the most technologically advanced aircraft flying today. These programmes took much longer to move from concept to delivery stage. The 787 programme, at a cost of approximately $32bn, was first announced in 2003 as the 7E7, with the first test 787 aircraft rolled out in 2007 and the first commercial delivery made in 2011.

New aircraft

The long-term cost and commitment needed for the development and launch of a clean sheet commercial aircraft programme is the main reason why manufacturers take so much time and effort examining the market and demand for new aircraft. The so-called new middle-of-the-market (MoM) aircraft or New Midsize Airplane (NMA) concept from Boeing, which would carry between 220-270 passengers and have a range of 5,000nm, has been under discussion for some years. The aircraft has a preliminary entry-into-service date of 2025. To date, Boeing says it has sought advice and input from more than 60 airlines on issues such as configuration, cargo capabilities and other critical technologies. With so many contributing voices, Boeing says it has a variety of opinions on the best design for the aircraft. The participants of this report had variety of views regarding the potential success of the NMA but most expect Boeing to launch the programme.

One airline executive sees a major market for the NMA aircraft in South East Asia as those markets continue to develop and evolve, but notes the lack of suitable airport infrastructure to accommodate the predicted rise in air travel demand. “The airport infrastructure is not growing at the same pace and secondary airports are in short supply. Metropolitan cities continue to dominate travel and so before a MoM aircraft can become feasible, a demographic and economic shift towards smaller towns will need to materialise.”

GECAS’ Declan Kelly states that Boeing has likely already made up its mind to launch the NMA and that its past decisions have been “pretty accurate”; however, he does warn Boeing to ensure that any new variant does not cannibalise the 787 or the 737Max. “The narrowbodies have a lot more capability, and they’re certainly moving up into the middle of the market space,” he says. “And you’re seeing the A330 and the 787s play in a space closer to the narrowbody market. That mid-market has a large spread of aircraft already. That would shape any decision-making, and it would certainly shape our decision-making, but at the moment, our view is it’s just too large of a spread to require another variant.”

Limited demand

OEMs disagree on the predicted size of the middle of the market aircraft sector, which ranges from just 700 to 5,000 aircraft, with an average around 2,000-2,500 aircraft – still too few to justify a new aircraft programme.

Andy Shankland, executive director at Plane View Partners, who advises airlines on their fleet replacement needs, questions whether the market for the NMA is large enough to justify the programme. “Boeing knows very well how to design a great airplane, so if they design an airplane to do that mission, it will do the mission very efficiently,” he says. “The real question is whether there are sufficient airlines with space in their fleet to support this new ultra-efficient 220 to 270-seater aircraft.” Shankland refers to the growing trend for airlines to simplify their fleets with fewer aircraft variants, which he suggests could limit demand for a brand-new aircraft type, if it does not allow another type to be eliminated from an airline’s fleet at the same time.

SMBC Aviation Capital’s Peter Barrett says the price point of the NMA would be a decisive factor in its success but he also doubts whether Boeing will launch another new aircraft. “It is a pretty big decision for Boeing. The last time Boeing launched a brand new airplane was the 787 – it’s a fantastic airplane but it cost an awful lot of money to build and had a huge number of challenges. The question is has [Boeing] learned from that?” He also highlights the uncertainty over the engine choice. “All of the new engine types have had challenges, and all the engine manufacturers are facing their own corporate challenges that may not be resolved quickly.”

The efficiency and performance of the engine choice will be the key factor in the decision to launch the NMA and indeed in its eventual success. Engine manufacturers are facing immense pressures to increase production rates, solve the entry-into-service issues with numerous engines quickly and also produce parts for existing engines as well as maintain them. Plane View’s Shankland says that the engine OEMs are “probably pushing the limits of today’s technology” which is one of the reasons for many of these teething problems. “Without more radical thinking,” he says, “I think we’re probably reaching an asymptote of current aircraft design.”

Entry-into-services issues

Two of the greatest challenges for airlines and lessors alike is asset selection, deciding which new aircraft to invest in, often many years in advance, as well as then managing the transition of the existing portfolio from current technology to new technology in an orderly way. That orderly transition has been impeded significantly for some airlines as deliveries of their new aircraft have been blighted by entry-into-service issues with the new engines – both the CFMi LEAP and the PW1000GTF on the new narrowbodies and the Trent 1000/900 on the 787 – having been recalled for shop work. This has caused capacity and operational issues for airlines, while also boosting demand, values and lease rates for older aircraft and engines. (For a full review of all of the entry-into-service issues with new technology engines, please see the Airline Economics Aero Engine Yearbook 2018).

“Without doubt, [the entry-intoservice issues] have affected the popularity of the current generation of engines,” says Jon Sharp, former chairman and founder of Engine Lease Finance (ELF). “We’ve had many lessees simply extend the leases of the the V2500s and both the CFM56-5B and- 7B, which has been great business for us and we’ve also invested some more in some of those engine types by placing orders direct with manufacturers. What we haven’t done is place orders direct with the manufacturers for the newgeneration engines.”

Sharp goes on to explain that ELF has not placed direct orders for the new technology engines due to caution over investing in new technology that may be radically changed during the entry-into-service stage due to upgrades or other changes in spec that would impact the value of those early orders. “This phase is also heavily backed up by manufacturer support, which of course the manufacturers offer the product support function and they do it for free. We don’t do this for free,” he says. ELF has concluded a number of saleand- leasebacks for both engine types with airlines but still sees a very long future for the older engine types that do not reach a peak for shop visits until 2023/4. “We haven’t reached that peak yet and those engines are going to fly for years afterwards.”

The entry-into-services issues with the new engines have placed even more pressure on engine OEMs, which are not only increasing production rates on new tech engines but are also facing rising demand to produce more material for -5B and -7B variants, since demand is increasing as new tech engines are taken off wing for shop visits. There is a similar situation in the widebody market as well-publicised issues with the Trent 900/1000 engines for the 787 aircraft rumble on and take up time and shop space needed to cope with rising demand for parts and overhauls for older technology engines such as CF6 and Trent 700 programmes.

Variants

The number of new technology aircraft coming online today is impressive. However, with the addition of the forthcoming 777X and potentially the NMA at some point, some market players are beginning to comment that there are simply too many aircraft variants. “We will always say there are too many aircraft variants,” says Goshawk’s Kelly. “We are at a strange point in the market because there’s so much new technology being introduced today, and the general trend is towards fewer models and less variance. We’re not particularly concerned that there are too many models, we choose the ones we want to invest in – the ones we think are most liquid and will preserve their values most; we stay away from the more niche varieties.”

Craig Segor, chief executive officer of Plane View Partners, suggests that there is a much greater degree of convergence in the Airbus and Boeing product lines particularly with what the lessors are seeing as their primary assets; the A320s, the A321s, the MAX 8s, the MAX 10s, and the 787, A330 and A350 on the widebody side. “This is where the lessor community has concentrated a lot of their efforts,” he says. “For the mainstream, the majority of the lessors, they concentrate on a small number of variants and I believe it will continue to be so.”

Engine lessors are less concerned about variants of aircraft because the number of engine variants is much lower and most engines are transferable between airframe, which is what makes them such investable, long-term assets.

Engine types

“The current number of engine types across the programmes is of less concern to us as an engine investor,” says Willis Lease Finance’s Dan Coulcher. “If you have an IAE-powered A319, A320 or an A321, it’s the same engine, it’s just a thrust change. We tend to buy higher thrust engines so they can operate across all three types. The days of having three engine types for the 747 and then on the previous version of the A330 did cause investment and re-marketability issues.

The 787 is a big enough market with both Rolls-Royce Trent 1000 and GEnx options. You can make investment cases for both on market share and number of airline operators. Rolls-Royce though, we have concerns because of their aftermarket control, which means their residuals are an unknown to us, so it’s harder to confidently invest in the product but we are investing in the GEnx. We’re investing in both engine types for the A320Neo without any real concern.”

ELF’s Sharp suggests that the discussions about supplying different engine types to the proposed NMA aircraft could introduce new technologies and pose further issues. “The more engines you have, the more you segregate and separate the user base and therefore the liquidity in the engine begins to erode,” he says.

Sharp adds that a greater concern around variants should be production rates and the fact that engine overhauls for the new-generation engines will begin in significant quantities in around 2026, straining capacity. “The big issue is that overhaul shops are already full but they’re going to need to increase that capacity by about 30% by the year 2026, which is a massive challenge for this industry.

One airline observer is also concerned with maintenance capacity. “My concern is that too many variants will results in MRO saturation and a depleted spare pool for older aircraft. Logistics challenges compound this issue,” he says.

Production rates

The airframe OEMs’ current rate of production is between 57 to 60 aircraft a month and it has been suggested that this figure could move up to 68 to 70 a month. Engine OEMs for the new narrobodies are reported to be producing seven engines a day, equal to more than 200 a month. The potential production rate increases, which effectively imply a 6.8% to 7% annual growth rate, are worrying almost everyone in the industry, especially given the prospect of a choppier operating environment featuring rising interest rates, volatile fuel prices and a strong dollar.

“For us, the threshold for a manageable increase is around 6% ASM growth,” says Segor. “The reality is airframe manufacturers are incentivised to make airplanes and they will continue to do so at a growth rate the market can support. There will need to be a rebalancing in the future, but we should expect increasing production rates at least until there is a supply chain limitation.”

Shankland adds that there is no incentive at all for the OEMs to reduce production rates. “As long as there’s a buyer that wants the aircraft and as long as there’s financing available, the OEM will always choose to deliver that airplane and therefore will continue to increase or at least keep production rates where they are.”

Firm order backlogs are also much larger than they have been in the past, which is another incentive to raise production. But the problems occur when there is a steeper downturn than expected.

“If you go back far enough through multiple cycles, you’ve seen OEM’s ramp up a bit too much and then when the music stops, they run into issues as to capacity,” says ACG’s Tran. “When you look at growth projections now of 6-8% and where the volume comes from, I don’t know if they can actually sustain those kind of levels in the longer term. It’s going to be tough. We’ve seen this music play before.”

ELF’s Jon Sharp believes it would be a mistake for engine OEMs to ramp up production further at this point in the cycle. “I am concerned with the very high production rates of aircraft and engines. CFM is currently producing seven LEAP engines a day and they’re swiftly going to up to nine engines a day. That is just an extraordinary production rate. If I see storm clouds on the horizon now, the oil price volatility in particular and the interest rates ticking up, then I get concerned that the system is due for quite a big crash because of those very high production rates.”

The real brake on production rates comes from supply chain capacity issues, which most say are at breaking point now.

Declan Kelly says: “Most rational people would say that 70 a month is not achievable. The supply chain just cannot support it. 60 feels right to maintain the growth. To go to 70, you would have to radically change the supply chain.”

Stephen Hannahs agrees, adding that the entire industry and infrastructure could not handle that rate of aircraft production. “Presently, I don’t think the industry can absorb it. The infrastructures to support those aircrafts, i.e. pilots and flight crews, are not being brought on fast enough. It’s one thing to produce an aircraft but you’ve got to fly it. I don’t think we’re ready for pilotless airplanes yet.”

Hannahs adds that MRO capacity is also insufficient to support any further increases. He cites one example where Wings Capital had taken a young A321 back from Monarch that had engines in outstanding condition but it needed a gear replaced. Unfortunately, he was unable to secure shop time to carry out the work. “We had signed a new LOI for that airplane within about 65-70 days on a long-term lease with a good credit, but it took us five months to have the gear overhauled. So, the plane sat idle. We finally delivered the airplane, but the MRO was busy, the supply chain just wasn’t there, and so we had to wait. The infrastructure to support these new deliveries is currently, in my view, insufficient to support rapid growth.”

OEM M&A

Airbus and Bombardier have now concluded their partnership on the former C Series, now A220, with that programme now in full swing, meanwhile Boeing and Embraer, have agreed terms, which were approved by the Brazilian government on January 10, 2019. The sense is that these partnerships by the two large airframe manufacturers with the regional OEMs will create a broader user base for those aircraft which in turn could generate more interest – possibly from lessors – in those products.

“We’ve already started to see the impact of the Airbus-Bombardier C Series (now A220) tieup,” says Segor. “Even though it is the same airplane, with Airbus on board, it’s easier to convince an investment committee or a risk management department that this is a viable investment for a lessor. We’ve already started to see some of that interest with some of the sale leaseback campaigns that have been going on for incumbent operators. If the Embraer and Boeing marriage happens, I think that we’ll see a similar halo effect on the E2 with the association of the Boeing name.”

Mike Inglese comments that Airbus essentially saved the C Series project, but views the Embraer- Boeing tie up as a different animal.

“There was an industrial logic to getting Boeing and Embraer together on the commercial side in the famous duopoly to have a regional jet. Embraer introduced the E2 product on time and under budget, which isn’t a phrase you hear often in new programme development. Boeing’s broader marketing sense and scale and an industrial supply chain infrastructure can benefit the Embraer programme and ultimately, we think it’ll be good for the programme, good OEM M&A for Embraer and good for the E2 as an asset in the marketplace.”

The general sense is that this support of the new regional jets will result in more orders from leasing companies although as they are still niche products, this will be slightly more muted than predicted.

Speaking at the Airline Economics Growth Frontiers New York 2018 conference in October, John Slattery, president and CEO of Embraer Commercial Aviation, stressed that the proposed tie up with Boeing is fundamentally different to Airbus’ partnership with Bombardier, which was an acquisition of an aircraft programme. “The Boeing and Embraer conversations are a full carve-out of Commercial Aviation from Embraer, including all the engineering, the development work, the programs, the services, everything from the E145s to the E1s and E2s,” he said. “Our transaction gives us an amazing tailwind as we go forward for, let’s say, innovation, other opportunities on innovation as we look forward, and access to a bigger balance sheet. So, I think it’s going to spur competition.”

Not only competition but also innovation. Slattery commented that he would like to launch another aircraft program with Boeing to broaden Embraer’s stable of products and he pointed to a new turboprop. “The business case for a state-ofthe- art turboprop is extraordinarily robust, in my opinion,” he said. “The incumbent platforms are aged. They’re 1980s technology, 1980s materials. They’re not comfortable from the passenger perspective. They’re not kind to the environment, and they’re not economically efficient, relative to what you could replace it with today. There’s a large incumbent operator base around the world.”

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Joe O'Mara

Joe O'Mara

Head of Aviation Finance & Leasing

KPMG in Ireland

+353 1 700 4205

joe.omara@kpmg.ie