Wednesday, October 21, 2020

The Coming Airliner Consolidation

The COVID-19 pandemic severely impacted air travel. While air travel is starting to recover, it will take years to fully recover. Much of the recovery at this point is in leisure travel, not in business travel. Businesses have moved aggressively to work from home and video conferencing technology even for meetings across town. This technology will result in less demand for travel until travel for in-person meetings is viewed as a competitive advantage.

The pandemic occurred at a moment of a worldwide economic peak, and a major recapitalization effort on the part of the airlines. The pandemic offered the opportunity for airlines to accelerate the retirement of older aircraft ahead of schedule, while deferring the delivery of newer replacement aircraft.

But the broader and longer-term effects are different. In some cases, entire sub-fleets of aircraft are being retired, primarily due to the length of time expected for demand to recover, and because of accounting issues. An aircraft which is owned outright can be retired and sold on the secondary market. An aircraft over 20 years old is fully depreciated, and while this offers no operating cost reduction through expensing depreciation, these are cash-flow cows, operating at very low expense costs at least until their next major maintenance check ("D-check"). Instead, a new approach to accounting is taken. Older aircraft approaching D-checks are retired ahead of schedule to rationalize fleets. Newer, but fully owned aircraft, especially small sub-fleets are sold because they have some value on the secondary market. Leased aircraft are retained, because the lease payments must be made regardless of if they are flying or not.

The upstream impacts to the aircraft manufacturers are the next consideration, and where things will change considerably.

In good economic times, "thin" routes can justify their own dedicated investment in nonstop routes and equipment. In bad economic times, these cities are served via consolidation and connections. As a result, the pandemic sees less value in aircraft at the small end of a category. Aircraft like the 737-700, A319, etc. in the domestic space, and the 767-300ER, A330-200, and 787-8 in the international space. At the same time, lower passenger demand on the middle routes means these aircraft have ideal capacity points for routes formerly flown by larger aircraft. But often, these are smaller subfleets, so there is pressure to serve the thin markets using a different approach.

My expectation is we will see the manufacturers try to wrap up current production of the small capacity variants of their major product lines, and they will not introduce new small models. For example, there are only 14 orders for the Airbus A330-800neo, the upgraded version of the A300-200. The A330-800neo is designed to directly compete against the 787-8, however, the 787-8 has pretty much made its production run, and most new orders are for the 787-9 and 787-10 variants. The 787-9 is the "sweet spot" for the 787 series, with similar range to the 787-8, but greater passenger capacity, lower manufacturing costs, and with the 787-8’s bugs worked out. With the shift of 787 manufacturing exclusively to Charleston SC, there is the possibility of wrapping up production of the 787-8. Boeing can steer demand towards the 787-9 using pricing and financing. It can also fill 787-8 demand with used aircraft traded in, coming off of lease, or early lease return aircraft.

Regarding the Airbus A330-800, the same is true for Airbus. They can try to get open A330-800neo orders converted to A330-900neo orders, and they can leverage trade-ins and lease returns of A330-200s to fill A330-800neo demand. The main value proposition of the A330-800neo is extreme range at relatively low passenger load, and that market is a "good economy" market negatively impacted by the pandemic.

The same logic applies to the planned Boeing 777-8X. The 777-8X is seen as a follow-on to the "C-market" (ultra long-haul) 777-200LR. But the 777-200LR did not sell well. Boeing has already pushed back the 777-8X, and it is possible Boeing could cancel the project.

An obvious question is: "What about the dedicated freight airliner market?" Dedicated freighters operate on different economics than passenger aircraft, and as such do not demand the latest models with the best efficiency. The Boeing 747 has continued production as a freighter, but will wrap up over the next few years. The Boeing 777-200LR, which was not popular as a passenger airliner, but has sold well as a dedicated freighter. Similarly, the Boeing 767-300ER, being retired right now out of passenger service, continues in production as a dedicated freighter. 767 military variants (the KC-46A aerial refueling tanker) remain in production.

Airbus has not had the success with dedicated freighter variants Boeing has had. Airbus offers a dedicated freighter version of the A330-200, but there are only a few outstanding orders.  Airbus also offers an aerial refueling tanker version of the A330-200, with a number of outstanding orders. Airbus is offering passenger to freighter (P2F) conversions of its A320 narrow body and A330-200 and -300 wide body aircraft. Conversions could also impact the market for dedicated military variants.

Boeing has always had a strong passenger to freighter conversion business, and other companies also offer passenger to freighter conversions of airliners. There are currently proposals for 777-300ER passenger to freighter conversions, but with the pandemic accelerating retirement of 777-200ERs (in favor of more efficient 787s and Airbus A350s), there is a possibility of a flood of used passenger aircraft on the market, depressing acquisition prices, making passenger to freighter conversions very economically compelling, and negatively impacting the new build dedicated freighter market, especially the long-term prospects of the 777-200F.

Finally, on the wide-body front, talk of further stretches of the A350-1000 and 777-9 have been talked about, but with the pandemic reducing overall demand, both of these seem less likely.

Therefore, it is a reasonable assumption for the decade of the 2020s, major wide-bodied airliner production will look like this:

Airbus: A330-900neo, A350-900, A350-1000

Boeing: 787-9, 787-10, 777-9X

Dedicated freighters and military variants can keep a line in production even when significant economic downturns cause passenger orders to be deferred or canceled. In the case of the Boeing 767, it will remain in production for another several years. If more orders are made for 767-300F or KC-46A aircraft, production will continue longer.

In the narrow-body airliner space, the smaller end of the series is also likely to be impacted.

Airbus presents a very interesting case, due to its acquisition of Bombardier’s C-Series airliner (now the Airbus A220). Airbus ended production of the A318 in 2013. Airbus has offered an A319neo, but orders have been very limited (~1% of total A320neo family orders), with fully half of the A319neo orders from one airline, Spirit Airlines. Spirit’s order was made in late 2019, with the A319neo portion finalized in January, just prior to the pandemic’s impact. Will this order survive? Would it make sense strategically for Airbus to steer A319neo demand to the A220-300? After a wave of A320neo orders, the current "hot" model of the A320neo family has clearly become the A321neo, which is targeting the Boeing 757-200 replacement market.

The biggest challenge for Airbus trying to steer demand for the A319neo towards the A220-300 is the A319neo shares a common pilot type rating with other aircraft in the A320 family. But, if it can overcome the cost impact of this, it opens up increasing opportunities for the A220 family.

Assuming Boeing recovers from the 737MAX issues, and is able to shift production exclusively to the MAX and wrap up the 737 Next Generation line, it is reasonable to assume the majority of the 737MAX line will be the -8, -9, and -10. Only two airlines have ordered the -7, Southwest (a large 737-700 customer), and WestJet (also a large 737-700 customer). Like the Airbus A319neo, the 737MAX-7 orders represent just over 1% of total 737MAX orders.

With the Boeing 757 aging (the last model was produced in 2004), the 757-200 replacement market is becoming a factor. As a result, like the A321neo, the 737MAX-10 is becoming popular.

Unlike Airbus, Boeing has nothing like the A220 to shift 737-700 demand to. Also, Boeing is likely to get some military and business jet business for the 737MAX-7. Airbus is now promoting an Airbus Corporate Jet (ACJ) version of its A220, which may compete directly with the ACJ version of the A319. Military versions of the A320 family have not been significant, as European militaries have been more likely to use commuter or business jet platforms for smaller use cases, and the A330 for larger purposes.

Regardless, the A319neo (if it survives) and the 737MAX-7 will represent very small portions of the production of these families, more like the A318s and 737-600s of the prior generations. As such, their production runs may be limited, and production wrapped up at some point early in the production runs, allowing manufacturing optimization to focus on the larger variants.

For the A220, the A220-300 clearly dominates the orders, being the "sweet spot" of passenger capacity, range, and operating costs.

The reasonable assumption for narrow-bodied airliners for the decade of the 2020s will look like this:

Airbus: A220-300, A320neo, A321neo

Boeing: 737MAX-8, 737MAX-9, 737MAX-10

The Boeing 767-300ER represented a unique passenger capacity and range capability which is not easy to replace. Aircraft like the Airbus A321LR and XLR will support about 170 international two-class seats, while the 767-300ER supported about 215, and the next step up, the 767-400ER, Airbus A330-200, or Boeing 787-8 support about 240. The gap between 170 passengers and 240 passengers is fairly significant. Next are the range considerations. The Airbus A321XLR has a range of about 4,500 nautical miles, compared to the 767-300ER’s 6,000nm. While 4,500nm may look fairly long-ranged, one has to consider traveling westbound against winter headwinds, which will reduce that range down to about 3,600nm vs. the 767-300ER’s 5,000nm. This makes a route like the 3,980 nm Charlotte, NC to Munich, Germany route (think BMW automobile related business) likely require a refueling stop in the winter. The options are a connection either in Europe or in the US to a larger aircraft.

The prospect of the pandemic forcing the aircraft manufacturers to consolidate production to fewer models, may allow both Boeing and Airbus to consider new options by the middle of the 2020s. Boeing, if it gets the 737MAX issues behind it, consolidates the 787 at Charleston, and gets the 777-X out the proverbial door, could again look at its proposed New Midsize Airplane (NMA). If 767-300F and KC-46A production is continuing, it could again look at a derivative of the 767, perhaps with a new wing and certainly with the latest generation engines, but this seems unlikely. Alternatively, the shuttered 787 line could be restarted with a shortened 787 with a new wing and engines for this market—but the line could also be retooled for an all-new airplane. Or, most likely, a new airplane could be designed (the proposed Boeing "797"). If the 767 line wraps up by mid-decade, and the Everett 787 line is shuttered, it means the 777-9 would be the only aircraft manufactured in Everett, and the prospect of a new design is increased. I think the most likely outcome is an all-new design proposed in the latter part of this decade.

Likewise, Airbus has the option of looking at aircraft between the A321neo and the A330-900neo. The prospect of an "A322" stretch of the A321 to go after the intra-Europe and US domestic market is possible. Also, while Airbus is rarely mentioned in conjunction with a middle of the market (MoM) aircraft like Boeing is with the NMA, it is certainly possible Airbus could consider something to go after the market once dominated by the 767-300ER.

In summary, I expect the following to happen in the airliner industry. I do not expect the 777-8X or the A330-800neo to be produced. If the Spirit Airlines A319neo order is withdrawn, I do not expect Airbus to continue to offer the A319neo. If it does go forward, I expect the A319neo to wrap up production shortly thereafter. I expect the 737MAX-7 to wrap up after the Southwest and WestJet orders are fulfilled, with the possible exception of business jet and military variants. I expect Airbus’ dedicated freighter and military variant product to wrap up in the next few years, and given the glut of low-time wide-body aircraft on the market, I expect Boeing’s dedicated 777 and 767 freighter orders to dry up, resulting in those lines wrapping up by mid-decade. Likewise, if there is not a follow-on order of KC-46A military refueling tankers, it is possible the 767 line wraps up by mid-decade. I expect the 787-8 variant to wrap up in a few years as well, possibly with the transition of the 787 line to Charleston. I also do not see a market for stretches to the A350 and 777 beyond the A350-1000 and 777-9X. Finally, I expect these consolidations to set up the aircraft manufacturers to explore new designs in the latter years of the decade of the 2020s.

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