July 13, 2014 10:02 am

Jetmakers braced for slowdown in orders

Lufthansa planes are seen on the tarmac through a plane's window©Bloomberg

Inside view: a glut of capacity late in the decade could lead to lower prices and weaker margins

Fabrice Brégier is hoping that 2014 will be remembered for Airbus delivering the A350 passenger jet – the company’s first new type of aircraft in seven years – to its initial customer, Qatar Airways, by the end of the year.

The chief executive of Airbus’s commercial business can reasonably claim to be the father of the A350, after supervising its progress for eight years. If it is supplied to Qatar Airways in the fourth quarter it will break with the recent record of aircraft being delivered very late.

More

On this story

IN Aerospace

However, 2014 will remain in the industry’s memory for darker reasons. The disappearance of Malaysia Airlines’ flight MH370 has cast a long shadow; a painstaking search for the jet in the Indian Ocean will resume in August.

But more pertinently for the Farnborough air show, which starts on Monday, there have been signs that the boom in aircraft orders of recent years may be coming to an end, or at least starting to slow. Evidence is mounting that airlines, on the back of economic recovery, are expanding their fleets too fast, resulting in falling ticket prices and declining profits. This in turn suggests that Airbus and Boeing, the two giants of airliner manufacturing, plan to make too many aircraft over the next few years, and could become embroiled in price wars – or be forced to cut production.

The biggest threat to a stable duopoly between Airbus and Boeing could lie in the increasingly competitive long-range jet market, where the European manufacturer is expected to launch a new version of its popular A330 jet. The two groups risk engaging in “mutually assured destruction” towards the end of the decade after cranking up production of widebody aircraft, says Douglas Harned, analyst at Bernstein. “A glut of capacity late in the decade could lead to lower prices as wide-bodies are overproduced, ultimately weakening margins at Airbus and Boeing,” he says. A lot of unwanted aircraft could end up parked in the desert.

Against this backdrop, there is no respite at the two aircraft makers’ defence businesses. Both are grappling with western governments’ cuts in military spending and chasing limited deals in developing countries. There are particular problems in Europe because defence companies are struggling to unite around a single project to develop a military drone. US groups, and some Israeli companies, look well-placed to dominate this market.

In the civilian market, it was US airlines that, throughout the financial crisis and its immediate aftermath, appeared to establish a trend among western carriers of curbing fleet growth – enabling them to raise fares and profits. The bad practices of the past – deploying too much aircraft capacity, resulting in price wars – seemed to have ended.

Yet in a sign old habits may be hard to kick, Air France-KLM last week became the latest airline to warn of excessive capacity being introduced on the north Atlantic run – one of the most profitable long-haul routes in the world. This overcapacity depressed Air France-KLM’s yields – a measure of the average fare paid by passengers. The company reported similar problems on long-haul routes to Asia, where it competes with fast-growing Gulf carriers led by Emirates Airline. Air France-KLM issued a profit warning, as did Lufthansa last month, citing similar difficulties with overcapacity on north Atlantic routes.

Such woes are not confined to Europe. Delta Air Lines, the US carrier, this month reported lower than expected average fares on international routes.

In Asia, where airlines have been growing rapidly, as more and more people can afford to fly, there is evidence of similar problems. This is partly because some countries, notably China, are experiencing slowing economic growth and partly because of intense competition between airlines.

Casualties have resulted. Tigerair, a Singapore-based budget airline group, last month announced that Tigerair Mandala, an Indonesian carrier that it part-owned, was shutting down amid a “difficult operating environment”. An order for 25 Airbus A320 narrow-body aircraft was cancelled.

Cancellations of orders – and deferrals of deliveries to a later date – are often a good indicator that demand for aircraft is waning. Airbus recorded a large number of aircraft order cancellations in the first six months of this year – 225 jets, against 116 in the whole of 2013. In June, the European group suffered its largest ever cancellation when Emirates said a contract to buy 70 A350s – worth $16bn at list prices – had lapsed. Emirates said the cancellation was not due to the airline having to rein in expansion plans because of slowing growth in emerging markets. Rather, Emirates is understood to have been dissatisfied with the performance of the A350.

Some of Airbus’s cancellations have involved financially stressed airlines. Alitalia, the Italian carrier trying to avert bankruptcy by persuading Etihad Airways to become its largest shareholder, cancelled an order for 12 A350s in March.

In spite of all this, Mr Brégier insists the market is “still extremely bullish and positive” and hints at aircraft sales announcements by Airbus at Farnborough. It will be a “good air show”, he says.

It is telling, however, that he does not expect Airbus’s 2014 book-to-bill ratio – calculated by dividing annual aircraft orders by deliveries to customers – to be as high as in 2013, which was a strong year for sales.

Analysts closely watch this calculation, with some seeing a declining ratio as early evidence of a deteriorating market. However, Mr Brégier stresses that Airbus’s expected net aircraft orders this year should still exceed deliveries.

Airbus and Boeing risk ‘mutually assured destruction’ after cranking up wide-body production’

Like Airbus, Boeing is making several of its aircraft at record production rates which are justified by a large order backlog, according to Randy Tinseth, a senior marketing executive at the US manufacturer’s commercial business. “Demand in the market is greater than supply,” he adds.

Boeing has seen orders for 54 aircraft cancelled this year – a level Mr Tinseth says is below average trend.

But in research published in April, David Strauss, analyst at UBS, estimated that 20 per cent of the orders placed with Airbus and Boeing – contracts for more than 2,000 narrow- and wide-body aircraft – were vulnerable to cancellation partly because airlines have made over-optimistic assumptions about their growth.

Nick Cunningham, analyst at Agency Partners, reckons the two rivals could have to start cutting production of their aircraft in 2016, beginning with wide-body jets.

Airbus and Boeing have enjoyed an unusually long 12 years of almost uninterrupted growth in aircraft deliveries. The boom in jet orders since the financial crisis has been made possible by a rare combination of large deals with fast-expanding airlines in emerging markets and contracts to replace old jets at longer-established carriers in western countries. This business, much of it focused on the manufacturers’ new, more fuel-efficient jets, has been driven by recent high oil prices.

But analysts and consultants insist the manufacturers cannot defy gravity: the aerospace industry is inherently cyclical, because increased air travel is closely correlated to economic growth.

“There are some signs that commercial aircraft order volumes are beginning to slow down in 2014 after several strong years,” says John Dowdy, McKinsey’s head of aerospace and defence. By the next Farnborough air show in 2016, he adds, “the industry will be forced to adjust to the return of cyclicality, which will ultimately mean reductions in jet production rates by the aircraft manufacturers”.

Copyright The Financial Times Limited 2014. You may share using our article tools.
Please don't cut articles from FT.com and redistribute by email or post to the web.