Blain’s Morning Porridge – Sept 25 2020 – Flying High or Low?

“An excellent landing is one where you can still fly the plane the next day!”

It’s been a topsy turvy week. We’re seeing conviction under pressure as investors weigh up a) the likely new coronavirus path – which now points to a W shaped recessionary whammy on growth as infections rise (although deaths remain muted – suggesting a rethink is needed), b) the renewed focus on stock fundamentals (ie spot the bubbles, c) a sense of weaking in corporate bonds (despite record issuance in 2020), d) a sense of danger, like how could a messy US election discombobulate sentiment, and, e) a renewed and growing concern the market distortions caused by QE Infinity and negative real rates are ultimately unsustainable.

Unsustainable is a 2020’s buzz word everyone likes to hang their hats upon. It sums up markets pretty well. How will pension funds, insurance companies, savers and traditional investors function when returns have been repressed to zero? There are only two choices; 1) keep picking up the scraps from the central banks by looking for marginal incremental gains in bonds as rates stay low forever, or 2) go gamble in higher risk markets. The result is the levels of risk across the whole financial system inevitably rise.

An obvious danger is desperation – like “this time it’s different” belief in miracle companies and technologies promising to utterly change the world. The world is changing – but companies like WeWork, Wirecard and others will always suck in the desperate and gullible.. That list is set to grow..

However – any crisis is also opportunity… 

Every smart investor has ideas about what opportunities the Pandemic will throw up. As it’s a Friday I am allowed to wander off tangentially on any subject I fancy… So….. let me propose some wild ideas:

· Aircraft are cheap and investible, 

· Airbus is going to rule the skies, 

· and, the Aircraft you fly tomorrow will be determined by your children. 

Before you wonder as to my sanity, and ponder the causes of my rediscovered enthusiasm for aircraft… I am very aware we look headed back into pandemic lockdown, 1/3 of aviation assets are sitting parked and unused, and many airlines and leasing companies are clinging on by their finger-nails. We’re at the stage where airlines and aircraft owners need cash – which means everything has a price, and in aviation that price is probably much lower.

As a French general famously said… “The outlook is dire. My front is collapsing. Excellent! Time to advance! 

Sometime soon airlines will resume flying and people are desperate to travel again. (It all depends on your definition of “soon”. For instance, In Elon Musk time “soon” can be a very long time indeed…)

Airlines are raising “secured” private debt placements backed by gates, slots and routes in double digits to tide them over till travel markets reopen. I heard an American airline doing 10.75% last week. Some are going cap-in-hand begging more subsidy, while others are paying up for sale and leasebacks on unencumbered aircraft. Lessors are desperate to shift assets – meaning they are biddable. If there is a definition of a distressed asset market – Aviation is it.

Just be careful what you chose to buy. While freighters and air-cargo rates are going through the roof, some aircraft types are unlikely to be seen again. The last few B-747 Jumbos, like those flown by BA, Virgin and Quantas have flown into the great celestial bone-yard in the Mojave desert (or a knackers yard near Cheltenham.) Lufthansa has dumped half its A-380s and put the rest in long-term storage. A-330s, B-767 and B-757’s will score bonus extra points for plane spotters. The pandemic has triggered a massive ongoing shakeout – bargains might not be bargains.

The Original Equipment Manufacturers (OEMs), (the plane-makers in lay-terms), share the pain. Airbus stock has plummeted more than 56% since it peaked in early Jan – just before the end of air travel as we knew it in March. Its fallen about the same as Boeing (down 55%), although Boeing has a host of other gravity-defying problems. Airbus is less damaged, but has declined more?

Why my enthusiasm for Airbus? There is a lot not too like. If a camel is a horse designed by a committee, then Airbus is what we got when Europe’s fraxious tribes decided to cooperate on plane making rather than shooting each other down. The result was a bizarre mish-mash of naked self-interest and national pride. No sane business would organise itself like that.

Yet it worked. They are now clearly the more successful of the Airliner Duopoly. (But partly because they aren’t Boeing and didn’t build the Max.)

Airbus makes very good planes. (Unlike Boeing.. they make them well.) The problem is, they haven’t always made the right plane. The A-380 Super-Jumbo is/was a technological marvel, a flying palace, a beautiful thing to behold and fly in, but of zero practical value to all but a tiny number of airlines. Airbus, pushed by France, built the Superjumbo mainly to show they could make a better Jumbo than Boeing. 37 years after the Iconic B-747 first flew, the Airbus rival took to the air in 2007. Bravo! Just as everyone else was swapping out from Jumbos serving the hub to hub model.

Boeing got it right – building the right plane for the point to point long-distance market – the B-787 Dreamliner. (It now turns out they have built them very badly – but hey-ho..) Airbus bet the shop on building the A-380 and has lost heavily because they built the wrong plane for a market that didn’t exist anymore.

Airbus spent over €25 bln developing the A-380. They have then lost money on every single plane built under the programme. Ouch. No wonder they have stopped making them. Few of the airlines using them will put them back into service after the pandemic. Aside from Middle East hub routes, the only use for them will be flying pilgrims to Mecca. The lessors that bought them will struggle. The investors who financed them… bad news.

The losses will hurt Airbus, but aren’t terminal. As far as France is concerned, Airbus remains a state entity. The French persuaded the Germans that subsidies are not a problem.. although the British sold out, uncomfortable with the concept. The Americans want to ban and tariff Airbus as unfair competition – the military orders keeping Boeing aloft are definitely not a subsidy or state aid. Definitely not..

Regular readers will know the depth of my contempt for Boeing’s former management. They have disgraced the core concept of shareholder capitalism of ensuring the efficient allocation of capital. Instead they proved themselves greedy piglets gorging at the trough – milking the company dry. They cut corners to save money, compromised on safety, and ran the company’s reputation for safety and engineering brilliance into the ground by cutting jobs and scrimping on pay. They failed to invest in new aircraft. They had the opportunity to spend $20 bln developing a fuel efficient super clean replacement for the venerable B-737 jet – but spent $43 bln on stock buybacks instead – which they used to justify boosting executive bonuses while cutting paychecks to workers. They modified the old 737, making it unstable, called it the Max, and then blamed the pilots when 2 of them crashed killing 346 people.

In my opinion Boeing fails every ESG – Environment, Social and Governance – test there is. Yet, to my shame as a 35 year fixed-income veteran, the bond market still funded a $10 bln issue earlier this year, sparing the company the embarrassment of grovelling for a government bailout. The still grounded Max is just one problem – it remains essentially unflyable and unfixable. No one really wants the cursed plane to fly again. They are an abomination that should be taught in every business and engineering class. No passenger will willingly fly them. Everyone hates them – especially the Boeing staff looking for somewhere to park them…

It gets worse. Morale across Boeing got so poor standards were allowed to slip. The Military found dropped spanners in the wings of their aircraft. Dreamliners are being decked and returned because of shoddy workmanship and ill-fitting shims – a direct result of bad management.

The bottom line is Boeing doesn’t have the money to paint the office, let along the $40 bln it would now need to completely overhaul and develop new environmentally friendly aircraft.

Airbus has seen the opportunity. It can probably afford to spend money launching the three new Hydrogen powered aircraft it proposed earlier this week. They look brilliant. Two of them are actually achievable, according to some of my aerospace engineering contacts – they think the third lifting body model was probably added to the line up just to bait Boeing.  Airbus is saying it can achieve ZeroE flight by 2035.

Boeing took the bait and immediately responded. The head of product development, Michael Sinnett, opined it’s unlikely hydrogen planes will be entering service within 15 years. Well… he would say that.. wouldn’t he. Boeing thinks it’s doing its bit for the environment with some gentle tinkering on the noise levels on the Dreamliner. Airbus is out there with some ambition – and if they get a hydrogen plane flying, I will be delighted.
And so will your kids. Because smart airlines don’t really care what your or I think about flying. They care what tomorrow’s passengers want. Smart airlines are thinking 20-40 years ahead – and know clean flight matters. My kids (in their 20s) want environmentally friendly planes to take my grandkids on holiday. They want plastic free. They want clean power. They want change. Airbus is playing that card. Airlines know where their money comes from and who buy tickets.

The airliner business can change faster than you think. In the 1950s, it was the UK, not America, that was seen as the source of aviation wizardry. We dropped it after the Comet crashes. Today, the Chinese are said to be decades behind in terms of aviation tech – but tell that to military pilots who’ve seen its latest fighters. China may yet surprise us.

I’ll put my bet on Airbus. They could achieve a lot in the next 15 years – my fear is they may prove too bureaucratic and hidebound to move forward. I suspect Boeing will still be digging itself out the hole it’s dug for itself.

Next month I’m doing a “World Tour”Ishka webinar on a panel with Cathy Pacific talking about ESG in Aviation – we will cover everything from Boeing, clean fuel and recycled carpets in the cabins. Please sign up… if it looks interesting.

Five Things Too Read This Morning

FT – Sunak is warned that support scheme will not stop redundancies

WSJ – High Jobless Claims Suggest Slowing Labour Market Recovery

BBerg – Chanel Designs a Fabulously Fab Bond

BBerg – Getting Real About Electic Cars, Batteries and Hype

WSJ – America’s Pensions Have Been Shunning Stocks at Their Peril

Out of time, back to the day job, and have a great weekend….

Bill Blain

Shard Capital