Where will the orders come from? February 2003

The shakeout in the airline industry combined with impending war in Iraq has left the manufacturers and the lessors with severe headaches.

Airbus is being quite optimistic about its deliveries this year, predicting 300, the same as in 2002, while Boeing is being more cautious, forecasting 280, 100 less than in 2002. Much more problematic is where their orders are going to come from.

This table summarises the relative importance of the five main customer groups both historically — i.e. net orders for jets placed and deliveries taken — and currently — i.e. backlogs as at the end of 2002. The major carriers account for 75% of orders and 82% of deliveries but only 38% of the current backlog. The LCCs account for only 8% of orders and 5% of deliveries but now have 22% of the backlog. The two mega–lessors, ILFC and GECAS, dominate the current backlog, with 40%, while they have placed 18% of orders and 12% of deliveries.

The US majors are distinctly unpromising candidates for new orders. Further cancellations and deferrals are on the cards. Airbus is especially exposed to the Chapter 11 airlines, United and US Airways.

Of the Euro–majors only Lufthansa and Air France have substantial orderbooks at the moment and only Iberia seems to be active in the market, being on the point of confirming an order for A340s. The Asian majors are being targeted by Boeing and Airbus as potential customers, in particular for the new super–efficient 7E7 and the A380.

Airbus is, as always, finding it very difficult to prise the Japanese airlines, JAL and ANA, away from Boeing products. Still, its latest sale of the A380 to MAS goes to prove that there is still scope for winning massive capital commitments from perpetually loss–making state–owned flag–carriers. But in the short term, demand for new aircraft is likely to come from the proposed low cost subsidiaries of these carriers, and they will be expecting the same type of terms as the LCCs have achieved.

Following easyJet’s and Ryanair’s megaorders last year it might have been thought that the LCCs would have no more appetite for new aircraft. Not so; Ryanair has just announced another order for 100 737–800s (though 78 are options) and AirTran, having risen from the ashes of Valujet, is about to order 50 to 100 717s or A319s.

Nevertheless, the next few years will see the LCCs concentrating on digesting their 737 and A320 deliveries.

Lessors under pressure

The recovery in the order cycle in the mid 90s was largely driven by the lessors who placed mega–orders at what seemed to be superb unit prices. Today, however, those prices no longer look so good.

Taking advantage of their bargaining power at this point in the cycle, easyJet, Ryanair and JetBlue have succeeded in driving new jet prices to unprecedented lows.

Meanwhile, the lessors, having committed to escalation clauses on their orders at a time when dollar interest rates were significantly above current levels, are taking delivery of new narrowbodies at unit prices up to 30% above those negotiated by the LCCs.

One of the lessors' key advantages has been severely undermined.

On the other side, the lessors are being put in an invidious position by the weakness of the major carriers which became important leasing company customers in the 90s.

They have at present little choice but to concede to demands for reduced lease rates, by 40% in many cases. The alternative is to risk being frozen out if the airline goes into Chapter 11 bankruptcy.

Second–hand values have also cratered, depriving the lessors of their main source of profits, selling on aircraft at the end of their leases at prices well above the depreciated book value. Indeed, there is a very real risk that if lessors were obliged to readjust the book values of the fleets to current market values, many of them could find themselves breaching loan/value covenants.

The one alleviating factor is the historically low level of US interest rates. If rates were to rise significantly, then this sector would be in really dire straits; fortunately, that looks unlikely at the moment.

The question then becomes how does the leasing sector shake out in parallel to the airline business? Last time around, in the early 90s, the answer was simple: the de facto bankruptcy and dismantlement of the very over–extended mega–lessor, GPA. This time the solution is not clear.

ILFC and GECAS have been adversely affected but remain solidly profitable; some like Boullioun seem to have found a good niche. This leaves a large number of "others" whose parents, usually banks, entered this sector in pursuit of ILFC–type profits (see Briefing, November 2002), but have failed miserably to find them. Mergers and takeovers are improbable, which leaves two possibilities: liquidation or, probably more likely, support from their parents until the market eventually turns up.