:: May 2015 Letter ::
Larry David popularized the term Curb Your Enthusiasm as a self-deprecating comment on his own cynicism. After ten days in Europe, I’d also use it as a description for Europe’s civil, business, and military aero markets, which are quite flat and look set to remain that way. The entire world aircraft industry might need to learn about flatness and curbed enthusiasm, too.
My first stop: Britain. The once-great maritime power and the US’s most steadfast ally is today embracing Napoleon’s disparaging put-down: A Nation of Shopkeepers. Newly re-elected Prime Minister David Cameron has reduced the Army to its smallest size since before Napoleon, suspended the Royal Navy’s air arm (for much of this decade) and refused to guarantee defense spending at 2% of GDP. Yet stock analysts’ notes heralded Cameron’s re-election as a big victory for defense (“Buy BAE Systems”). The alternative, Ed Miliband, was worse, proposing defense budgets like the rest of Europe, where defense markets are indeed worse than the UK’s. France, the only European country that’s actually using its military anywhere, is slashing Rafale procurement rates since Rafale export orders will pick up the slack.
Another stop on my trip: Geneva for EBACE. This was an interesting show. But talk of growth? Well, that’s for other parts of the world. European business aviation folks seemed grateful to no longer be falling. My typical American “When’s the big recovery coming?” attitude seemed way out of place. The mood wasn’t helped by first quarter delivery numbers, which were in line with the grimmest of the grim years of the downturn. Teal’s latest business aircraft forecast now has single-digit yearly growth numbers, the slowest recovery we’ve forecasted since we started forecasting a recovery from the 2008-2010 market downturn, which saw a 27% decline.
In addition to flat military and business markets, Europe’s jetliner market has been flat for years. When Lufthansa joined Emirates in launching the 777X in 2013, it wasn’t for growth; they ordered just 34, about as many as the A340s they’ll be replacing (Emirates, of course, ordered 150, as part of Operation Conquer The Planet). Europe’s Low Cost Carrier (LCC) craze came and went, with Norwegian providing the likely last gasp of large block orders.
Europe’s market flatness may be our industry’s mid-term future. Consider: between 2005 and 2014, the world aircraft industry grew at a very healthy 6.3% CAGR in value of new deliveries. Between 2015 and 2020, we forecast growth to soften to a 1.7% CAGR. That’s not a hard landing, but it won’t be easy. It doesn’t help that almost every other new-build segment looks kind of flat. Even during the defense downturn after 2011, there were still some fast-growth aerospace segments, but not now. Here are five market changes we’re likely to see in a time of slow growth:
Unsustainable upturns. Airbus and Boeing are both talking about raising single aisle rates above 60 per month. That would give them short-term revenue and market share benefits, but after a year or two these rates would prove unsustainable, and rates would fall. The supplier base would bear the burden. Consider Bombardier’s Global business jet production cut last month. They had been pushing metal out the door, growing market share and bringing in very badly needed revenue. Yet the market couldn’t sustain this level of output, and production rates were bound to drop.
More M&A Activity. Holding on to business units that aren’t core makes sense in a growth market, but not in flatland. Sikorsky was an essential part of UTC when the military helicopter market was growing by an 11.5% CAGR in 2003-2013; that market is now falling. Expect to see more companies follow UTC and divest themselves of non-core stuff.
Flight To Sustainment. Between London and Geneva, I spent a weekend in Malta with friends. One afternoon, I did some casual primary research into yacht fleets in Valetta. Despite the Euro-recession, there were more yachts around than in the same season in 2008. In other words, even when deliveries decline, fleets still grow. That’s true for business jets too. In his May Navigating 360o newsletter, Rollie Vincent notes that in 2005-2014 Europe’s business jet fleet grew at a multiple of 8.4 times GDP growth (of course, GDP growth has been minimal). This explains why aftermarket work gets more important relative to new build. This also explains why UTC bought Goodrich, which offered great aftermarket exposure.
Payouts In Lieu Of Growth (Or Investment). With a relatively flat market, you’d think investor interest would be flagging. That’s not quite right. As of late May, the Dow Jones U.S. Aerospace and Defense Total Stock Market Index grew 6% this year. The S&P 500 has only grown 3.25%. This might have something to do with defense companies throwing off cash. Capital Alpha’s Byron Callan recently noted that in 2014, US defense primes returned over 100% of cash from operations to shareholders through dividends and buybacks. That’s not great for long-term company health, but it does keep investors happy even with a slow market.
Finally, I’m concerned about Investor Attitudes Towards Aerospace. While defense stocks have held up thanks to cash returns, many investors have also come to regard high jetliner book-to-bill ratios as our industry’s second most attractive feature. But those three-to-one ratios can’t keep going. I’m expecting a few hundred orders at Le Bourget, but this will still be a one-to-one book-to-bill year, which for many will signify that the great times are ending. We’re not forecasting a market drop, but I’m concerned that investors might be addicted to growth, which is running out.
Remember, too, that US investors’ motivations are somewhat different than European investors. Europeans are often content to park their cash in a safe place, in part to avoid taxes. They’re okay with a flat market. US investors worship returns. Either US investors need to curb their enthusiasm and regard jetliners as a safe haven (rather than as a perpetual growth machine), or they need to focus on new industry segments that are still growing, like the aftermarket. Flat markets mean new challenges for everyone.
Speaking of flat markets, we’ve updated our annual Regional Aircraft overview this month. Other updated Teal aircraft reports cover the V-22, 737/P-8, ATR, E-2, EA-6B, AV-8B, and P-3. See you in Paris, perhaps.
Yours, ‘Til Our PowerPoint Lines Start Pointing Up Again,
© Richard Aboulafia 1997-2006, All rights reserved.