Clouds of uncertainty
The mood at this year’s Farnborough International Airshow (FIA) was clearly under a cloud called BREXIT. While British politicians are still debating the hard vs. soft options, the rest of the continent is already planning for worst-case scenarios. Let it be clear that in our opinion, with the EU preparing its member states to plan for a no-deal scenario, the outlook is less than likely that a “Norway plus” agreement can be reached. Such an agreement would be the most desirable option as it would allow the UK to maintain full, tariff-free access to the single market. While the UK would not be able to shape EU policies, not being a full member of the Union, there are several issues clearly stalling a “Norway plus” deal: the free movement rule, the Northern Ireland border, and the ECJ (European Court of Justice). These will likely lead to continued turmoil and a conservative party leadership challenge in the wake of the Prime Minister’s Chequers failing Brexit plan.
Airbus has been particularly vocal on the issue, and has expressed significant concerns about potential for disruption ahead of the official UK exit from the EU on 29 March 2019. There are near term concerns, and there are also definite strategic implications for Airbus’ future UK presence.
Besides Brexit, here are some of our takeaways from a painfully uneventful, very well organized but potentially decreasingly relevant trade show; in short, no vintage, but actually borderline vinegar.
OEM Order inflation, so who “won” the show? Sorry Seattle, it is Toulouse for the number that matters, which is firm orders.
Airbus has reported 136 firm orders, 101 new orders and 35 as a conversion for a previous commitment. Boeing is reporting 125 firm orders, 105 new orders and 20 from previous commitments. These are the numbers that matter most to us analysts.
Now for the PR side we have:
- Airbus has 0 customer confirmation from a previously announced orders, Boeing has 148 confirmations of previously announced orders (mostly 737 MAX8).
- Letters of intent and Memorandum of understanding represent nearly 60 percent of Boeing’s FIA announcements (396 aircraft). That number, adjusted for previously announced orders, is actually 76 percent for Boeing and 68 percent of Airbus‘ (287 aircraft).
In a webinar organized by Desjardins Securities and AIR the week prior to the show, we were asked what we would be looking for at the show; our answer had been emphatically a return of quality orders. There were some, particularly for the A330NEO and the E2, however the show also confirmed that we are on a definite downward trend for narrow-bodies, which is to be expected after record levels of orders and backlog. We reiterate our forecast target for an average 0.7 book to bill ratio in 2018, which is still very strong based on the current and rising production outputs. We anticipate that next year’s Paris Airshow will be all about the NMA and the A3XX, as well as the inception of a wide-body upward cycle – if trade & politics do not get in the way.
Major takeaway: Airbus’ continued lack of a cargo solution is really showing and hurting the company’s outlook. Boeing has been clearly dominant (88 to 0) and we do not expect much relief for Toulouse in the near to medium term. If Boeing is able to introduce a 787 cargo variant soon, they may dominate this market space for the decade ahead. Seattle has their strategy on target.
Tempest in a teacup, or divide and conquer strategy
The Hawker Tempest (V1 killer) was a derivative of the Hawker Typhoon during World War II; familiar names aren’t they? BAE Systems was showing a model of a possible 5th/6th generation aircraft to replace Tornados and Typhoon for the RAF and export customers. With Brexit in mind, it is clear that the UK fighter aircraft design and production capabilities are at risk of going dormant. The F-35 choice is helping some of the UK market participants, but it is also a significant industrial risk for a country that has been a leader in that domain for the past century. F-35 is certainly not a long-term solution for the UK industry, in fact quite the opposite.
Tempest is possibly more an attempt at keeping and protecting competences near-to-medium term than ultimately introducing a full solution to the market. Dirk Hoke, the head of Airbus Defence and Space, stated last week that the UK and EU should collaborate on a future combat system rather than risk another market fragmentation of the EU defence marketplace; wise words.
With Dassault and Airbus leading the future combat air systems (FCAS), room for major partners is becoming more limited. However, if unmanned and derivatives of FCAS are proposed, then the potential definitely exists to expand and grow the role of the EU industry beyond these two primes. That should be the major focus of European defense customers, to ensure protection of industrial capabilities and deliver optimal operational relevance early into FCAS service life.
Should there be more than one EU project? Cui bono? Primarily those who do not want to witness the emergence of an integrated EU industry, principally the United States and Russia. Boeing and Saab’s interest in Tempest stems from the current declining position of Boeing Defense into the 2020s and the post-Gripen uncertainty for Saab.
Tempest is first and foremost a clear symptom of strategic misdirection by the UK government and the Eurofighter partners. By selecting the F-35 and the tempting promise of work packages, these countries have fundamentally damaged Typhoon’s potential evolutionary curve and its long-term competitiveness.
This is in sharp contrast with Sweden and France, who have decided to strategically support Gripen and Rafale’s investments to ensure technological and operational value into the 2030s. Those decisions will provide Saab and Dassault (and their respective technology partners) with a much stronger foundation for a 6th generation product. The F-35 is a highly capable machine no doubt, but it is also the fastest way to industrial dependency from a user point of view. With Typhoon investments stalling, we can only wonder where this is going to leave BAE Systems as a fighter aircraft prime in two decades if Tempest ends up on the road to perdition. With SU-57 at a pause to direct resources and develop a fieldable system, it is clear that current 4.5 gen TACAIR assets will do the job efficiently into the 2020s. Furthermore, F-35 is beginning to look like a capability overkill for now, at a price tag that jeopardizes future efforts and budgets. This makes Boeing’s approach with F-18E/F/G and F-15, Dassault with Rafale F4 and Saab with Gripen E all the more sensible as a path forward. We particularly like Boeing and Dassault’s evolutionary strategies, which are not driven by product limitations but simply by market and operational realities. Canada, Finland and Switzerland will be major tests for all involved.
For Boeing and the US administration, it’s about slowing the rise and addressable market of FCAS. A strategy of divide and conquer could lead to some players being caught in a zero-sum game. BAE’s loss is Airbus’ gain, and for BAE not to lose, it must redirect its strategy. This strategy however contains too many ifs to provide a clear path to market, as the company cannot do it alone. The watchwords are “if Boeing joins, if Saab joins, if others join ” because it simply cannot be alone. While F-35 cash-flow is good for BAE Systems near term, the long term outlook is not positive in our opinion, and may well force the company to either partner or merge. Thus, an agreement with Airbus would be particularly positive for the European defense industry.
Finally, there is a final and major risk for the UK with Tempest; if it chooses the US partner over the EU approach, then the UK’s role in Airbus commercial activity will face severe risk of irreversible damage. Tough choices lie ahead.
As expected, no launch for NMA at FIA. Clearly those expectations were driven by irrational anticipation for a product that is still being defined and needs tweaking to ensure maximum market traction. While we generally agree that Boeing’s projections for the middle of the market (MOM) size are correct, the business case for NMA is far from being clear-cut. Boeing faces multiple challenges and cost pressures that are essentially being driven by the competition. Rarely in recent history has a competitor’s existing or potential product influenced so much the product & sales strategies of another player. Airbus continues to dominate MOM sales with its A321NEO solutions and for Boeing, this causes a major headache over the next 7-8 years as the business case for NMA is slowly but surely being eroded by NEO. MAX is no true MOM option, and neither is 787-8. As Boeing also attempts to kill the A330NEO, it is making significant financial concessions with customers to ensure that the MOM market is not further eroded at the upper end.
There is enormous pressure on Boeing to come up with a solution that can compete on price with Airbus, address growth markets (including cargo) and be sufficiently technologically advanced to maintain its advantage over two decades at least. There lies the risk. All Airbus needs to do is ensure that technology insertion for A321NEO is used optimally, and then launch a new product in the mid to late 30s that will have considerable advantages over a likely low risk NMA. This possible Airbus strategy potentially erodes NMA’s optimum market window to ten years (2026-2036 or about). In all, we expect Airbus A321/A32X to capture roughly 48 percent of the MOM segment versus 42 percent for Boeing’s NMA. We will revisit the issue of NMA technology and market choices in a new note next month.
Supply chain on edge – fault-lines ready to crack
The supply chain is about to crack – the dam is feeling the pressure and the current trade spat is making matters worse. We are very concerned with the materials side of the supply chain – lead times are rising, especially for aluminum, smaller tier 4s in EU and Canada especially are expressing concerns that tariffs will force them out. Raw materials are the canary in the coalmine of our industry – if it cracks, then rates will suffer and dominoes will fall.
With Boeing’s vertical integration accelerating and its aftermarket characterized by its recent acquisition of KLX – Tier 1s and 2s are reexamining their options to a) increase potential shipsets on the current and future programmes and b) develop synergies that can increase competitive reach, reduce cost and maintain services revenues. This is going to unavoidably lead, in our opinion, to further Tier1/2 or Tier 2/2 consolidation near term. Targets abound and the mega Tier1s are not finished augmenting their capabilities through acquisitions in the next calendar year.
Of course, the Embraer-Boeing deal was very much discussed during the show. It is the object of this note which can be downloaded from the AIR website if you are a research services client.