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Most airlines taking cautious approach to next gen aircraft

11-Apr-2011

Despite overwhelming concern for fuel supply and costs, most airlines surveyed by a joint CIT/Forbes study indicated that they are likely to take a wait-and-see approach to how the next generation aircraft perform before making a commitment.

CIT Transportation Finance President Jeff Knittel discussed the survey during a recent media briefing at the International Society of Transport Aircraft Traders conference (ISTAT). In the survey, 68% of those surveyed said they would wait and see how new aircraft perform while 32% would be the first to acquire or lease the new aircraft.

Although not cited in the survey, among that 32% will likely be Southwest CEO Gary Kelly, who told attendees at the recent JR Morgan Aviation, Transportation and Military conference that he is anxious for Boeing to take a position.

See related story: Southwest "can handle two or three aircraft types"; "anxious to have answers this year" from Boeing

The survey results suggests that perhaps Boeing is right waiting to deliver more than just new engines to the market, despite the fuel urgency. But during the JP Morgan conference Boeing CFO James Bell said it has yet to make up its mind as to whether or not it will re-engine the B737, pretty much echoing what President James Albaugh told ISTAT.

Even so, doubts about re-engining were high at ISTAT as GECAS CEO Norman Liu pushed the fact that putting a larger fan on the B737 is impossible without a lot of other major modifications. The big question, according to Mr Bell, is whether Boeing will be able to deliver the “big step change improvement” airlines are seeking. “The constraint for us is the innovation we need to have for a completely new aircraft,” he said, adding the company is selling all the 737NGs it can build.

For now, it is looking into how else it can improve the B737 to equal the neo’s promises. He noted that offering more than one engine helps competitiveness but it is too early for a decision yet.

Interestingly, in the CIT/Forbes study, the vast majority – 83% – indicated they were extremely likely or likely to acquire or lease newer, fuel-efficient aircraft within the next five years.

How likely are you to acquire or lease newer, fuel-efficient aircraft within the next five years?

In the CIT/Forbes survey 51% indicated they were extremely concerned by fuel supply and costs with another 31% ticking "very concerned".

Recently, the Air Transport Association sent another letter urging the Commodity Futures Trading Commission to adopt stiff new rules intended by Congress to curb commodity speculation. The organiation is seeking support for its email campaign to CFTC.

“Unfortunately, the CFTC is wavering, in part because the opposition has been working feverishly to protect the status quo,” it said. “The five commissioners, who soon will vote on a rule to establish speculative position limits are under tremendous pressure to adopt weak, ineffective rules. This harms all of us. Speculation contributes to volatile energy prices that affect the cost of nearly everything we buy, from gasoline to groceries. USA Today reports that corn prices have soared 52%, sugar is up 60% and wheat is up 24% compared with a year ago. The government now predicts that the average family’s gas bill will rise 28% over last year -- a painful USD700 increase. These price increases hurt families and, ultimately, put our nation’s recovering economy in danger.”

How concerned is your business about fuel supply and costs

Concerns over composite materials, regulations and aircraft supply shift took a back seat to fuel supply and costs and carbon emission regulations, both of which will drive sales more than the other factors.

How concerned is your business about the following aircraft-related issues?

As to how the multitude of aircraft scheduled on to the market over the next five years will be financed, operating leasing will lead all other sources, including manufacturer support, bank loans, export credit loans, security bond structure, government funding, tax leases and Islamic leasing. With the exception of government funding all sources will play an increasing role in financing with manufacturer support, tax leasing and bank loans growing the most in importance to those surveyed

How important are the following sources of aircraft financing to your company?
(% answering extremely important and very important)

Complicating the picture is the trend toward consolidation which, according to the survey is far from over with 81% indicating they expected consolidation to increase or significantly increase over the next five years.

Compared to the past five years, do you expect airline consolidation activity to increase
or decrease over the next five years?

Survey raises questions

CIT is planning to repeat its survey, said Mr Knittel, who indicated that while some answers confirmed what the company thought, others required more thought in what it all means. “We are  trying to anticipate the market and meet the needs and our narrow-body position supports that,” he said. “Some 25-30% of our portfolio is twin-aisle aircraft. The growth in that sector is terrific and the yields are very strong.”

As with its leasing counterparts, CIT is focussing on the narrowbody having ordered B737-900ERs among the 100 aircraft it has on order. On the widebody side, it has also ordered seven A350s and 10 B787s which are now scheduled for 2015 delivery. He confirmed what most leasing companies at the ISTAT conference suggested, taking delivery later in the production cycle is better, and CIT is after the first 100 off the production line.

Mr Knittel expressed excitement at the aircraft as a game changer, concluding, “Sometimes the pain gets you the gain.” In response to a question, he acknowledged that it was not surprising, given the economy, that there was not as much push back on delays as there otherwise would have been.

He suggested there was not only growth but growing optimism in the industry although the US would concentrate more on fleet replacement while the growth will be outside of the US in emerging markets, especially China. He pointed to the number of airports being built in China and Asia.

“Every month a new airport is coming on line,” he said, “especially if you look at the number of cities that have a one-million-population market and the number able to generate strong point-to-point services. People under-appreciate how many there are and they could be good markets for wide bodies as you have already seen at airlines in Asia.”

He indicated that the A380 does not work for lessors. Lessors “help to create airlines for manufacturers,” said Mr Knittel. “The A380 will be a good aircraft and they’ll sell a lot just because of the lack of real estate. Lessors have to increase the number of airlines and when you look at the A380, creating a new 747 or A380 customer is not easy. The amount of infrastructure needed is too much.”

In response to a question on whether financing for used aircraft will come back, Mr Knittel indicated it would not come back as robustly as new. “That’s logical,”  he said. “The first thing you look for is safety and the risk increases with age and financial institutions don’t like risk. In my view, if more liquidity comes back into the market there will be more financing for used aircraft. Liquidity will be the driver.”

He also said there was no sense of urgency to acquire the neo as the company continues to evaluate the new offering. “It could fit our strategy but there is no need to make a decision right now,” said Mr Knittel. “Airbus is still thinking about the segment and that goes with our theory for acquiring the 737-900ER. You have to drive the seat-mile costs down and the 900ER and A321neo will do that. But it won’t replace the 757. The A321 is range limited, but the combo sharklets and new engine changes that. If Boeing does the new technology the question then becomes whether they have the wherewithal to proceed now.”

CIT’s concern about the future of the neo largely hinges on what Boeing will do with the B737. Mr Knittel believes there are three possible directions Boeing might go.  Boeing could re-engine the B737 with the same or similar engine technology as the A320neo or launch an all-new replacement aircraft – which also would have the same engine as the neo but an optimised airframe.

The third possibility that Mr Knittel suggests is that CFM, the engine supplier to the 737, could incorporate many of the technological advancements that are already available into the existing CFM56-7 engine used on the B737 today. 

Although this third alternative of upgrading the existing engine would not have the same efficiencies as an all-new engine, it could provide enough of an improvement to keep the 737 slightly ahead of the A320neo and has other side benefits, according to Mr Knittel.  First, it is a much less expensive option for Boeing than a new engine or new airframe, which would translate into lower cost of ownership. Second, the improvements could be accomplished and available earlier than the neo – perhaps as early as 2013. Third, it would buy time for Boeing to launch an all new aircraft and develop further engine improvements that will come in the future. Lastly, it would have a much less dramatic impact on residual values – a concern for all owners, lessors and airlines alike.

Mr Knittel also suggested it is critical for Bombardier to produce more orders

“They are working a lot of campaigns,” he said. “the more important question is more strategic and that is whether or not Boeing and Airbus are vacating that space. For us the jury is still out. I don’t think they are ceding north of 130 seats. That’s what killed the the Fokker 100 and it became an orphan. My sense of the 100- to 150-seat market is that it is a good spot but it has been a kill zone for a long time and you just have to look at the Fokker 100 and the 717. I think there is a market. It is conceivable to me that gap will go unaddressed. That’s where the 737-200 and DC-9-30 were. The question is does the market dynamic make smaller aircraft too costly. In the US, there is a different argument and that has to with labour. But when you move outside the US there is potential a for growth in markets that are not immediately obvious. I just don’t know if it as big as [Bombardier Commercial Aircraft President] Gary Scott thinks it is at 6700 aircraft.”

He would not commit to buying or recommending the CSeries, punting instead, saying he would have to understand the depth of demand. It was clear during the ISTAT conference that the lack of A319neo orders was a concern.

“If they had a need for 120 to 130 seats I’d tell them to go forward but we still have a lot of work to do in terms of evaluating the CSeries for CIT,” he said. “But we have time. We don’t need to make a decision or a defensive move while we are waiting for Boeing to make their play. Once they decide where they are going, we’ll figure out where we’ll be.”

Then he said something very interesting with respect to the Chinese C919. He noted that the Chinese have been investing in a lot of countries all over the world which has created a lot of opportunity for them.

“When I look 10-15 years out, the Chinese will be a player,” he said. “The question is not whether they can develop the aircraft which has historically been the biggest question, but will they have the right product support and that is huge.”

“The neo is not as helpful and I think it is interesting the order in which it will come out – the 321, the 320 and the 319,” he continued. “That says they are still thinking about that segment and that goes with our theory for acquiring the 737-900ER. You have to drive the seat-mile costs down and the 900ER and A321neo will do that but it won’t replace the 757. The A321 is range limited but the combination of sharklets and new engine changes that. If Boeing does the new technology,  the question then becomes whether they have the wherewithal to proceed now.”

It was clear during the ISTAT conference that there would be not Boeing offering to replace the 757 which needs replacement, according to operators. Speaking before the JP Morgan Aviation, Transportation and Defence conference last year, Airbus Americas President Barry Eccleston indicated the company is anxious to bring the NEO to market in 2015. He sees the A321neo, the first to hit the market now scheduled for 2016, as a 757 replacement. He also sees the A321neo as the company’s answer to winning over Boeing 737 customers depending on what Boeing ultimately decides to do.

However, the company, said Mr Eccleston, has yet to identify all the resources necessary to bring the A321neo to the market a year ahead of schedule, he told investors. He noted the 332 orders and memoranda of understanding for the neo family in only three months since the company announced plans to re-engine the aircraft. It is projecting sales of 4000 neos making the business case even more compelling considering the investment needed to bring it off. Further goosing Boeing, Mr Eccleston added the A321neo's fuel efficiency is less than half the B737-900 or 900ER.

Of course Boeing's James Bell, at the same conference disagreed, saying the B737 currently has a fuel advantage over the A320neo and whatever decision it made, would put the B737 and A320neo on par.

Mr Eccleston also plugged the fact that the current A321 is already 14% more fuel efficient per seat than the B757 with almost as many passengers and, with sharklets, will increase that advantage to 17%.

Manufacturers still best hope in short term

Given the length of time before biofuels make a dent, the differing philosophies amongst the manufacturers will make a big difference. It is clear Bombardier and Airbus have made their bets. However, Boeing and Embraer remained largely silent on in their deliberations.


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