Seminar: backlogs will sustain industry through downturn

Aviation International News » August 2008
July 30, 2008, 6:12 AM

Analysts at last year’s Corporate Aircraft Transactions conference agreed that the business jet market was “extremely strong” at the time, but they also expressed doubt that the boom would continue indefinitely. “There are signs that concern us,” said David Strauss, executive director, U.S. aerospace and defense senior analyst for UBS Investment Research. “We’re uncertain how much higher the market can go.”

Strauss’s concerns were apparently warranted; at this year’s conference, held June 17 and 18 in New York, he said the U.S. market is “slowing significantly,” and the rate of new orders and deliveries has been declining since February. Corporate profit growth is also declining, driven by the weakening financial market, and as a result the future outlook for the industry looks “increasingly more pessimistic”–in the U.S. and the international markets. “Our best guess is that the market is deteriorating from its peak in 2006 and 2007,” Strauss said. “We think deliveries will drop, and we’re concerned about the ability of the supply chain to ramp up and meet demand.” Stock prices have also dropped, he said, due to the state of the market and the smaller number of orders.

On the other hand, he also speculated that large backlogs amassed during the “extreme” peak of the past two years might help to keep the industry afloat during the hard economic times. He expects deliveries of 1,400 new aircraft over the next couple of years, and some manufacturers, such as Cessna, are still seeing “unbelievable demand.”

Rising fuel costs and concerns about the environment might also prompt owners and operators to purchase more fuel-efficient aircraft. “Operators might start exchanging older aircraft faster than we thought,” he said, adding that there has been a slight rise in used inventory levels. In addition, he explained that the drop in demand and deliveries indicates a return to normal levels.

“The business jet market might be able to power through this unscathed,” Strauss concluded. “We’re remaining positive that backlogs are strong enough to carry us through.”

Sentient Flight Group’s vice president of aircraft management Gil Wolin cautioned attendees not to be too concerned about the state of the industry. “It’s not time to slash your wrists with a dull butter knife yet,” he said. “Things are better than they appear.”

He said the media loves to focus on the bad news during election years, but the number of new millionaires who view business aviation as a valuable tool is increasing every day. “They’re willing to invest a lot of money in this industry,” he said, adding that the number of first-time buyers has increased significantly. In the past, such buyers accounted for 5 percent of total sales. “That has changed dramatically,” he said. “Today, 20 percent are first-time buyers.” As a result, charter activity at Sentient Flight Group is down and jet card activity is flat, but aircraft management is “through the roof,” he said.

The charter industry should also improve, he said, because of deteriorating airline service and the rising cost of airline tickets and associated fees. “Airline costs are going to continue to rise,” he said. “Charter is going to start to look cost-effective, and it will create a re-birth of charter growth.”

The international market is also “propping us up” for the moment, Strauss said, but some analysts are questioning how long that will actually last. “All the demand coming out of Russia, China and India is keeping the large cabin sales going, but how long can that continue?” asked Louis Seno, vice president of aircraft programs, GE Capital Solutions. He added that the international buyers “are going right to the top of the product line, whereas domestic buyers work their way up. It will be interesting to see how long that continues,” he said.

However, other analysts believe international buyers will continue to be key players in all segments of the market. Rudy Tenore, senior vice president and sales manager of Banc of America Leasing & Capital, said that international buyers will eventually contribute to used aircraft sales, as well. “International demand is a function of backlog,” he said. “A lot of people don’t want to wait for backlog, so they’re going to the used market.”

Joe Dini, senior vice president of Sovereign Bank, added, “If it wasn’t for what’s going on outside the U.S., we wouldn’t be seeing the backlog we’re seeing. This isn’t oil, a limited resource. As long as there’s a need, manufacturers will continue to build and people will continue to buy.”

International customers will also continue to purchase aircraft as long as the U.S. dollar remains weak, according to Brian Foley, president of Brian Foley Associates, an aviation brokerage and consulting company. “The international market is seeing about a 25-percent discount on aircraft,” Foley said. “That’s what’s making the market right now.”

He added that international deliveries have also propelled the industry into Wall Street’s spotlight. “Worldwide deliveries year over year have seen 20-percent gains, and at the end of 2007 there was $60 billion in backlogs,” he said. “When you see this kind of growth, you’re going to see folks coming in to get a piece of the action.”

Operational Control
Recent enforcement actions by the FAA and the DOT, following the introduction of the new A008 OpSpecs and the FAA’s increased emphasis on operational control, were also a hot topic of discussion.

“[The certification action against] TAG was a huge shock to the industry,” said Eileen Gleimer, conference co-chair and a partner at Crowell & Moring. The situation has made it more difficult for lawyers, who do not know what to advise their clients, she added.

The issue of foreign ownership, specifically, is especially disconcerting, Gleimer said. “Citizenship was huge piece of the FAA’s case against TAG, even though it came under the guise of operational control,” she said. “In 2005, AMI was restructured to DOT satisfaction. Two years later, the FAA acknowledged that TAG met the standards in a mathematical sense, but then [the agency] decided that the people really running the business were non-U.S. citizens.” The FAA used the fact that TAG and AMI shared offices and employees as the basis for its revocation order, Gleimer said.
“There’s no question there was a strong relationship between TAG and AMI. That’s not a problem, except in the FAA’s eyes.”

Jacqueline Rosser, director of regulatory affairs for NATA, called the situation “troubling.” “The FAA kept asserting that it wasn’t concerned about business arrangements, yet those were the very things being asserted as an allegation against the operator,” she said. “They assure us they’re not in our business, but they are. Every lease, every pilot agreement, every insurance document…your entire business will be under scrutiny.” A 30-day suspension order could cripple a small operator, she said. “An emergency suspension may as well be a revocation,” she said.

The revocation of AMI’s Part 135 certificate also calls into the question the relationship between operators and their local FSDOs, Rosser said. “The FAA now has the right to correct its POIs [Principal Operations Inspectors],” she said. “Even if a Principal Operations Inspector tells an operator to do something, it’s not a defense. Sometimes operators aren’t even involving their local office anymore because they feel the local offices can’t be trusted.”

Tim Sullivan, COO of Chantilly Air, added, “Your POI might have one opinion, but it might not agree with guidance. It might not reconcile. If you’re asked to do something, ask why you’re doing it this way and ask them to show where it can be found in the regulations. It might not be the silver bullet when you need it, but you can at least show the FAA why you did it.”

Sentient Flight Group’s Wolin added that the TAG revocation order had “nothing to do with safety.” Rosser agreed, saying, “There was no indication that their airplanes weren’t airworthy, or flown by pilots who were not trained or qualified.” Aaron Goerlich, of Washington, D.C.-based aviation law firm Garofalo, Goerlich and Hainbach, added, “Safety was not an issue, but that made no difference to the FAA.”
Gleimer said operators must be more vigilant in managing their operations. “The bottom line is that an operator must have complete, effective and sustainable control,” she said. “Some of it is an issue of semantics, but in the end, the operator is putting his or her certificate on the line. What they’re risking is their license. The industry for many years was relatively cavalier, but I don’t think it is anymore.”

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