Business jet market still waiting for solid economics to trickle down
In this article, Richard Aboulaﬁa, VP, Analysis at the aviation and defence market intelligence and consulting company Teal Group Corp, sets out his vision for the business jet market. The article originally appeared in the October issue of Professional Pilot magazine, and you can read it here.
This year has been another disappointing one for the business jet market. While used aircraft transactions are up and used aircraft inventories are down, pricing remains weak. General Aviation Manufacturers Association (GAMA) numbers indicate that business jet deliveries rose just 1% by unit in the first half of 2017 relative to the first half of 2016.
Even the modest delivery increase is driven by small and midsized jets, while large cabin aircraft are under pressure, and these larger aircraft drive the value of the market. As a result, Teal Group is projecting a slight market decline in 2017 (-2.8% by value). This market remains stuck at 2005 levels, before the last great boom cycle propelled the industry to new heights. All the gains of the post-2009 deliveries recovery have been wiped out, too.
But there is some good news. We see that two of the most relevant macroeconomic market drivers – corporate profits and business confidence – clearly imply that a recovery is, indeed, just around the corner this time. But the price of oil, a third market driver, implies additional sluggishness ahead. These issues are impacting a market that is bifurcated between the aircraft “top” and “bottom” half, and a trickle-down surge in ultra-high-end jet deliveries.
Corporate profits, spent or not
The health of the business jet market is most closely linked with corporate profits. As these profits vastly increased in two discrete cycles (mid-1990s and mid-2000s), business jet sales vastly increased in two discrete cycles too. And, of course, when profits declined, a business jet bust cycle followed, usually within two years.
This narrative has worked very well… until the past few years. The jet market’s upturn (purely in value, not units delivered) in 2013–2014 was quite anaemic compared with the strong increase in corporate profits seen in 2010–2014. And the relatively modest hiatus in corporate profits growth seen in 2015–2016 wouldn’t account for the business jet market’s serious decline in 2016.
Also, corporate profits have come roaring back, with an 8.1% year-over-year increase in Q2 2017 to an annualised $1.786 trillion, up from $1.652 trillion in Q2 2016. Ironically, the failure of President Trump’s economic agenda, particularly with regards to tax reform, has served to weaken the dollar. This has strengthened US exports, particularly to Europe, and increased profits at export-orientated manufacturing companies. Yet there is no sign of any increase in business jet demand as a result.
One theory is that the post-2010 increase in corporate profits has not been accompanied with a rise in business investment. That is, as companies made money from business operations, they did not invest it in machine tools, workers’ salaries, new plants, or business aircraft. Instead, they either kept this money in liquid assets, or they gave it away to shareholders in the form of dividends or share buybacks.
The numbers bear this out, to a point. US private non-residential investment fell precipitously after Q1 2008, falling from a peak of $1.982 trillion that quarter to a low of $1.584 trillion in Q4 2009. This figure stayed well below that 2008 peak through the start of 2012.
However, business spending has since come roaring back in a largely consistent upward trend since 2013. US private non-residential investment in the Q2 2017 came to $2.43 trillion, a record level. But for some reason, so far, this money isn’t being spent on business aircraft.
Lack of confidence by business execs
The most logical conclusion is that the real issue is confidence. Businesses are reluctant to invest in new aircraft at a time when they feel uncertain about the business cycle and about regulatory and tax changes that could impact their industries. Political instability doesn’t help their confidence at all. Businesses also might not see prospects for market expansion, and simply reason that the best thing they can do with their wealth is to give it back to investors.
Perhaps most of all, businesses need to feel confident that they are not investing in an asset that will be worth less in a year or two. There may be a gradual but unpleasant deflationary spiral at work here, where demand for jets remains weak because jet prices are persistently declining and jet prices are declining because demand for them remains weak.
A second, related explanation simply involves a legacy of jet overproduction, leading to a lost decade. As indicated in Chart 1 (below), business jet output in 2005–2008 grew at a much faster pace than corporate wealth, and the business jet cycle greatly outlived the corporate profit cycle. This dynamic, the argument goes, represented a clear sign of overbuilding. This excess capacity has been plaguing the market since 2008, showing up in the form of high inventory levels. Weak used jet pricing is a legacy of this overproduction.
Whether the issue is confidence or excess capacity, or a combination of these two factors, Chart 1 implies that a recovery could happen any time. And when it does, it’s likely to be a very fast recovery, fuelled by readily available cash and deferred demand. Companies still hold a lot of their assets in cash and, as their aircraft age, they may decide to suddenly invest this cash in new jets. And if companies are waiting for prices to bottom out (to avoid buying an asset that will lose value), the end of this deflationary process could see a very sudden recovery too.
The world economy
World economic growth, as measured in GDP, is another driver behind business jet demand. While the correlation isn’t quite as strong as the link between corporate profits, it’s clear that, in the long run, a healthy business jet market depends on healthy GDP growth.
The year 2009 was the first since World War II to see zero economic growth. In fact, the world economy actually fell that year by just over 1%. That global economic downturn helps explain the inevitable business jet deliveries downturn. But that downturn does not explain what happened next.
Since 2010, the world economy has resumed its upward trajectory. The US, in particular, has enjoyed a near-record long economic expansion run. The past two quarters (through mid-2017) have seen nearly 3% annualised growth. Yet the business jet market has been stuck with no growth in that post-2010 period. To put it another way, business jet market downturns are usually correlated with economic downturns. Yet the business jet market has been hit by a downturn over the past 18 months, even though we haven’t seen any kind of economic downturn in years. The US economy has not been in recession since mid-2009. Even Europe has shown solid growth for some time, and of course Asia continues its long-term growth story.
Here again, the overbuilding thesis holds up, as does the business confidence thesis. Looking at business jet output relative to the world GDP trend line, as indicated in Chart 2 (below), clearly implies that there might have been considerable overproduction in the 2006–2008 time period. The market is still digesting this overcapacity. When the supply has been reduced (and again, inventories are at low levels), prices will firm, orders will rise, and production will increase. It’s just impossible to say when this will finally happen.
Mired in oil
If the first two macroeconomic trends offer hope for business jet demand, the third trend implies that the market may be in for more hard times, or at least a disappointing level of very slow growth. Of all the top-half market drivers, oil prices are overwhelmingly important. This is because the price of oil, stuck at $45 to $50 per barrel at the time of writing, is closely linked to high-end market demand.
Sales of large cabin aircraft are heavily reliant on the economic health of oil-rich countries (Russia, Saudi Arabia, United Arab Emirates, Qatar, Kuwait, etc) and on the corporate prosperity of resource extraction companies, particularly in the oil and gas industry. Thus, as Chart 3 below indicates, there is a clear connection, at least between 2003 and today, between oil prices and top-half jet demand.
Oil prices started falling in 2012 and 2013, but thanks to the usual delay between orders and deliveries and normal backlog considerations, large-cabin jet deliveries kept going. Relative to their peak, oil prices have fallen by over 50%. Top-half jet deliveries, by contrast, have fallen by 35%.
This oil price trend implies that the top-end market has few hopes of making a sustainable recovery in the next few years, barring a massive uptick in demand from China or the US – two countries where business jet demand is relatively (but not completely) unlinked to oil wealth.
This does not mean that the top half is overdue for further pain. The link between large jet demand and oil prices is far from precise, and output at the three big large-cabin OEMs seems to be stabilising – for now at least. What is more concerning is that oil prices appear to be stuck at around their current level. Very few forecasts call for them to go much higher than $60 per barrel over the next few years, and more than a few forecasts call for further market softness (some even to the $30 to $35 per barrel range).
A bifurcated market
These three drivers are impacting a market where the high end is now effectively the core of the business jet industry, in terms of value.
After the start of the Great Recession in 2007/2008, the bottom half of the business jet market (jets priced at $3 to $25 million) fell by 57%, while the top half (jets priced at $26 million and above) just kept growing. This top half grew through 2014, a remarkable 11-year run. In fact, this top half actually managed a 6% compound annual growth rate between 2010 and 2014, while deliveries of bottom-half jets fell by a devastating 57%.
Historically, top-half market demand had been about 50% of industry output by value (hence the use of the terms “top half” and “bottom half”, even though that’s no longer the case). In fact, the top half represented exactly 50% of deliveries in both 2006 and 2007.
The market’s profound bifurcation after 2008 changed all that. By 2013, the top half was a remarkable 77% of industry output. Large jets built by just three players – Bombardier, Dassault and Gulfstream – effectively drove almost all the business jet industry. Looking further we see that Cessna, Embraer, Bombardier’s Learjet unit, and Gulfstream’s G150 and G280, represented a mere 23% of output.
But over the past two years, soft emerging markets, low commodity prices, and China’s anti-corruption campaign have all pressured the high-end market downward, with deliveries falling 27% by value between 2014 and 2016. Predictably, record high-end business jet output rates were sustained well after demand was showing clear signs of softening. This guaranteed a steeper drop and a worse market oversupply situation. New and used large-cabin jet prices suffered in tandem, helping to pressure down prices of aircraft in all lower price segments.
Slumping deliveries remain probable
The supply side of the top-half jet market is equally problematic. Next year, Bombardier will start delivering large numbers of its Global 7000, a belated – and even more expensive (nearly $80 million) – response to Gulfstream’s ultra-high-end G650ER. Since Gulfstream shows no signs of backing away from its 45-per-year G650 production rate, the ultra-high-end segment will grow as at least 30 to 40 Global 7000s are delivered annually.
If the top-half market top line doesn’t grow, and the market sees this surge in ultra-high-end deliveries, the net result will inevitably be more pain for all the other aircraft manufacturers. This will show up in the form of slumping deliveries for new aircraft, and in continued declines in pricing for both new and used aircraft. Gulfstream’s G450 has already been a casualty of this trend. It’s easy to see the G550 following it, particularly as the all new G500/600 aircraft come online. Bombardier’s Global 5000/6000 could face heavy pressure too, along with Dassault’s Falcon 7X and 8X trijets.
Clearly, the business jet industry faces considerable uncertainty in the next few years. The broader market’s fortunes should be lifted by relatively positive macroeconomic trends. But so much of this industry’s fortunes are clearly connected with oil prices. And there, the news is unlikely to be positive for some time.