Despite protestations from the manufacturers that orders are not saved up for shows, there is the inevitable speculation of what may be announced at the Farnborough International airshow in mid-July. But before the industry gathers for its annual show fix, it is worthwhile taking a detached look at some of the market fundamentals.
Although there has been some fine-tuning of the profit forecast, the airline industry in broad terms is expected to report an overall operating margin of some 3% by 2007 – which is unlikely to be viewed as compelling in terms of an investment story. Beyond 2007 there are a number of concerns in relation to the financial performance of the industry, yet the aircraft ordering continues. Against this background, however, the level of new orders for 2006 to date has remained relatively strong, with over 500 orders announced. Boeing, in terms of aircraft, is ahead by a ratio of almost 4 to 1. It is also interesting to note that almost a quarter of the 309 orders that Boeing has taken for the 737 are accounted for by the conversion of options by Southwest Airlines.
While attention is perhaps inevitably focused on the difficulties that Airbus continues to experience with the A380, it may be too early to say what the consequences are for the company, either financially or managerially. It does, however, underline the long-held view that each time a new programme is launched, management still, in effect, “bets the company”. One outcome, however, is that the difficulties in Toulouse will enhance the prospects for the Boeing 747-8 series.
In early June, at IATA’s annual meeting, David Bonderman, chairman of Texas Pacific Group and also Ryanair, suggested that in effect 2005’s level of aircraft ordering was a sign that it was as good as it was going to get. This is a view that we agree with, and also a sentiment expressed in this column. It remains difficult if not impossible to obtain an aircraft in the near term, an outcome which for most programmes – apart from one obvious exception [the A340] – is reflected in lease rates.
There are a number of visible and less visible signs that suggest that we are moving through the top of the market. Deploying aircraft profitably either as a lessor or as an airline requires a different set of skills than placing an order. There is a risk that the momentum seen in the market results in “me-too” ordering behaviour that could prove financially damaging.
As we have suggested in the past, we do not subscribe to the view that world economic growth has defaulted to some steady rate in the region of 3-3.5%, with the positive accompanying effects for the airline industry. If this prognosis is right, just as night follows day the industry will be shown to have over-ordered. Then attention will inevitably have to focus on how to adjust to a more difficult environment.
Order shuffling is an inevitable consequence of a downturn in the airline industry. For a manufacturer there is a difference between taking an order from a customer and the ordered aircraft being delivered to the same customer at the time specified in the original agreement. A key but unanswered question is whether against the background of the 2005 order intake the manufacturers have changed their view on the conversion rate of orders into deliveries.
With a lag on some programmes of perhaps four years between placing an order and receiving a delivery, it is worth asking about the ability to accurately anticipate the economic and industry circumstances into which an aircraft ordered now will be delivered. This is particularly true of 150-seaters. It raises issues about the timing of all new aircraft in this segment and the consequences on the values of later delivery aircraft from the current programmes.
Add to this the very real prospect that the actual need of some customers will fall short of their expectations then surely the apparent shortage of aircraft will lessen. This suggests that the need to place an order now will continue to reduce rather than increase.
However, as with all things in life, success is often about timing. In this respect attention perhaps should focus on seeking to capture the next upturn. But as there is an inevitability that things will get worse before they get better, the best deals may be obtained by those who are prepared to be patient. Of course, generalisations are dangerous and the potential varies between programmes.
Perhaps the principal conclusion is that there are good reasons to expect buyers will retain the upper hand in aircraft acquisition negotiations – if indeed they ever lost it – the need as ever will be not to blink first. ■
Source: Airline Business
