The Paris Air Show and the Outlook for Aviation – its “Dynamic”!

Orders are piling up at the Paris Airshow, but fractured supply chains, labour shortages and engine problems means new aircraft deliveries are delayed for years. That’s opportunity, but also hints at new dynamics in terms of how the aviation sector develops – the Age of Cheap Flight may be over.

Blain’s Morning Porridge 21st June 2023:  The Paris Air Show and the Outlook for Aviation – its “Dynamic”!

“A mile of motorway will take you a mile. A mile of runway will take you anywhere!”

Orders are piling up at the Paris Airshow, but fractured supply chains, labour shortages and engine problems means new aircraft deliveries are delayed for years. That’s opportunity, but also hints at new dynamics in terms of how the aviation sector develops – the Age of Cheap Flight may be over.

It’s Midsummer’s Day! What happened to the first part of the year.. where did it go?

I’m paying extremely close attention to new aircraft orders at the Paris Airshow this week – I have skin in the game.

Together with a leading Aircraft Leasing Company we’ve begun marketing a new Aircraft portfolio deal – a securitisation based around the underlying value of mid-life aircraft, which have been driven higher by the slow delivery of new aircraft post-pandemic. The deal will achieve a double-digit coupon with mitigated risk in terms of diversity of aircraft types and airline obligors. (If you want to know more, its institutional investor only, and send me a line.)

Our investment thesis is simple: ongoing supply chain breakages, engine problems and labour issues mean under-delivery of new aircraft from the duopoly at the heart of the aviation industry, Airbus and Boeing, has become a crisis. It will be a decade or more before they normalise order backlogs. New aircraft being ordered this week are for delivery between 2031-35! Airlines need planes now, so they will use older ones for longer – extending leases – and renting older ones if they can’t get them new. It means the returns from older mid-life aircraft are significantly enhanced.

Some institutional investors have already told me they won’t invest in aviation because of ESG concerns, while others say older aircraft are not for them because they are not “sustainable”. I disagree – using older aircraft for longer and flying them efficiently is far more sustainable that replacing them with brand new aircraft – which are only some 12% more fuel efficient than earlier models, but are proving less reliable due to engine problems. And the new engines use the same fuels and also create CO2 burdens.

Paris is buzzing with glam stories about electric air-taxis, but a quick glance at the penny-stock prices of flying car SPACs should tell you these are not part of the long-term solution in terms of who will fly them, can they fly over cities, how will ground control oversee them, and where are they going to land? It is likely to be decades before we see a real technical revolution where zero carbon hydrogen or electric aircraft are innovated. Until then the big hope is aircraft will be flying on new Sustainable Aviation Fuels (SAFs) when these start to come online in coming years to move towards Carbon Zero by 2050.

These are frankly tomorrow issues for aviation – today it’s about how quickly the sector has reopened and what opportunities it creates. Our new deal is a five-year play exploiting the current strength of aviation, the new-aircraft supply bottleneck and the returns to be made from mid-life planes. Enough marketing.

The pace of orders in Paris highlight how India is now the most exciting market for new aircraft. Air Indigo has announced the largest ever order for 500 Airbus jets, while Air India has confirmed a split order for 470 Airbus and Boeings. Airbus’s A320/321 regional jets account for nearly 800 of the 1200 orders announced or confirmed so far in Paris.

Only 250 B-737 Max have been ordered – perhaps a reflection on what passengers think of the type, and the manufacturer after the MAX scandal. Earlier this year I found myself on a Max, but the emergency card said it was a B-737-800 (an older model without the crash record of the MAX). I asked the Stewardess and she confirmed it, adding they’d been told not to mention it was a MAX. I asked how she felt flying it, and she gave a crooked embarrassed smile.

The reality is the aviation sector is likely to remain short of aircraft capacity for years. Boeing reckon the world needs 40600 new aircraft over the next 20 years. The best year ever was 2018 when the two OEMs (“original equipment manufacturers” as everyone in Aviation insists on calling them) managed to deliver 1636 new planes. In 2022 they managed a mere 1156.

The two OEMs are desperately trying to ramp up production, but have still not recovered from the steps the industry took in the face of Covid. Airlines laid off pilots, engineering staff and closed maintenance facilities, the OEMs let staff go and many retired – including critically skilled engineers who just aren’t coming back into the industry, while many small businesses supplying critical parts went bust. It is still a crisis today. Everyone knows how dire UK airports are – having been unsuccessful at luring staff back into the industry.

As a result of the scarcity of new aircraft there is something of a pandemic “toilet-roll moment” going on in aviation. Airlines are ordering as many aircraft as they can – deliberately over-ordering – fearful if they don’t get their slots now, then they will find themselves struggling in years to come. Order a new A-321 today, and its very unlikely to arrive this decade.

Airlines are even said to be paying full list price to get slots on the order book – something that would have been inconceivable in the past when everyone understood the list price of a plane was a wholly fictitious negotiation starting point. Some may even suspect the two OEMs are quite happy to maintain the current scarcity, making the call that earning larger margins on building fewer planes is the best way to impress the market and create Shareholder Value. (The fact new plane costs are rising is another reason for smarter Airline execs to look at using older models.)

 “Nothing Is on time, everything is delayed” said Akbar Al Baker the mercurial CEO of Qatar Airways on Bloomberg earlier this week. He added that airlines ordering planes today are not going to see these planes for years. Getting slots is critical. He agreed that overcapacity will become an issue – but not for years as airlines seek to replace older wide and narrow body planes.

There is also an element of regionality to the aircraft market – Indigo has an order backlog of over 1000 new aircraft (effectively a year plus production for Airbus). Saudi Arabia has just funded a new state carrier Air Riyadh specifically to connect Saudi to both the business and tourism market. While Etihad, Emirates, and Qatar, are all flying hub routes through the Gulf – and competing on cost and service, the new Saudi carrier is specifically there to build business and mass tourism to Saudi.

The CEO was interviewed in Paris and said he was confident they will get their aircraft in time to launch commercial services in 2025 – not only have they got guarantees and penalties from the OEMs for their delivery slots, but he inferred there is a special relationship between Saudi and the OEMs. “They can’t fail Riyadh Air” he said. I would not want to be the Boeing exec explaining to Crown Prince MBS why Air Riyadh’s order for 72 Dreamliners is delayed. Currently Boeing is delivering 3 Dreamliners per month and an order backlog of over 500 aircraft – new orders could be waiting 14 years at current production rates!

Boeing is hoping to raise deliveries of the ill-starred B-737 Max from 31 aircraft currently to 42 by the end of this year. It currently has a backlog of at least 4600 Max’s on order, meaning it will take over 6 and a half-years to clear the backlog even if they can raise production to a planned 60 aircraft per month – and that assumes no new orders.

In coming years the demand for new aircraft will moderate, we will reach an supply/demand equilibrium as the current engine and supply chain issues are solved, and new engineers are trained up, but I suspect a new equilibrium will also come with higher ticket prices. The era of ultra-cheap low-cost flying may be coming to an end – the OEMs will want to keep new aircraft prices high – don’t expect them to rush the production of new aircraft just so airlines can batter down their prices! Meanwhile, airlines will be forced to pay more for the new SAF fuels (we suspect these will end up costing a multiple of current fuels), and choices may become more limited as aircrew demand higher wages.

Aviation has always been a dynamic market, but the key metric for the next decade is going to be the value of aircraft, and we’re confident that plays to our new mid-life aircraft deal! After that.. who knows..

Five Things to Read This Morning:

FT                    Unhedged – RIP Bear Market?

Guardian         Rolls-Royce ready to rejoin smaller jet engine market, says boss

WSJ                 SoftBank’s Masayoshi Son Says He’s Focusing on AI Inventions

WSJ                 Why Tesla’s Stock Rally Doesn’t Make Sense – in Eight Charts

BBerg              European Firms Grow More Pessimistic on Doing Business in China

Out of time, off to the station, and on to the day job…

Bill Blain

Strategist – Shard Capital