Aircraft cancellation rates are worth keeping an eye on
The role of an analyst is to look for and seek out market turning points. In this respect it is important to identify a series of hopefully reliable leading indicators.
At the moment there are a number of mixed signals emanating on the economic front: in the US there is the so-called crisis in the "sub-prime" (high risk) loans market and also some evidence of a fall in house prices, which will inevitably result in a "feel bad" factor as it impacts on perceptions of wealth and feeds through into spending. In the past we have considered the role of expectations as an indicator of future behaviour and it is believed that this continues to be important.
The latest economic figures for June make interesting reading. The text accompanying them uses phrases such as "less upbeat" and "subdued". Although there appeared to be a bounce in confidence in May, interrupting a downward trend that began after the peak reached in February, in all areas June was again weaker. The conclusion on consumers was that they were "guarded about short-term prospects".
Just as generalisations are often dangerous, it is also the case that a single set of figures does not constitute a trend. Despite this, there have been at least two recent announcements from airlines - Southwest and Gol - that merit further consideration. Both airlines have announced reductions in originally planned fleet sizes. Southwest, which revealed plans to reduce the net increase in its fleet to 19 aircraft in 2008 (originally 34), cited "the slowing US economy" as one of the reasons. The other was the rising fuel price. At a similar time, Gol said that it would cut eight Boeing 737-300s from its fleet. While this improves the age profile of its fleet, it represent a decrease in capacity.
One of the questions asked at the Geneva Aircraft Finance Forum in February was whether delegates thought the industry had over-ordered. At the time a majority thought there were signs of this. While there is certainly some background noise suggesting that it is possible to obtain aircraft for relatively near-term delivery on programmes that were thought to be sold out, there are other significant indicators to consider. The relationship between announced gross and calculated net orders is often a good starting point.
Cancellation rates
Using data for Airbus and Boeing from the "World Jet Inventory", since 1990 cancellations expressed as a percentage of gross orders have ranged from 97% in 1993 to 1.4% in 2004. In the last downturn the cancellation percentages were 23.1% in 2001 and 24.9% in 2002. However, since 2003 the annual cancellation rate of some 3.5% of gross orders has been significantly lower than the 1995-2000 average of 8.7%. This inevitably raises the question of whether this is an indication that the cancellation rates are likely to pick up in the near-term or, as in the case at the end of the 1986-1990 upswing, a rather greater correction is likely. Concerns also remain over the ability of the low-cost carriers to find buyers at an appropriate price. Their ability to sell 7-10 year old aircraft to "create space" for some of the aircraft on order is also worth watching, as the failure to achieve this will have a number of financial implications.
Although we have often questioned whether the manufacturers reassessed the effective coefficient for the conversion of orders into deliveries, we have had no answer. For the first six months of 2007 gross orders were 680 for Airbus and 549 for Boeing. If we examine the change in the total backlogs for each manufacturer, this shows that for Airbus net orders were 623 and for Boeing they were 539. In other words cancellations represented 8.4% of the gross orders announced by Airbus in the period, and 1.5% for Boeing. At this stage there is no evidence of a step up in cancellations, but clearly this is something to watch.
It was also of interest to note that Southwest cited the rising fuel price as an issue. The latest forecast for the full-year outcome from IATA is that fuel will be $80.5 a barrel, meaning the fuel bill will be some $5 billion higher than in 2006 or, put another way, equivalent to almost a third of the operating profit currently forecast for the full year.
The forthcoming results season may be particularly telling and, as ever, it will be important to examine the comments surrounding the results and what is left unsaid, as well as the actual figures themselves.
Source: Airline Business
