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Production Rate Hike Will Continue to Constrain Residual Values

May 14, 2018

Narrowbody Residuals Not Expected to Increase

The pressure – and resulting planning – for a further increase in narrowbody production early in the next decade will do little to aid residual values for both older and newer narrowbodies.

There is little doubt that the recent above trend growth in passenger traffic – IATA reported a 9.5 percent increase for March 2018 compared to the same month in the previous year which compares with the 5.5 percent long term trend – has seen a shortage of capacity. Passenger load factors are now 81 percent, a level that essentially sees airlines having to turn passengers away. Asia/Pacific airlines reported international growth of nearly 12 percent with capacity increases of just over eight percent. Domestic travel in China rose by 15 percent with capacity increasing by 14 percent. There is therefore considerable demand for additional capacity but used aircraft are far from being perceived as a viable option. Instead, new aircraft are preferred due to lower fuel costs and greater reliability.

Airbus are now considering increasing production to 70 A320 family members per month by approximately 2022 if not before. This compares with the intended 60 per month as of next year and potentially 63 per month by early 2020. In 2008 Airbus delivered an average of 31 A320s per month. Boeing is also considering increasing production still further. In 2017 an average of 44 B737s per month were produced with 57 intended for 2019. If ordering a new B737MAX today the earliest delivery slot is currently 2023. There are currently more than 6,000 A320 and another 4,600 B737 family members remaining to be delivered – a total of more than 10,000 – representing more than six years production even with Airbus and Boeing producing some 60 per month each. Even if double counting is included as well as fragile orders then a backlog of 7,000 aircraft amounts to more than four years production. The need for the manufacturers to increase production is therefore all too apparent particularly for customers.

Absolute production rates of the A320 and B737 families has already increased by more than three times for Airbus and doubled for Boeing over 20 years while the world’s jet fleet has increased from 13,000 to 26,500. It can therefore be argued that the production rates for narrowbodies, while increasing, is still proportionate to the total aircraft fleet. There was a concern five years ago when Airbus and Boeing announced rate increases to nearly 50 aircraft per month. Yet, while demand is still strong despite the rate increase, the values of new aircraft being delivered have not increased.

Yet, focusing on the number of narrowbodies being delivered fails to appreciate the substantive increase in the number of seats being delivered. For example, in 2008 of the 386 A320 family members delivered, only 66 were for the A321 while there were 98 A319s; in 2017 of the 558 delivered over 200 were for the A321 but there were only 10 A319s delivered. A far greater proportion of deliveries are therefore for larger variants offering far more seats. Of the 6,000 A320 family members on backlog more than 2,000 are for the A321 and conversions from the smaller to the larger are a common occurrence as operators struggle to meet demand. Moreover, the number of seats being delivered in each aircraft is increasing. The idea of the A320 or B737-8 being a 150 seater is no longer relevant. The majority of A320s are being delivered with at least 180 seats with 186 SpaceFlex configurations also becoming more relevant. The A321 is not seeing 190 seats but is more likely to see 220-230 seats. Boeing has already launched the B737-10 and this may well see a significant number of orders being changed. Consequently, the number of seats alone being delivered has increased by 15-20 percent. The real increase in production is therefore not a 50 percent rise from 40 to 60 aircraft per month but at least a 65 percent increase in the number of seats. Rising to 70 aircraft per month would effectively see a doubling of seat production in the narrowbody sector in less than ten years. This even ignores the introduction of new types from other manufacturers. The overall increase therefore has the clear potential to represent

Both Airbus and Boeing are of course under pressure to show a return for investors and an increase in narrowbody production allows for greater profits to be made even if additional expenditure is required by all OEMs to facilitate rate rises. The ability to sell ever more aircraft is also perhaps a consequence of offering the aircraft at a price that has failed to keep pace with inflation. Indeed, new aircraft pricing has remained virtually static for more than 20 years even with the incremental improvement in specification. One of the key reasons why the backlog is so strong is that aircraft are being sold at a relatively low price – particularly when compared to their revenue earning capability. The low cost of finance in terms of lease costs and interest rates has also enabled the manufacturers to increase production. Increasing production rates in turn allows for greater efficiencies and therefore lower or stable pricing for new aircraft. With little or no increase in the value of new aircraft, the values of used aircraft are adversely impacted.

The concern for residual values in the next five years is that production will be peaking in 2022 just after demand has peaked. The demand for new aircraft nearly always sees a production peak in the first five years. The A320neo has already been in production (sic) for four years so by 2022 will have seen eight years of production with the B737MAX also having been in service for at least five years. The A320neo and B737MAX will no longer be seen as new technology as fresh environmental concerns will be seeing the development of new aircraft types. Customers will be anxious to secure an attractive price to offset the potential risk of ordering a mature rather than new product. Fuel prices have already risen and have contributed to the demise of some airlines and lower profitability of others. The growth seen in recent years has been on the basis of lower fares, something that cannot be sustained. Higher ticket prices will in turn lead to traffic issues. Just as the U.S. was seen as the powerhouse 20 years ago, Asia will not always be able to enjoy the growth seen in recent years with China perhaps turning more to domestically produced aircraft as a consequence of recent insular U.S. policies. Both Airbus and Boeing may find themselves by 2022 having to find customers for some unwanted aircraft which in turn will lead to lower pricing. Just as the rise in production in the last decade has already clearly had an impact on new and therefore used aircraft, then so too will a further rise have a constraining effect on residual values in the next decade.

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