POSITION & HOLD
Bizav sales disparity shows big jets holding, small jets struggling
By Richard Aboulafia
VP, Teal Group
Business aircraft deliveries fell along with corporate profits in 2009. Despite a historical correlation between profits and bizav market health, that connection seems to be broken for now.
So the corporate profits picture looks great, both in aggregate and for the one segment of the economy that matters most to business aircraft demand. Since aircraft delivery rate changes typically trail corporate profits changes by 12–24 months, the good news is that, in theory, we might see a production increase as early as mid-2011.
The bad news is that this time there are serious complications to this rosy corporate profits outlook. The first complication is that these corporate profits do not resemble the broader economy. Unemployment is still quite high. The economies of the developed world—especially the US and Europe—are only growing at an anemic pace.
The IMF is projecting Eurozone growth this year of around 1%. In the US, GDP growth in 2Q2010 fell to a mere 1.6% at an annualized pace. In September, the US Federal Reserve pointed to “widespread signs of deceleration” in the US economy. But most of all, key equities markets have not recovered in line with corporate profits.
The Dow Jones Industrial Average (DJIA) fell from an all-time high of 14,093 on Oct 12, 2007 to a low of 6626 on Mar 6, 2009. It then rebounded, but stalled out at the current level. It has spent all of this year trading in a 10,000–11,000 band with no signs of sustainable growth. Equities analysts have turned quite pessimistic.
According to Bloomberg, fewer than 29% of stock ratings are now “buys”—the lowest level since 1997. As of Aug 2010, a record 71% of ratings were “holds.” Like corporate profits, the DJIA can be used as a leading indicator of business jet deliveries. And the DJIA has much in common with that most important indicator of bizjet market health—used jet availability numbers.
The DJIA, like the broader economy, closely resembles an old-fashioned square root sign. There was a sharp upfront drop, followed by a recovery, creating a mini-V. But this V then turned right, creating a flatline plateau. Both the DJIA and those used jet availability numbers took a turn for the worse, made a rapid partial recovery, and are now a long way from a full recovery, let alone renewed growth.
As for corporate profits, while their recovery has vastly outpaced the DJIA recovery, that might not be an indicator of the economy’s sustainable health. Instead, companies are making money because they have slashed costs. This means mass layoffs and countless plant closings.
The modest increase in consumer and business demand over the past year has benefited increasingly lean and very productive companies. Meanwhile, the corporations generating these profits are reluctant to spend on anything. Like those equity analysts, they have turned quite pessimistic and are clearly concerned about a double-dip recession, prolonged sluggish growth, or anything that would threaten their ability to access lines of credit.
Unable to voice concern about a double-dip (since no CEO wants to help cause a downturn), they are blaming the Obama administration (rightly or wrongly) for being anti-business —all the while generating record profits. Investment in business jets is an extremely low priority. In conclusion, corporate profits are something of an anomaly, given the broader economic uncertainties.
Therefore, Teal Group believes there are ample reasons to be conservative and forecast a flat 2011, with no deliveries uptick until 2012. There is a chance that corporate profits will prove to be paramount. But it’s more likely that the economy needs another year to recover, and that businesses need another year to feel confident enough before making major investments, such as business aircraft.
This is a three year downturn. Of course, the economic indicators discussed above are all US-based. Yet this is now a global industry, with deliveries outside the US now constituting over half the market (compared with over 70% just 10 years ago). This change is having a profound influence on the character of the market in terms of segment growth (and shrinkage) trends.
Teal Group does not see a recovery of any kind until 2012, and the market will not return to its 2008 peak until 2016.
Historically, the business jet market could be split in half by value. The top half consists of jets costing $25 million and more (in 2010 dollars)—the bottom half consists of jets costing less than $25 million. As the chart below indicates, these 2 halves have risen and fallen in tandem, more or less. Over the past 20 years, in aggregate, both halves stayed roughly equal in size.
Yet this market downturn has seen a major change in the relationship between these 2 segments. Deliveries in the bottom half of the market declined in 2009 by a remarkable 42.8% by value. This excludes very light jets (VLJs).
This represents the worst decline of any aerospace market in the present downturn. It was worse than the decline suffered by the majority of world economic markets. Yet deliveries in the top half of the business jet market actually stayed almost constant, falling by a mere 4.1% by value.
In fact, Dassault, the one company that plays exclusively in the top half of the jet market, was the only manufacturer to increase output in 2009 relative to 2008. The most obvious explanation for this bifurcation lies with the greater economic sensitivity of the customers involved.
The bottom half of the market is generally more dependent on small and midsized businesses that are more sensitive to an economic downturn. The bottom half also depends more heavily on mature markets such as North America and Europe. The faster-growth economies in Asia and the Middle East have held up better, and customers there have a preference for higher-end products.
Also, high-end jets generally have better exposure to the government market, which tends to be much less cyclical. Since bottom-half jets depend on a customer base that is more economically sensitive and more typically North American or European, it’s also safe to say that they depend more heavily on third-party finance.
These bottom-half market customers are much less likely to pay for jets with cash and are also less likely to have access to robust credit lines. They are also less likely to be based in emerging markets with relatively strong government-backed financial institutions. The credit collapse is the biggest difference between this downturn and previous downturns, and therefore is the best explanation for the unique bifurcation the market is seeing today.