What’s Ahead For Aircraft Manufacturers?

For the last several years, airlines and leasing companies have been racing to catch up with an equipment shortage they did not foresee. More than two thousand jets still in service are now over twenty years old. Traffic growth, fuel prices, and approaching Stage 3 noise deadlines have combined to create an urgency for new, quieter, more fuel efficient planes. The response has been booming orders.

1990 set records. The big three manufacturers posted orders for 1,160 planes valued at $US80bn. They are now so backlogged that the next available delivery date on most models, assuming these orders hold, is 1995. With an estimated 2,200 planes valued at $US200bn on order, the backlog itself could affect the way airlines acquire planes.

Yet, the crystal ball begins to dim. The Gulf War is over, but the recession it spawned is not. Airlines remain in a slump. Eastern has been liquidated. PanAm, Midway, Continental and Air Europe are in bankruptcy. TWA, Hawaiian and others are highly indebted and grossly under capitalised.

Within the past year, nine carriers have cancelled or delayed pending orders for 85 commercial jets. More airlines are pondering such moves. Air Canada and Canadian have offered to sell delivery slots on 747-400s. American Airlines warns that it may allow some options to lapse. More order cancellations, especially with airlines in Chapter 11, could come soon.

Boeing chairman and CEO, Frank Shrontz, is realistic about what that would mean: “If the airlines get into a desperate financial situation and say ‘We know we’ve got a firm contract to take an aircraft, but financially we can’t do it,’ a firm contract all of a sudden doesn’t mean much. ”

So far the manufacturers are unscathed. Dean Thornton, president of Boeing’s commercial aircraft group, says that for every customer who wanted to delay, “other carriers have asked us to accelerate deliveries. Even if a considerable number of these orders were deferred – and we have no reason to believe they will be – the backlog would still remain at high levels. ”

Others are more pessimistic. A report by SG Warburg Securities of London sees the recent spate of order deferrals and cancellations as the start of something worse. Warburg fears they will reach unprecedented levels over the next 12 months, with deliveries due in 18 or 24 months most at risk. The impact, according to Warburg, on those who believe “that a golden era for civil aviation has dawned will be devastating. ”

John Walsh, known in the industry as “Dr Gloom”, is director of market planning at California based Rohr Industries, which supplies components to Boeing, Airbus and McDonnell Douglas. “When we look at the fundamentals,” Walsh warns, “we see a lot of potential for postponing things. ” In contrast, John Hayhurst, who recently released Boeing’s annual market outlook for commercial jets, cautions, “Don’t read too much into short term conditions. This is mostly a matter of timing, and the long term outlook for air travel remains strong. ”

A great deal depends on who is right. Unquestionably, orders are down. As of late February, airlines had ordered only 9 Boeing planes worth $US600m. At the same time a year ago, Boeing had orders for 88 planes worth $US7. 3bn. Airbus lndustrie expects orders this year for 170 aircraft, down from 404 in 1990. Moreover, Airbus blames this downturn on the cyclical nature of the industry, rather than any lingering effects of the Gulf war. Boeing’s John Hayhurst is sanguine about the drop in orders. “We can’t forecast orders,” he says. When it comes to buying planes, “there is no way you can assume when two hundred airline executives will make up their minds. ” Long term forecasting is where the crystal ball turns to fog. Looking beyond order deferrals or cancellations or even the pace for new orders, manufacturers must plan production rates to meet demand projected as far ahead as a decade. To no one’s surprise, this is the area of greatest controversy.

In the next ten years, manufacturers project demand for some 6,725 new jets valued at $US400bn – roughly equalling the annual gross domestic product of the United Kingdom. To build that many planes means pushing up production rates on the models in greatest demand.

But therein lies the dilemma. Increasing production rates – called “ramping up” – is no small matter. The lead time on fuselage panels, for instance, is about two years. Legions of suppliers must be consulted, assembly areas enlarged, new workers trained. “We can’t afford to do this haphazardly,” says Bob Hagerman, program management director at Boeing’s 747 plant, “there are substantial amounts of money involved. ” This year, Airbus will ramp up production from 95 deliveries in strike-affected 1990 to 170. Boeing will increase 737 production from 17 to 21 a month,and boost 757production next year from ?to 10 a month. Are the projections on increased sales reliable enough to justify these actions?

In view of aviation’s mixed signals, some think not. John Walsh predicts softer demand for new aircraft. “We see depressed housing, automotive and banking sectors, a large war bill, rapidly eroding Eastern European economies, and an awesome US budget deficit. ”

New aircraft forecasts rely on two assumptions, growth and replacement. Few question the 5-6% growth rates used by the manufacturers and regulators in all their estimates. The dispute is over replacement rates, and it has major implications.

Of the estimated 672 new planes needed each year for the next ten years, manufacturers assume 70%, or 470 planes, will be for growth, and the other 202 will replace older aircraft. But, if older planes are retired at a rate of, say, only 60 a year, as they were in 1990, then the ten year projection is overstated by a third and planned production will simply create a glut of aircraft.

Edmund Greenslet, a former Wall Street analyst whose company, ESG Aviation, handles used planes, predicts a massive oversupply of serviceable, used jets as early as next year. “The people who own those aircraft, the leasing companies especially, are going to do everything they can to resist scrapping their assets,” he says. “Expecting 300 jets or anything like that to go into the scrap heap is Adamsville. ”

Boeing claims that a surge in aircraft deliveries during the 1960s means that a growing number of planes will reach retirement age this decade. It concedes that retirements in the last two years fell far short of its forecasts, but older planes stayed in service longer than expected due to traffic growth and a shortage of capacity to handle it. The world’s fleet of almost 9,000 jets now has an average age of 11. 8 years, which translates into 3,500 to 6,500 retirements, according to Boeing, over the next fourteen years.

Replacement strategies by airlines vary. New planes are more fuel efficient, but Robert Crandell, chairman and CEO of American Airlines, says he cannot justify the capital required for new planes simply to cut operating costs. Alaska Airlines takes the opposite view. During the 1990-91 fuel crisis, it replaced older planes as fast as it could to cut fuel costs. Capitalisation obviously plays a major role in an airline’s fleet replacement planning.

Over the short term, while Stage 3 deadlines are still several years away, replacements may continue to lag behind projections. Routes, age and condition of existing planes, availability of new aircraft, and the market for disposal of used ones will all influence an airline’s fleet planning. Multiply these uncertainties by all the carriers in the world, and the guesswork inherent in replacement forecasts becomes apparent.

Even if the manufacturers are right, or even close, the question remains as to how they will divide this potential multi-billion dollar market. Debate has raged, not only over the size of this market, but how many players it can support. The consolidation now occurring in the airline industry is unlikely to affect total orders because the demand is the same regardless of the number of airlines. But fewer carriers mean fewer transactions, and that means more competition for each order.

Each of the big three manufacturers faces this prospect differently. Boeing is coming off a banner year with profits topping $US1bn on record sales of $US48bn. Earnings would have been even higher except for a $US418m loss in its defence division. Boeing’s share of the commercial jet market is well over 60%.

CEO Frank Shrontz expects 1991 to be a good year. “In terms of firm orders,” he recently told Reuters news service, “we are in quite good shape for the next 24 months. ” Shrontz admits some airlines may cancel orders, but many orders are with fast growing Asian airlines, where he is especially optimistic. The three fastest growing air traffic markets in the world are Europe/Asia, intra-Asia, and trans-Pacific.

Boeing’s newest plane, the 777, remains something of an enigma. Launched in October on the strength of a United Airlines firm order for only 34, All Nippon’s placement for 15 is the only other order. Shrontz says his company will concentrate this year on finding more customers for this $100m aircraft.

Airbus lndustrie is also coming off a profitable year, its first in 20 years of operation. Sales for the A320, acclaimed as the “world’s fastest selling civil aircraft,” have been sharp. Last year’s strike by workers of consortium partner British Aerospace delayed deliveries, but production should be back on schedule by mid year. A big key to success is expansion of the Airbus product line.

Three new models are now in production, with first delivery of the A340 scheduled for January 1993. The A330 will follow about nine months later, and the A321 in early 1994.

Orders for these new planes have helped Airbus boost its market share near to 30%. That is its target for the 90s – a goal it seems likely to achieve. Like Boeing, the value of its orders has grown, reaching $US72. 5bn by the end of last year.

McDonnell Douglas is struggling simply to stay in the race. Unlike Boeing and Airbus, it lacks the full range of jets that might allow it to use revenue from one model to develop another.

The MD-11, so vital in maintaining its credibility as a commercial manufacturer, has cost it dearly. Development costs are now over $US3. 3bn, yet problems remain. American Airlines was an MD-II launch customer, but now refuses to use it on its Tokyo route because of computer and fuel problems. Commenting on the MD-11, American’s Robert Crandell says, “we are very, very, very unhappy. ”

The MD-11 gave McDonnell Douglas an initial advantage over competitors with the first launch of a 325 passenger jet. But its order book is now full through the dates when the first of its competitors, the A330s, A340s and 777, become available. So its advantage is spent. Moreover, as Jack Gamble, Boeing spokesman, observes, “The last guy in the game always has the advantage of the most recent technology. ”

To retake the lead, McDonnell Douglas has embarked on the MD-12X, and will spend large sums to develop it. A stretched version of the MD-11, the MD-12X might carry from 372 up to 550 passengers. Speculation is that it may be officially launched at the Paris Air Show in June. The company’s first priority is to find risk-sharing partners. McDonnell Douglas is offering a stake of up to 50% to primary partners willing to invest that much in developing the MD-12. The company’s willingness to offer so large a share reveals its financial caution and may suggest an evolution in roles towards more of a general partner and less of a manufacturer.

McDonnell Douglas recently received another blow when Swissair and Austrian Airlines decided not to place expected orders for the MD-80EC, explaining that it was not technologically advanced enough for a fleet replacement program. That prompted MDC to announce plans for a new 170-220 seat twinjet to compete with Boeing and Airbus.

Facing technical problems with its new MD-11, and seeking risk partners for its MD-12X, observers wonder whether McDonnelI Douglas is in a position to launch a completely new aircraft against well-established models Boeing and Airbus already have on the market. It is hard to compare MDC’s performance with Boeing and Airbus because the company does not segregate military and civilian sales. The best estimate is that it took commercial aircraft orders for about $US5bn in 1990, with some $US30bn pending at year’s end. If so, its share of the commercial aircraft market has dropped well below 10%.

Last year, while its competitors made record profits, MDC’s profits fell 5% after adjustment for extraordinary items. 1991 will be the first full year of MD-II production. If its problems are solved, that could help the company’s position. But the longer range view from Long Beach is far from clear.

Manufacturers of smaller aircraft are also witnessing consolidation. The sale of Boeing’s De Havilland division to the European consortium of Aerospatiale and Alenia (formerly Aeritalia), known as ATR, gives that group a presence in all turboprop size classes from 30 to 65 seats. ATR may also be forming a “little Airbus” by joining with Germany’s Deutsche Aerospace to finance and develop a 100-130 seat jet. The high costs of new aircraft are forcing turboprop and small jet manufacturers to reorganise.

In the meantime, Japan and the USSR seek a larger commercial manufacturing role. The Japanese are gaining ground as major component suppliers for Boeing and Airbus. During his April visit to Tokyo, Soviet President Gorbachev discussed with the Japanese the possibility of Ilyushin participation with Japan in building fuselage and wing parts for the Boeing 777.

Despite its headaches and uncertainties, the Soviets recognise that aircraft manufacturing is big business on a global scale. Over the next 15 years, the world’s airlines will take delivery of $US615bn worth of new jet aircraft, depending, of course, on the validity of the estimates