The Next Generation, November 2006

For all widebody aircraft, residual value performance over the next decade and beyond will be driven by the new technologies being introduced.  The innovative Boeing 787-8 (220-250 pax, 8,500nm range) is planned to enter service in May 2008, but we expect this to be delayed by up to 12 months.  It would be impressive if Boeing can manage to successfully orchestrate the many suppliers in the 787 program's global network according to the current schedule.  They are also studying a second production line, which would move the competitive threat sooner in time.  We expect future market values to feel the worst effects of the 787 in the 2012-13 time frame, when the operating fleet will have sufficient numbers to shift the landscape of the airline market in a material way, and the A350XWB may also begin entering service. 

The -8 and its sister aircraft the 787-3 (290-330 pax, 3,500nm range, 2010-11), 787-9 (260-290 pax, 8,300nm range, 2010-11), and the planned 787-10 (310 pax, 7,600nm, 2013?) will offer game-changing efficiency and range, probably at a lower purchase price than the 767 it is replacing.  We currently estimate that values for the 787-9 are in the range of $80 - 85mn, assuming a single-aircraft sale, and the production efficiencies/learning curve of a maturing program will allow Boeing to share some of these benefits with customers over time.

One possible negative for larger competitors to the 787 family is that while most orders have been for the smaller -8 version, these are probably also convertible to the larger -9 (or eventually the 787-10).  This process may be helped along by demand from other airlines or leasing companies for these early delivery positions, as we expect the 787 to increase the growth rate of point-to-point, non-hub operations.  Boeing estimates that the 787-8 will burn 20% less fuel, provide a 10% reduction in seat-mile costs, up to 30% lower maintenance costs and up to 45% more cargo revenue space compared to the 767.  The aircraft's range will be about 2,300nm further, with a MTOW only 68,000lbs. greater.

For passengers there will be a wider, more spacious cabin, 50% larger windows, higher humidity and a lower pressure altitude, as well as increased overhead bin storage.  The new, more efficient engines from GE and Rolls Royce will be interchangeable to aid in eventual aircraft remarketing and support residual values.  The extensive use of lighter-weight composites, which will account for more than 50% of the structure, new electric architecture, and several other technologies combine to produce an attractive product.  The 787 family is already the most successful aircraft in terms of orders (478/39 customers) so far ahead of its planned entry into service, and the 787-8 is due for its first flight later this year.  The first 787 deliveries are scheduled in mid-2008 to launch customer All Nippon Airways, and Boeing hopes to deliver 112 787s during the first two years of production. 

The use of composites and other lighter weight materials/systems will result in ultra long range (ULR) capability with a much lower structural weight, and this is the biggest threat to the market for the current widebody fleet over the next 5-10 years.  It may be a simple physics problem, but a lower MTOW requires less powerful engines/runway length, allows the aircraft to climb more quickly, fly at a more efficient angle of attack early in the flight, and burn less fuel flying metal/fuel around, which results in more operating range no matter what other improvements are made.  The situation of the 757 (255,000lbs.) when compared to the A321-200 (205,000lbs.) or the 737-800 (173,000lbs.) may have been a useful lesson for Boeing here.

The capacity of the 787-8 and -9 aircraft may also prove to be a better fit in terms of demand, and this will mean higher load factors and a further boost to orders and the profitability of operators. They also offer the option of nine-abreast seating which increases capacity to about 300 and 350 respectively. The low structural weight of composites may increase the risk over time of stress-related problems, but the experience gained through years of development in gliders, light aircraft, business aircraft, and high g-load military aircraft will help mitigate this.  As usual, the new-build 787 is coming in overweight versus the plan and an extensive improvement program is hoping to remedy this.  Later serial numbers/models will benefit from a continuing effort to reduce airframe weight and improve engine performance.

The new Airbus A350XWB is based on the A330-200, but the wing is of largely composite construction and apparently the wider fuselage will be changed to this material also.  The various crises and delays at Airbus have shifted the planned delivery date into 2013 for the A350-900 (314 pax, 7,400nm range) and 2014 for the smaller A350-800 (270 pax, 7,800nm).  We expect that these dates will also slip by up to 12 months.  Both aircraft will have a MTOW of 540,000lbs., which is about 60,000lbs. heavier than the 787-8 and 40,000lbs. more than the -9, but they will offer more capacity as well.  Airbus had about 100 orders for the previous version, expects most to be converted to the new A350XWB, and they are forecasting another 100 orders in 2007.  The new A350 will also be a competitor to the 777 series, with the A350-1000 eventually facing the 777-300ER and the A350-900 challenging the 777-200ER. This makes the 787-10 more likely even though this aircraft will also compete directly with the 777-200ER. The bottom line in all of this is that the future value curves for many widebody aircraft no longer appear as rosy as many were predicting a few years ago.


Labor Union Scope Clauses, November 2005

It is ironic in our opinion that the end effect of pilot union scope clauses on the airline industry may end up being the adoption of RJs by low cost carriers, through partnership or code sharing deals with regional airlines.  These scope clauses restrict the capacity of regional jet aircraft operated by the major legacy airlines, and many have already been relaxed as a result of pressure on the airline's finances and employees.  Chapter 11 carrier USAirways has raised the limit on 50-seaters from 70 to 465, and allowed the operation of 70 seat aircraft for the first time.

The new Embraer and Bombardier 70 - 110 seat aircraft have low enough cost per seat mile performance to make sense as feeder aircraft or thin route airplanes in an LCC operation.  The Boeing 717 has already shown that even at that size and weight it can be the basis for profitability, as Airtran has gone from the "airline formerly known as", to one of the most respected in the world.

JetBlue has ordered 100 Embraer 190s with deliveries beginning next year, and Southwest has toyed with a similar idea as well.  Other less financially flexible LCCs may decide that a code sharing deal with a regional airline is a better way to grow, and orders for these aircraft could increase, as the concept of scope clauses looks increasingly like a bad idea.

Airline Industry Conditions, June 2004

After an extended and very ugly downturn, there have been several signs of good news and a possible recovery underway in the airline business, especially in certain Asian and European markets. With the U.S. having been hardest hit, the major carriers there have taken the necessary steps to right the ship and get pointed in the right direction again. Seeking to take advantage of their global alliance connections, integrated loyalty programs, and broad network coverage in the world's leading economy, they have been reducing their costs, rationalizing their fleets and route systems, and revolutionizing their pricing strategies to find a way to compete against the low cost airlines, and to attract more business traffic.

We note with interest the plans by start-up RivieraJet to launch trans-Atlantic low-cost service from three East coast cities to several points in Europe. If the carrier chooses to operate used aircraft, still available in fairly large numbers, this would be reminiscent of the beginnings of the airline formerly known as ValuJet, since renamed AirTran and recently riding a wave of profitability, due to increasing demand for this business model. It would be more difficult for them to afford new widebody aircraft, and the availability of B767-200/300s or A310s may prove tough to pass up. Such an announcement was not unexpected here, and will not be the last of its kind. This sort of competition will force the major network carriers to re-align their pricing on routes which see traffic trending over to the new entrants, who may find it difficult to receive the required route rights if their plans threaten the incumbents "over there". The end result of current negotiations between the U.S. and E.U. over open skies across the Atlantic may prove to be a useful midwife, but nothing is likely to be agreed anytime soon.

Narrowbody Market

Following is William Loh's June 2003 interview with Airline Fleet and Asset Management magazine in London (Alison Tucker).

AFAM: How do you see the future of MD-80s/90s? What are their strengths?

The MD-90 is definitely an efficient aircraft but since there are so few of them, it may not be the best bet. The main advantage of the MD-80 has become its price, which allows lower operating costs per seat mile, even though they do burn some fuel. With all of the talk over the last few months about an AMR bankruptcy, values really got hammered. The aircraft are very well-built though, so they'll be around for many years.

AFAM: In view of large fleet numbers of MD-80s in American and Delta do you see its future being largely assured for the short term at least?

Since the major airlines are having to borrow and do sale/leasebacks just to keep going right now, they won't be in a position to buy many new aircraft anytime soon, and until traffic comes back, they won't need to. It's a cost game now and it was all along anyway. If it takes 2 years for the economy to recover, and the unions are stubborn and don't come close enough to matching the costs at other carriers, we will see more Chapter 11 filings…and more downsizing/parking airplanes/etc…

AFAM: What has been the effect on B737NG/A320 family with regard to order cancellations/deferrals?

Cancellations and deferrals are a fact of life in this environment and the airlines don't have any choice really. If we see an economic recovery fairly soon, the long-term effect should be minimal for these types since they are clearly the market leaders. The biggest risk they each may face in the future is an updated 737/A320, or maybe a down-sized 7E7.

AFAM: Would you say that the downturn has actually worked, for the most part, to the benefit of the aircraft within the 120-180-seat segment as airlines focus on smaller aircraft, and as increasing numbers of airlines jump on the low-cost bandwagon?

The downturn has definitely increased their potential attractiveness due to the drop in values and new aircraft prices. It is true that smaller aircraft are easier to fill consistently, and have lower operating costs. The LCC market will grow for many years still, and this is the only sector buying a significant number of airplanes, so the manufacturers will fight over every deal. JetBlue just ordered ERJ-190s and these smaller, more efficient airplanes will continue to have an effect on this market, especially as more scope clause restrictions are relaxed. Some of the replacement market demand will also be filled by these smaller aircraft. The main driver of the 120-180 seat market will continue to be the cost per seat mile these airplanes can offer. Whether you are JetBlue or Air France, that is going to be your favourite number.

AFAM: By how much do you see the market share of LCCs increasing over next 20 years?

If you include any future LCC operations set-up inside of incumbent carriers, the potential growth is nearly unlimited over 20 years. I was at Hahn again last week and Ryanair's operations there and at Stansted were impressive, and the flights were full. If I were Lufthansa I would be a little more concerned. The interesting thing is that with the world awash in airplanes, someone may decide to try the LCC model on long-haul flights from Hahn to Orlando/Sanford or New York/etc…then Lufthansa would really have something to be concerned about.

AFAM: Boeing makes much of the sales figures of the B737 but is this due to the fact rather that so many customers were already B737 customers and it therefore made better sense to continue to invest in B737s rather than the B737 being the better aircraft or is it the better aircraft for low cost operations?
Both the 737 and A320 families are capable aircraft, so it comes down to price and what the airline is operating already… Also, the A320 is a newer addition so it has some catching up to do in the low-fare market, and it is looking pretty good at JetBlue already. Airbus will be motivated to expand their share of this market, so the 737 market share will fall, but I don't think Boeing is too concerned since it's only natural.

AFAM: What do you think are the chances of the B737-900X bearing in mind the little interest in the B737-900?

These are niche airplanes intended to fill out the family, and hopefully take a few orders away from the A321s… It's still early days, but you would think that someone like Ryanair would have a few routes that eventually will need the 737-900.

AFAM: Which will be the most important model of the A320 family looking into the future - the A321 with aircraft moving up a size as traffic returns?

The most important A320 family aircraft will probably be the updated versions, which will surely come at some point.

AFAM: What explains the relative popularity of the A319 in the US bearing in mind, US is the homeland of Boeing and the B737?

It is easier to fill consistently than the larger A320, not to mention cheaper to buy and operate. Homeland has little to do with it, and it comes down mostly to price or lease rate and the flexibility that may have been offered by the manufacturer. There was a lot of the usual bashing going on 10 years ago, but the A320 family have proven themselves to be excellent aircraft, and they show up for work every day.

AFAM: How do you see the 120-180 market evolving?

We need a clear economic environment before airlines will be buying lots of airplanes, since they will need the banks to assume some of the risk, something they're not too thrilled with doing right now. Operating leasing is another way for these aircraft to be distributed around the world, but the major lessors already have plenty of these aircraft for the next few years. All of the under-utilized and parked airplanes still have to be worked back into the market as well, so the manufacturers may be looking at a dry spell.