Aircraft Manufacturing & Inventory Trends
COVID-19 Industry Brief
EFFECTS OF THE CORONAVIRUS ON THE Aircraft Manufacturing & Inventory INDUSTRY Updated April 24, 2020
- Commercial Air Travel Reductions: Commercial aviation will be hard hit by huge reductions in air travel brought on by the pandemic. Airlines are anticipating that the impact of the pandemic will be even worse than the 9/11 terrorist attacks, the 2003 SARS epidemic, and the 2008-2009 financial crisis. The four largest U.S. airlines have adjusted their spring schedules downward to attempt to right size demand. This has resulted in scheduling cuts of 40 percent at Southwest, 42 percent at United, 70 percent at Delta, and 80 percent at American. Air passenger miles flown declined by 84.7 percent in the second half of March 2020. The International Air Transport Association has forecasted that global passenger numbers will fall 55 percent this year compared with 2019.
- Commercial Market Sentiment: At current flight levels, and at the flight levels that will likely be achieved in the second half of 2020, there is significant excess commercial capacity in the marketplace. It is hard to project at what level air travel will return, but it may hit 2017 or 2018 levels, or lower, by the end of 2020. This will have a negative impact on the sector and has negative implications for inventory and related equipment values.
- Impact on Original Equipment Manufacturer (OEM) Production: Commercial flights dropped by 55 percent in the final week of March 2020 compared to 2019 levels, according to flight-tracking service Flightradar24. Because of the dramatic slowdown in air traffic due to the COVID-19 travel restrictions, Boeing suspended production at its South Carolina facility that produces the 787 Dreamliner on April 8, 2020. This followed the March 2020 closure of multiple facilities in the Pacific Northwest and Pennsylvania, which were extended indefinitely as of April 5, 2020. Boeing reported deliveries of 50 commercial aircraft in the first quarter of 2020, as well as 39 defense-related aircraft. The company also reported orders for an additional 49 planes (most of them defense related) and 196 cancellations for the same period. Airbus paused production at its facility in Mobile, Alabama, through April 29, 2020, as well as its facilities in Germany. Airbus also announced on April 8, 2020, that it was reducing its production rates for the A320 by 33 percent, the A330 by 66 percent, and the A350 by 40 percent. Airbus reported delivering 122 aircraft in the first quarter of 2020. For the same period, Airbus also booked orders for 356 aircraft and cancelled 66 orders.
- Boeing 737 MAX Issues: On April 14, 2020, Boeing announced the cancellation of 150 737 MAX aircraft and removed another 139 737 MAX aircrafts from its backlog, as their order status was in doubt. While it seems likely based on Boeing guidance that the 737 MAX-recertification approval will come through in 2020, certification flights were recently pushed back from May to August 2020. This additional delay was due to the ongoing Federal Aviation Administration review of the new software fixes. In addition, the channel for these planes is fairly full, both for Boeing and its suppliers. Therefore, while the recertification approval will be good for Boeing in the long term, it likely does not mean that activity on that platform will pick up materially in the short term. Further cancellations are expected in the coming months given overall business conditions.
- Impact on Aftermarket Activity: For aftermarket demand, Gordon Brothers expects parts demand to falter substantially due to weakness in maintenance, repair, and overhaul (MRO) demand. A study released in late March 2020 by consulting firm Oliver Wyman estimated that “the total global impact of COVID-19 on MRO is estimated to be between $17B and $35B, a 19 to 39 percent reduction from our original $91B forecast for 2020.”
- Impact on Defense Related Aviation: Gordon Brothers does not expect there to be a material impact on defense spending in 2020, and have seen reports that defense spending has actually increased as the government attempts to push stimulus to the economy.
- Commercial Aviation Valuation Outlook: While it is difficult to gauge the impact of the coronavirus pandemic on appraisal values, Gordon Brothers expects it to be materially negative for both inventory and machinery and equipment. Gordon Brothers expects that on the OEM side of the business inventory values will decline due to reduced Tier I concentration and potential margin erosion, as well as commodity and general industrial weakness. On the machinery and equipment side, computer numerical control (CNC) dealers are comparing the current market to 2008-2009 for used equipment.
- Defense-Related Aviation Outlook: Gordon Brothers does not expect there to be a material impact on companies on the defense aviation side of the business, and accordingly feels values for inventory should be stable in this sector for 2020. Inventory valuation should be insulated as a result. For equipment, as much of it is sector-agnostic, weakness on the commercial side of the business and in other industrial sectors will bleed into this space, Gordon Brothers expects that values will decline.
Date May 2020
- Cancellation of Boeing 737 Max orders have ramped up, including 150 cancellations in March 2020
- The United States increased tariffs from 10% to 15% on European aircraft and aircraft parts, effective March 18, 2020
- Global air travel has dropped by 95% due to worldwide stay-at-home orders
- The coronavirus pandemic is projected to cost the airline industry $63 to $113 billion in lost revenue
Approximate net recovery on cost*
Ongoing Order Cancellations and Higher Tariffs Impact the Industry: Boeing continues to see backlash due to the grounding of the 737 Max. In the month of March 2020 alone, Boeing customers cancelled 150 737 Max orders, the most cancellations the company has seen in over a decade. In particular, aircraft-leasing firm Avalon cancelled 75 orders worth close to $8 billion because of the growing uncertainty around the reliability of the 737 Max and the increasing concern from the spread of the coronavirus. Adding to the pressure on the company, Alafco Aviation Lease and Finance Co., a Kuwaiti aviation leasing company, sued Boeing in April 2020 for the return of $336 million that it paid in advance for 40 of the still-grounded 737 Max planes.
The company faults Boeing for failing to deliver its planes on time and refusing to return advance payments on a now-canceled order for 40 aircraft. As the 737 Max remains grounded, additional orders are not being fulfilled on-time, allowing customers to cancel orders without penalty. The timeframe for the 737 Max to be back in the air remains unclear. At the beginning of 2020, Boeing stated that the plane will not fly until the middle of 2020 at the earliest. Year-to-date net jet orders for Boeing were negative 307 through the end of March 2020.
On February 14, 2020, the Trump administration announced it would increase tariffs on aircraft imported from the European Union from 10 to 15 percent in an attempt to help domestic companies compete more effectively. The tariffs went into effect on March 18, 2020, amid the continuing spread of the coronavirus and increasing fears of a subsequent recession. The tariff increase was driven by an almost 16-year dispute over the subsidies European governments gave Airbus that put Boeing at a disadvantage. The European Union is looking to settle the issue, and it remains to be seen if the United States and the European Union can come to a resolution on the conflict.
Market Impact of Coronavirus: The spread of coronavirus has had serious impacts across the air travel industry. Companies like Boeing and Airbus have been forced to temporarily halt production on some aircraft and have even gone as far as shutting down entire factories. In early April 2020, Boeing suspended production of its 787 Dreamliner in Charleston, South Carolina due to the fear of spreading the virus among workers in the factories. The Boeing production plant in Seattle, Washington also suspended operations, effectively halting commercial aircraft production. Boeing reported deliveries of 50 commercial aircraft in the first quarter of 2020 as well as 39 defense-related aircraft. However, the cancellations of 196 aircraft during that same period represents a significant issue for Boeing.
Airbus has also shut down many of its factories in the United States and abroad due to the spread of the coronavirus, including pausing production at its facility in Mobile, Alabama and its facility in Germany. On April 8, 2020, Airbus announced that it was reducing its production rates for the A320 by 33 percent, the A330 by 66 percent, and the A350 by 40 percent. Airbus reported delivering 122 aircraft in the first quarter of 2020. For the same period, Airbus booked orders for 356 aircraft and cancelled 66 orders.
In addition to halting production across the globe, strict stay-at-home orders have caused many airlines to ground the majority of their flights. This has had a severe impact on the commercial aviation industry as airline companies struggle for cash and have been forced to furlough staff or ask employees to take voluntary pay cuts. With air passenger miles flown dropping by more than 84 percent in the second half of March 2020, it is easy to see why companies like Delta and United have reported their first losses in over five years and adjusted their spring schedules downward to attempt to right size demand. Delta’s CEO has stated that revenue in the current quarter is projected to be 90 percent lower than anticipated, and the business could take two to three years to recover.
The same struggles are being seen abroad with Lufthansa, the German international airline company. The Lufthansa received a $10 billion bailout from the German government and has seen a dramatic revenue drop due to global travel restrictions; it is projected that the company is generating losses of approximately $1 million every hour. The International Air Transport Association has forecasted that global passenger numbers will fall 55 percent in 2020 compared with 2019.With the number of flights declining, a similar fate is presenting for the ancillary companies that supply and support airline corporations. With fewer flights each day, the need for companies to repair and maintain current aircraft fleets has dropped significantly. As a result, companies like Boeing and Airbus have seen staggering drops in activity and revenue. A study released in late March 2020 by consulting firm Oliver Wyman estimated the total global impact of the coronavirus on maintenance, repair, and operations to be between $17 and $35 billion, a 19 to 39 percent reduction from its original $91 billion forecast for 2020. It remains to be seen how much more the coronavirus will impact the entire aviation industry, and how long it will take the industry to recover.
Industry Outlook: The outlook for the commercial aviation industry is difficult to gauge due to the growing concerns and complications of the spread of the coronavirus and the associated global travel shutdown. Prior to the outbreak, the industry was continuing to grow as the economy grew and more people spent disposable income on travel. However, even before the outbreak the Federal Aviation Administration projected that the number of general aviation and air taxi aircraft would decline, causing the overall fleet to become younger and require fewer repairs and less maintenance and negatively affecting the industry.
Despite the downturn on the commercial side, manufacturers on the defense aviation side of the business are expected to remain stable.
Long-Term Agreements Make Inventory More Valuable: To manage the cost of subcontracted parts, aircraft manufacturers (original equipment manufacturers or OEMs) utilize long-term agreements (LTAs) as a way of securing the supply chain and controlling costs. Typical factors considered when entertaining LTAs include the size of the supplier pool for the part, the time it takes to bring suppliers on board, regulatory requirements, and the reputation of the supplier. The LTA obligates the aircraft manufacturer to purchase finished goods produced under the contract. Thus, aircraft parts suppliers’ inventory that is subject to LTAs typically carries higher liquidation values. In contrast, suppliers that are manufacturing to forecasts face deeper discounts because they do not benefit from a guaranteed exit strategy.
Inventory Intended for Active Platforms: Like automobiles, aircraft manufacturers are continually phasing models in and out of production. Inventory manufactured or warehoused for active platforms or current models typically retains more value than inventory servicing retired models. While planes certainly remain in operation for many years after they are discontinued, predicting the need for replacement parts becomes more of a challenge. Because of the specialized nature of products and the economics of order-size efficiencies, manufacturers often produce more parts than are ordered and keep the extra quantity on hand as “spares.” Inactive spares typically retain minimal value in a liquidation scenario.
Raw Material Lead Times Impact Value: Some aircraft components require the use of specialty metals in proprietary forms to meet performance requirements. These alloys may be lighter or have different chemical properties that enable materials to wear longer and withstand greater stress. But the lead times for these raw materials can be lengthy – six or more months in some cases. Manufacturers producing these types of products (castings, forgings, various nickel alloys, and aviation-grade aluminum, titanium, and other alloys) should be procuring these materials subject to existing orders or LTAs. If a company faced liquidation, those raw materials would likely retain a higher value, as the customer contracting the parts would be motivated to purchase in order to move to a new supplier, minimizing disruption and production delays. In some cases, these metals are being purchased from the OEM or the agent of the OEM, increasing the likelihood that they would want to buy them back in a liquidation.
Note: This publication is provided for informational marketing purposes only. The material contained herein should not be regarded as advice, nor relied upon to make financial, operational or other decisions; nor should it be used as a substitute for an asset appraisal. Actual recovery values may vary from transaction to transaction and the recovery values referenced herein are for representative transactions without regard to specific key factors. This material may be redistributed only in its entirety, including notice of copyright. All rights reserved. ©2020 Gordon Brothers, LLC.
Reference sources: airbus, boeing, forbes, nbc news, the new york times, bloomberg, reuters, ibisworld, euractiv