OEM Keynote: How Fleet Planning Can Support The Capacity Discipline Principle

Transcript

Mr. Michal Nowak:Good afternoon, ladies and gentlemen. My name is Michal Nowak, but to some of you I might have introduced already as Michael. I'm perfectly fine with both versions, and I represent Embraer Commercial Aviation today. I will be joining the— in a few minutes, the panel about the OEM's fleet financing. But before this, I was given an opportunity to give a short presentation with the OEM view. One of the biggest challenges was to actually come up with the relevant topic for this presentation that could be reasonably explored within a confined space of 10 minutes. At the very end, I decided to go for capacity discipline, as I believe this goes in line quite well with the theme of this event, which is Global Aviation Outlook. Uh, the how you manage your capacity is directly correlated in with how you, uh, view and forecast the future of the industry condition. But it is also definitely closely related to the fleet procurement, fleet sourcing processes, because it is through the aircraft purchases that we plan our capacity. And in particular, it is relevant to us in Embraer because We very often have to sell not only our aircraft, but we also have to sell our segment first. As a matter of fact, the topic of capacity discipline is becoming more and more often a central part of our discussion with the airlines. Why is that? One might say, and this is probably obvious to all of you, that we are in a golden age of aviation, golden decade, unprecedented profitability, return on investment, income, and still strong growth. Maybe we are already past the top point of the cycle, but it's still— everything's going strong. So why to talk about capacity discipline? Well, one of the reasons is to the right, and this is something that is striking me. You all know about the correlation between the GDP and the traffic growth, and historically this correlation is at the level of 1.5 to 2%— sorry, 1.5 to 2 times the GDP growth. If you take a look at the European market between 1990 and 2010, this multiplier was already at the 3, at the level of 3. So much, much higher than historically. It can be maybe explained by the things like liberalization and introducing of the open market, stimulation of the market by the low-cost carriers, But then you go to the following decade, current decade, 2010 and 2019, economy on average slows down, and we have the multiplier even growing to 4.7, which already raises a question: is it sustainable? Wasn't this growth slightly supercharged over, over the last years? And there was a question about the books earlier today. Actually, I'm reading right now the book that is already quite old. It has 10 years. It is called The Black Swan. And then it's about the unexpected big things that can happen. And one of the topics is how you never should simply extrapolate from the past. And I think it is extremely relevant, the question. In our industry, is it reasonable to extrapolate based on what happened in the last 10 years? The common topics, themes, words that I would put to describe the last decade in aviation would be deregulation, liberalization, consolidation, market stimulation, upgauging growth. I have doubts whether these are the words that we'll be using over the next 10 years. And some of those terms are definitely contributing to this supercharged growth. But the valid question, in my opinion, is whether some of them were one-offs. After all, how many times you can deregulate? How long can you stimulate? At some point, this pull for growth will run out. Especially that there are many, many factors of uncertainty coming. And unfortunately, I have missed Peter's presentation in the morning, but I understand he touched upon many of them. This is the view that we share at Embraer. With trade wars, environmental debate, economic slowdown, but also many of the internal problems in the industry, I think it is worth to say that you should think twice before making any fleet decision with this uncertainty ahead of you. Because when we talk about the capacity, this is exactly when you make your decision. Once you get the fleet on board on your balance sheet, You're committed. You want to have as high utilization as possible. And the room to manage your capacity becomes slightly smaller. But let's take a step back. When addressing the topic of assumed overcapacity, one of the first things to look at would be the load factors. And globally, we see they are at a pretty healthy level. I actually started my aviation adventure with LOT Polish Airlines. This was the airline, it is the airline that struggled to be in the low to mid-70s in terms of load factor. So for us, the level of 82% would be an aspiration. So you can say we are very satisfactory. But the question is, is it really true? Is it really proper level and the target level for us? Firstly, the second line. What is the cost of keeping those load factors as high as they are? You can see the average yield globally. There are many factors contributing to the yield. Of course, there's fuel, etc. But I think it's safe to say that partially keeping those load factors high was at the cost of reducing prices farther and farther and farther. So it's quite costly. Second thing, as a matter of fact, there's another perspective to look at the 82%. At one of our events, Embraer's events, one of the representatives of KLM, when he walked on the stage to discuss the trends, he said, it is a disgrace for the airline industry to fly at 82%. With the current technology, with the artificial intelligence and big data technologies, actually we should aim much, much higher. So one can say that keeping this line flat at 82% is actually a sign that we're not managing our capacity correctly. quite right. And there's a third point that I will come back later on about load factors. I will park it for a moment. For now, let's only leave it with the sentence that with the load factors being flat, this enormous growth in traffic is translated— or the question is, it may be generated— by the growth in capacity. So where is this capacity coming from? Where is it manifesting itself? Basically, there are only 3 ways to put the capacity on the markets. You can either open new routes, you can increase the service level, meaning frequencies on the existing markets, or you can grow the number of seats that you put on an average flight. You would generally expect quite balanced distribution of those 3 factors. Actually, it is not. So we, in Europe at least, these numbers are representative for Europe. We can see that there is a lot, a lot of new markets being opened, which is good for the economy, industry. It provides connectivity, definitely. Unfortunately, we see less frequencies per market. I'm saying unfortunately because this is something that brings value to the customers and if you bring the value to customer, you can probably monetize it by putting a slightly higher price on this one. And the third, and the most relevant for us as an OEM, is the aircraft size. It grows quite steadily by 2% a year. You might say that 2% a year is quite balanced and relatively modest growth, but keep in mind that when you buy an aircraft, it's an investment with the time horizon of 10, 12, 15, maybe 20 years. And if you multiply 2% by 12, 15 years, it actually means that whatever you bought becomes slightly irrelevant towards the end of this period. So the growth of the average size of the aircraft is quite stable, but the big question is what will happen next? And yeah, it's a million-dollar question, and I cannot to give you an objective answer, mathematically proven. But my benefit is that speaking as an Embraer representing this segment of smaller aircraft, I don't have to be objective. I can be subjective and I can claim it will slow down. Why? 3 reasons. First, actually, I already discussed. We strongly believe that there is a lot of uncertainty and the cycle this supercycle is— we're at the turning point and that demand will soften in the future. With a softening demand, you would expect also the capacity to slow down. So this is already first reason. Second one is the environmental factor that was already touched upon. And I think it would be way too bold to say that we at Embraer already know what would be the impact. It is— it happened way too quick and we are still debating what actually will be the impact of this debate on aviation sector. But there are 2 things that I am personally certain is that it will create additional push for increasing the load factors. And this is the topic that I parked. I think with the pressure from the society and public on sustainable aviation, the social cost of flying empty seats would be bigger and bigger. Second aspect of this environmental impact is the cost of filling in the incremental capacity of the bigger aircraft. If governments proceed with the taxation on aviation, it will be much more challenging to fill in this additional capacity with the lower price and stimulate markets further on. The third point comes to economics. Why historically our segment, segment of below 100 150 seats was less successful came to the— it comes back to the fundamental economics of the aircraft. The benefit of the smaller aircraft is a lower price per trip, but it always came at the cost of lower— of higher cost per seat. Only now we are— we as OEMs are able to slightly change these dynamics because if you take a look at the portfolio of the new aircraft on the market, It is only within this segment that we have witnessed the clean sheet designs. E2 that came from Embraer, but equally A220 deliver much bigger improvement in terms of economics as opposed to the classical narrowbodies. This paradigm of cost per seat, I think, where it still will remain valid with the gap going down to only low single-digit number, will help our segment grow in general. Last aspect that I wanted to touch upon in my presentation is the flexibility, because in order to deliver the capacity discipline, you actually have to have some flexibility on your— in your fleet management. And if you agree with me that we have tougher times ahead of us, or at least you agree that there is a lot of uncertainty ahead of us, then you would probably want also to have some flexibility in, in terms of how you manage your fleet. We at Embraer, we never say that our portfolio should replace your narrowbodies, but we also, we, we very much believe that it's a perfect complement to the narrowbodies that are core of most of European and global airlines. And we strongly believe to this, in this crossover space, which somewhere between 110 and 150 seats. This is the space that was actually quite modestly represented historically, and now with the new generation of A319s and MAXs, it will be even more abundant because these are the aircraft that are not optimized for this size. And this is the segment that we at Embraer and Bombardier developing CSeries strongly believed in as a supplement. How they both can work together? Let's take a look at the application, potential applications of the aircraft on airlines' network. Any aircraft you buy, you can basically either put it on the new markets, you can put it on the existing markets to accommodate the organic growth. You can actually decide for some more aggressive upgauging when you face the aggressive competition and you really need to focus on cost per seat. Or you can do the opposite move to right-size your markets where you face the low load factors and, and, and believe that there's a especially big benefit of the given market of the additional frequencies. It remains valid for both large narrow-body jets and the crossover jets, but the, uh, probably the examples of those applications will be slightly different. The new markets on the narrowbodies are usually used by the low-cost markets. Uh, we focus, for example, on the hub feeding and the regional carriers that support, uh, hub airlines. But the fact that I wanted to say, when we mapped those applications, we wanted to actually check how airlines use the equipment in the real world. And as you can see that currently large narrowbodies are very much focused on only one application. What we see as a crossover segment is a much more balanced application that gives you more flexibility to build more robust networks and ultimately also manage your capacity more carefully ahead of uncertain times. With this, I will end my presentation and then join the panel. Thank you very much. Thank you, Michal.

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