an editorial opinion

Bizjet market flows at top and continues to stagnate at bottom

By Richard Aboulafia
VP, Teal Group

In addition, a record portion of corporate assets—over 7%—is currently held in cash. These 2 trends—profitability and ready cash—imply an economy that's ready to open the proverbial spending floodgates as soon as businesses are convinced that we are in a self-sustaining recovery.

While these good numbers were with us through last year, a series of exogenous shocks—Japan's tsunami and nuclear disasters, revolution in the Middle East and North Africa, an Israel–Iran nuclear confrontation, the threatened eurozone financial meltdown—conspired to create an atmosphere of caution.

Yet today most other indicators are looking strong, too. In 4Q2011 the US economy grew at a respectable 3% annualized pace. The Dow Jones Industrial Average has recovered almost all its losses since 2008.

Total industrial production is nearly back to pre-recession levels. Only the housing market and employment remain well below peak levels. But, even with relatively high unemployment, there are strong signs.

Deer Jet Gulfstream V at KMG (Kunming, China). China represents the biggest source of upside potential for the market moving forward.

The economy created a net 227,000 jobs in February, and this was the 3rd straight month too see payroll jobs increase by more than 200,000. If no serious exogenous shocks occur in the next 6–12 months, the overall economy will move forward at an increasingly strong pace.

As strong as corporate profits and other indicators are, perhaps the most encouraging macroeconomic indicator is commercial lending. The overwhelming bulk of small/midsize business jet purchases are dependent on third-party finance, while larger jet transactions are more likely to be self-financed.

This distinction is a key reason why the bottom-half market crashed during the past 3 years while the top half was stable.

The key distinguishing characteristic of this downturn was the collapse of commercial credit. Banks became increasingly risk-averse after the high-profile collapse of several key financial institutions. In addition, the increased reserve requirements that were a regulatory reaction to the crisis meant that banks needed to build up their cash base before they could resume lending.

Embraer Phenom 300. Embraer has successfully entered the bottom half of the market with the Phenom series, and will soon expand its position with the mid-sized Legacy 450/500

Consequently, the news that US bank credit is now growing at its fastest pace in 3 years is extremely welcome. Commercial and industrial loans rose by a respectable 10% year-over-year in 3Q2011, with 4Q numbers coming in above 13%.

These loans have now increased for 6 consecutive quarters. Clearly, the credit crunch is ameliorating. Companies that feel confident enough to spend their money will enjoy greater buying power as credit becomes available, further boosting the market.

An equal recovery?

If all of the macroeconomic data above looks focused on the US, there are valid reasons for that. While the US demand is now less than half of the business jet market by value, it takes a strong majority of small/midsize jet deliveries. As discussed above, this is where almost all of the market's decline was focused over the past 3 years.

In order for the business jet market to recover fully from the 2008–11 downturn, US demand for small/midsize jets needs to resume its growth, or at least return to its earlier healthy levels.

Our baseline scenario is that the US comes back in strength, with recovery growth numbers that match the kind of long-term growth numbers we've seen in emerging markets. We also assume continued growth in emerging markets, although no major breakthroughs in Asia demand (which typically lags far behind relative to GDP).

If China becomes a boom market for business aviation, that offers potential upside to our forecast.

Moving forward, Teal Group sees the market growing by 10% in 2012, and an additional 4% in 2013. Some of this is driven merely by the arrival of Gulfstream's G650, the most expensive and capable traditional business jet ever built.

If the HondaJet succeeds in arriving—albeit belatedly—in the next few years, Honda will be the 2nd new market entrant since the 1960s.

This limited 2-year recovery will be followed by a more robust 4-year growth spurt, with deliveries growing in 2014–17 at a 12% CAGR. With this forecast, it will take until 2015 before we reach the 2008 deliveries peak. But we will then grow beyond that peak level by a respectable margin.

But the most notable lasting legacy of this downturn will be a structural shift toward the high end of the market. Assuming that growth resumes equally for most segments, then what was once the top half of the market by value will from now on be the top 65%. That leaves the industry with no fewer than 5 bottom-half (now bottom-third) market manufacturers.

There are several more prospective new entrants, most notably HondaJet, with its eponymous new light jet. Many key small and midsize jet market price points now have 4 or 5 different competing products, and everyone has developed new derivative models to compete in as many price points as possible.

All of this certainly speaks to a strong level of fierce price competition and a level of overcapacity that may be unsustainable.


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