Aircraft Manufacturing & Inventory Trends
Date May 2019
- In March 2019 the Boeing 737 MAX was grounded by airlines and regulators globally; the company’s year-to-date net jet orders for 2019 are down as a result
- China will raise tariffs on U.S. aircraft parts from 10% to 20%, effective June 1, 2019
- Total estimated airline expenses for 2018 increased 9.8% driven in part by increases in crude oil and jet kerosene prices; estimated airline expenses are forecasted to increase by 7.8% in 2019
Approximate net recovery on cost*
Order cancellations and tariffs hit the industry: Boeing suffered a massive backlash in the marketplace after mechanical failures were implicated in two deadly crashes of Boeing 737 MAX 8 and 9 aircraft in October 2018 and March 2019. In March 2019, airlines and governments around the world grounded over 300 737 MAX passenger jets until safety assessments could be completed. Preliminary reports have since confirmed that the jets’ computerized anti-stall system was to blame for the crashes, which killed 346 people. Boeing has since completed its development of a software fix, which the company has tested on 207 flights for more than 360 hours to ensure its safety. The software now must go to the U.S. Federal Aviation Administration (FAA) and its foreign counterparts for a complete review; however, an FAA spokesperson noted in mid-May that the Boeing materials, including the software, had not yet been submitted to the FAA for inspection. For the year-to-date period ended April 30, 2019, Boeing’s net jet orders were negative as a result of 171 cancellations of the 737 MAX aircraft.
Airbus also suffered sales cancellations for some of its aircraft for various reasons including:
- Etihad Airways canceled an order for A350s as the airline was unprofitable
- Germania canceled orders for A320neos after the company filed for bankruptcy and ceased operations in early 2019
- Multiple canceled orders occurred for the A380 superjumbo after Airbus announced it is winding up the program early
Following the cancellations, the year-to-date 2019 net jet orders for Airbus are also negative. Expect the slowdown in sales for both of these major manufacturers to ripple through the supply chain and cause delays and pricing pressure going forward. Additionally, in response to the United States raising tariffs on approximately $200 billion worth of Chinese exports in May 2019, China increased tariffs on select goods including aircraft parts from 10 percent to 20 percent; these increases take effect on June 1, 2019. It remains to be seen what the increased tariffs will do to pricing and export activity; monitoring of pricing and maintained margin rates for manufacturers is critical as these added costs work through the supply chain.
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 don’t 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. Due to the specialized nature of products and the economics of order-size efficiencies, aircraft 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 including castings, forgings, various nickel alloys, and aviation-grade aluminum and titanium, among 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.
Industry outlook: Demand for commercial aircraft, especially large commercial aircraft, is expected to drive industry growth over the next five years. In the United States and other developed nations, airlines will look to continue replacing older planes with newer and more fuel-efficient ones. This will be in part to keep up with demand, as domestic air travel is expected to continue to grow with a strengthening economy boosting consumer spending. According to the International Air Transport Association, the commercial airline fleet increased by 5.0 percent from 2017 to 2018 and is projected to increase by 4.1 percent from 2018 to 2019. Global commercial airline revenue was up 8.7 percent for 2018 and is forecasted to be up 7.7 percent for 2019, as passenger numbers continue to grow.
Despite the forecasted growth, the March 2019 grounding of the Boeing 737 MAX could lead to some decline in the market. Boeing has felt the impact of the groundings, as the company missed its first-quarter expectations, and stock prices have declined since January 2019. While some call for the aircraft to be grounded indefinitely, The Wall Street Journal has reported that 737 MAX jets will likely not return to service until August 2019, as the company works with regulators to gain preliminary approval of its software.