Why Are Airline Manufacturers Witnessing A Slowdown In Commercial Orders?

by Trefis Team
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Despite having robust backlogs and a high delivery rates, Boeing (NYSE:BA) and Airbus have been suffering from lower commercial orders this year. Historically, orders from airlines have been cyclical in nature and it appears that the market is going through a slump at the moment. Additionally, market conditions have a significant and immediate impact on the demand for commercial aircraft. Given the fact that the world economy is slowing and oil prices have begun to recover, it seems like orders will remain low in the near term.

The commercial aircraft market is driven primarily by long-term trends in the airline passenger and cargo traffic. The principal factors responsible for long-term traffic growth are sustained economic growth and political stability in all key markets. Furthermore, demand is also influenced by factors such as airline profitability, availability of aircraft financing, technological changes, fuel prices and world trade policies.

As the fuel prices fell in 2014, air carriers saw their profits, and consequently, margins rising. The rising cash flows were used by the airlines for a number of corporate activities, such as debt repayment and share repurchases.   Most importantly, it has allowed carrier to increase capital expenditure, so as to to upgrade older fleets, expand capacity and upgauge existing aircraft. For instance, Southwest Airlines (NYSE:LUV), a low cost carrier, hugely benefited from the low oil prices and used its cash flows as follows:

Southwest’s Utilization Of Cashflows

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However, since early 2016, there has been a partial recovery in oil prices, which has increased the fuel costs for airlines from the lows of 2014-15. In addition, the slowdown in Europe and other international markets has led to immense pressure on the carriers’ unit revenues. To draw a link, a notable deterioration in the global economic environment, the airline industry or in the financial stability of an airline can all result in either fewer new orders for aircraft or the deferral or cancellation of existing orders. Additionally, since the commercial aircraft backlog consists of aircraft scheduled for delivery over a period of several years, any macroeconomic, industry or customer impacts could unexpectedly and severely affect deliveries for a long period.

Most airlines in 2016 decided to cut their capacity expansion targets in the face of rising competition and falling unit revenues. In line with this, the target for capital expenditure has also been reduced and deliveries postponed to spread over a longer period. An example to prove the point could be Southwest, which has deferred the delivery of 40-odd aircraft to 2025.

Southwest’s Delivery Schedule

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Another example would be of American Airlines (NYSE:AAL), which as a part of its 2016 fleet plan, will shrink its mainline fleet by approximately a net of 37, as it takes delivery of 55 mainline aircraft and retires more than 90 mainline aircraft.

American Airline’s Delivery Schedule

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Furthermore, the cargo market has been suffering over the past few years due to an economic downturn and a general shift to using cheaper alternatives such as ocean freighters for international and road transport for domestic shipping. Since, passenger airlines have emerged as leaders in air cargo, with 60% share of the total air freight market, a slowdown in cargo revenues affects Boeing’s impact on programs like the 747 and 767. In fact, Boeing is expected to kill the iconic 747 program altogether. Having said that, demand for air cargo will continue to be driven by high value, time-sensitive and perishable goods, which require the fastest and safest delivery option. According to a report by Boeing, cargo is expected to grow at 4.7% through 2033, with freight leading the way at 4.8%. Further, it also forecasts the world freighter fleet to increase to 3,198 airplanes from 1,738 by 2031. Of this, large freighters will represent 36% of the fleet.

Cargo Revenues For Major U.S. Airlines

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In general, airlines have shifted away from the fuel guzzling jumbo jets to the more efficient single aisle jets. This attempt by airlines is an effort towards a cheaper, more efficient and greener way of flying. Furthermore, single aisle jets allow airlines to accommodate more passengers per square meter, helping control expenses. We could see the positive impact of this initiative on United Continental‘s (NYSE:UAL) fuel and non-fuel costs, which have declined considerably.

United Continental’s Operating Expenses

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However, this has hurt orders on the larger aircraft. Additionally, freighter orders have suffered in the recent past due to a weakening economy putting a downward pressure on the air freight market. The 747 program has witnessed a tremendous fall in orders over the last year or so as can be seen by the latest figures in the table below. Furthermore, there a number of 767s coming out of passenger service presently which can easily be converted to freighters at a low cost. This would further dampen potential orders. That said, Boeing suffered lesser of a blow than main rival Airbus did. At the beginning of the decade, the European aircraft manufacturer had bet on its mammoth A-380 as the future of air travel. The company has delivered only about 190 of these giants as opposed to the expected target of 1200 deliveries by the end of the decade.

Boeing’s Orders and Deliveries Y-o-Y (July)

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With increasing fuel prices, a weak global economy and a slowing air cargo market, it comes as no surprise that airlines are not actively looking to expand their fleets at the moment. We expect commercial orders to remain low in the near term until airline profitability improves.

Notes:

1) The purpose of these analyses is to help readers focus on a few important things. We hope such lean communication sparks thinking, and encourages readers to comment / ask questions on the comments section

2) Figures mentioned are approximate values to help our readers remember the key concepts more intuitively. For precise figures, please refer to our complete analysis of Boeing

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