Backlogs shrinking at the major OEMs

 - December 29, 2008, 6:48 AM

Six months ago, business aircraft manufacturers were publicly confident that their backlog of new aircraft orders stretching well into the next decade would provide a buffer to ease the industry through what was already flagged as an economic crisis. Today, cancellations and delivery deferrals are eating into those backlogs, and the OEMs are making adjustments that were only being hinted at two months ago.

In the fall of last year, even with a U.S. economy feeling serious pain, life was good. Or that was at least the image OEMs were presenting.

Airbus was selling executive aircraft for delivery as far out as 2017 and competitor Boeing Business Jets was selling executive 787s into 2020. Bombardier’s backlog was valued at more than $26 billion, and Cessna’s backlog for more than 1,500 airplanes was valued at $15 billion. Dassault had a 500-aircraft backlog valued at about $12.5 billion, and Gulfstream’s backlog stood to bring in some $22 billion.

The General Aviation Manufacturers Association at the time released numbers that put the total value of the aircraft backlog for “the big six” OEMs– Bombardier, Cessna, Dassault, Embraer, Gulfstream and Hawker Beechcraft–at more than $82 billion, a dramatic increase of $23.9 billion from the same point in 2007.

Executives for the OEMs were publicly optimistic. Lewis Campbell, chairman and CEO of Cessna parent Textron, said last October, “We continue to have faith in a healthy, long-term systemic global demand and we have a robust new product pipeline over the next ten years as well.”

And why not? At the time, Cessna was projecting delivery of 535 business jets this year and was looking at a backlog, including the new large-cabin Columbus, that extended into 2014.

Dassault Falcon president John Rosanvallon forecast tough times ahead, but noted, “Global expansion and the strength of the backlog will make it less painful than it would be otherwise.” Charles Edelstenne, chairman and CEO of Dassault, agreed: “We are fortunate in these troubled times to have a solid order book with few cancellations.”

Luis Carlos Affonso, executive v-p of Embraer Executive Jets, said the company’s $7 billion backlog, roughly a third of the Brazilian OEM’s total aircraft backlog, would help carry the company through this year, and through the economic downturn.

But, as one industry analyst described the economic crisis, “Nobody realized how fast it would turn, and just how far down ‘down’ was.”

Economic Crisis Catches Up with Business Aviation

By early October, the U.S. bear market was unnerving the rest of the world and a deepening economic crisis in the U.S. had begun to spread. Dr. Robert Shapiro of NDN, a progressive think tank and advocacy organization, said the crisis in Europe would be at least as severe as that in the U.S. and “between Europe and the United States, we’ll take everybody else with us.”

Today, the economic crisis that began in the U.S. has expanded well beyond and those backlogs are not looking so healthy as order cancellations rise and deferrals of scheduled delivery dates mount. Hard numbers are hard to come by.

There have been a number of cancellations, said a Cessna Aircraft source in November, “but the number is not significant or unusual.” However, Cessna shortly thereafter announced the voluntary layoff of 150 workers and the involuntary layoff of some 500 more, citing customer deferrals of deliveries scheduled for 2009. It also revised downward its original projection of 535 business jet deliveries in 2009, to “fewer than originally projected but still more than in 2008.”

Embraer had already lowered its 2009 delivery forecast to reflect “an uncertain credit market.” And rather than deliver a combination of 170 Phenom 100s and Phenom 300s in 2009, the company revised its expectations to 145 business aircraft, including Legacy 600s and Lineage 1000s.

Also in November, Hawker Beechcraft informed its employees that it would lay off 5 percent of its workforce. Chairman and CEO Jim Schuster cited “serious challenges facing our company due to the unprecedented worldwide economic decline.”

Bombardier would say only that cancellations during the third quarter of its current fiscal year were “at a normal rate.” However, a spokesman added, “due to the impact of the current economic slowdown, certain customers have requested deferred deliveries.”

No Good News From the Industry Analysts

Even as OEM executives and industry forecasts were presenting a brave front at the NBAA Convention in September, some analysts were sounding alarm bells.

“It’s easy for forecasters to get caught up in what has been an extraordinary double-digit growth period for the market over the past six years and straight-line that growth into the future,” said Brian Foley of Brian Foley Associates, a Sparta, N.J.-based investment consultancy. “The OEMs have grown fat, dumb and happy with their current order backlogs and are oblivious to how quickly things will change.”

Less than a month later, Foley’s warnings became more focused. “The record order books will not be as firm as OEMs would like to think,” he said. “We’re warning our clients to expect double-digit percentage order cancellations, depending on the manufacturer.”

At the Middle East Business Aviation (MEBA) show in late November, the UBS Business Jet Update noted that of the inventory of 2,564 used business aircraft, 176 were new aircraft delivery positions. It went on to point out that the rapidly growing used-aircraft inventory is going to stall new-aircraft orders even as the current order backlog is shrinking.

In November, the UBS report was no more encouraging. The 11-percent increase in “young used inventories” is partly due to a 19-percent increase in new aircraft delivery positions, now five times higher than for the same period last year. A growing number of listed delivery positions for aircraft included Cessna’s Citation XLS, Citation CJ3 and Citation Sovereign, as well as Bombardier’s Challenger 300 and Challenger 605 and Gulfstream’s G450 and G550. “We believe the recent surge in delivery-slot listings reflects a combination of reduced customer demand and difficult financing conditions,” the report said.

Aircraft brokers are less than enthusiastic. Aradian Aviation, an aircraft sales and management firm in Guernsey, Channel Isles, UK, is heavily involved in new-delivery aircraft. Aradian sales and managing director Steven Rogers told AIN early last month that he had three G550s for sale “and no buyers.”

Another indicator, said Rogers, is the recent sale of a new G550 for $52 million. “The owner,” he said, “had been asking $59.5 million.” Rogers noted that aircraft delivery deferrals are more obvious at the upper end of super-midsize and large-cabin business jets, “and in the past few weeks it has become even more obvious. We can offer clients an airplane for pretty much any month they choose.”

Bryan Comstock of Jeteffect in Long Beach, Calif., had similar examples, most notably two G450s on order by Lucent Technologies. As of late November, he said, one had been delivered and both were being brokered on Lucent’s behalf.

Money Is Getting Tighter

The atmosphere at the lending institutions has changed considerably from May last year. That is when U.S. charter and membership operator XOJet announced financing agreements for up to $2.46 billion to fund North American operations and global expansion. The deal marked “the largest publicly announced business aircraft financing package in history.”

Since then, the credit crunch is taking a bite out of the business aircraft market and making inroads into the backlogs.

In the latest industry survey by UBS (published last month), “roughly one third” of respondents said financing had dried up, compared with 6 percent in September.

Shane O’Hare, president and CEO of Royal Jet of Abu Dhabi, said that despite the deepening economic crisis, the company’s plans remain on track. But he noted that difficulty in obtaining financing to purchase aircraft, along with backlogs at the independent completion centers doing interiors for single-aisle and widebody bizliners, was putting a damper on sales.

“There is ready money for a new-aircraft purchase,” said Rogers, “but it isn’t as easy as it was. We’re spending a lot of time nowadays putting clients together with lenders, even those clients who aren’t looking for some vast sum.”

Rogers also said more lenders are basing loan approvals on the client’s wealth rather than the company balance sheet. Lenders who had previously been willing to look at a business jet as an asset are less likely to do so today.

“People don’t trust ‘assets’ that much,” said Richard Aboulafia, v-p of analysis at the Teal Group in Fairfax, Va. “A flight department business jet is simply not perceived as generating income in the way that a 737 in an airline is earning money for the owner.”

Early on in the economic malaise, buyers outside the U.S. were snapping up the few order cancellations. According to industry analysts, this was motivated primarily by the falling value of the U.S. dollar as foreign buyers enjoyed the equivalent of a 30- to 40-percent discount when buying business jets sold in dollars. Now, with the economic crisis a worldwide reality and the dollar stronger against other currencies, that pool of ready buyers has virtually dried up.

Bombardier takes an optimistic view in the belief that while financing availability has been reduced, “there is still financing capacity, as the overall credit standing of our customers remains strong.” Meanwhile, a spokesman said Bombardier believes that “institutions that have made financing commitments to our business aircraft customers will honor them.”

A “small minority” of Bombardier customers have requested some form of financial assistance, according to a company source. “We are considering these requests on a case-by-case basis and are accommodating our customers by either repositioning their backlog slot or accepting a deferral on their aircraft delivery.”

She added that the company’s pre-owned aircraft sales group is available to assist in brokering the sale of customer aircraft, new as well as used.

Cessna Aircraft has its own Cessna Finance Corp., “which exists for the purpose of financing the acquisition of Cessna aircraft,” said a spokesman. “This gives us an advantage [and] allows us to work out an amicable solution for customers who have problems for whatever reason.”

Bright Spots on the Backlog

While the rest of the world was dealing with a credit crunch, there were few clouds on the economic horizon in the Middle East. At the MEBA convention in Dubai in late November, deals were wrapped up for approximately 74 business aircraft valued at nearly $1.7 billion.

At the show, Al Jaber Aviation of Abu Dhabi announced $530 million in new orders for executive jets from Airbus and Embraer. Prestige Jet, also a charter operator out of Abu Dhabi, announced it expects its fleet will double in size from 11 aircraft to 22 by November this year.

Royal Jet of Abu Dhabi has not been placing multi-ship orders but made it clear in November that the company is merely biding its time, expecting early delivery slots for single-aisle airliner-based bizliners such as the ACJ and BBJ to open as the economic crisis continues, and at bargain prices.

In general, charter operators continue to present an optimistic front, many convinced that the closing of flight departments and cancellation and delivery deferrals of new business jets spells more business for them, as well as price rollbacks for new aircraft. In fact, multiple-aircraft orders by charter and fractional ownership operators represent a major piece of the backlogs, totaling well over $6.5 billion.

XOJet took delivery of its first Challenger 300 on December 1, “on schedule.” It was the first of a $1.9 billion order for 80 Challenger 300s, and the West Coast charter operator also has on order 30 Citation Xs, valued at more than $600 million. According to a company spokeswoman, “XOJet has not cancelled or deferred delivery of any aircraft.”

XOJet has multi-aircraft orders in the $2.5 billion range and has said it will not cancel or defer delivery. AIN has learned, however, that the company recently laid off approximately 20 pilots and additional support staff.

NetJets Europe has an order for 20 Falcon 2000LXs with a value of approximately $720 million. Added to an earlier order for 10 Falcon 2000LXs, the total value of the deal exceeds $1 billion.

Jet Republic, a European fractional start-up, has placed orders for up to 110 Learjet 60XRs, 25 of them firm. If all options are exercised, the total value of the deal is about $1.58 billion. Deliveries are set to begin in October. “Given the size of the European private jet market and its strong prospects for growth, we fully expect to meet our targets…and have no need to re-evaluate our order,” said marketing manager Nicholas Priest.

Vista Jet, headquartered in Switzerland and offering “membership, partnership and ownership options” as well as charter, operates a fleet of more than 90 aircraft worldwide and is rapidly expanding. Also at EBACE last year, the company signed for 60 Bombardier aircraft, including firm orders for 11 Challenger 605s, 13 Learjet 60XRs and 11 Learjet 85s. With options on 25 more aircraft, the order has a value of $1.2 billion.

Even among the analysts, there is some cause for optimism. In Brian Foley Associates’ latest analysis on December 11, the forecast is for a somewhat shorter, if no less painful, economic recovery period. “Our proprietary business jet delivery forecast by model shows that the uptick, albeit weak, will be sooner than six years, but at the expense of a rapid, pronounced, painful downturn.” Foley concluded that elements for seeding the recovery have quietly begun in the shape of lower fuel costs, shorter delivery times, stabilizing financial markets, lower aircraft pricing and the possibility of government stimulus packages such as investment tax credits and accelerated depreciation.

Bizliner Orders Appear More Solid

The backlog for executive aircraft derived from single-aisle and widebody airliner airframes appears to be more solid than those for smaller aircraft.

Airbus, as of early last month, said it had taken firm orders in 2008 for 23 jets from the A318/319/320-based ACJ series, along with orders for nine bizliners based on Airbus widebodies.

“Generally speaking,” said marketing director David Velupillai, “our view is that we will be less affected by world events than smaller corporate jet manufacturers because our customers tend to be billionaires rather than millionaires.”

The Boeing Business Jets backlog also appears to be quite protected. “The norm for us would be no cancellations,” said company president Steven Hill. “This year [2008] we’ve had one green BBJ cancelled as a result of all that’s transpired in the financial market.”

For Boeing, 2008 was a good year, with orders for 10 executive versions of its airliners in a mix of BBJs, BBJ2s and BBJ3s, as well as four widebodies. Acknowledging that this year is likely to be “challenging,” Hill said the Chicago-based OEM is nevertheless forecasting orders for 10 aircraft, of which about two-thirds will be single-aisle. Even at that, he added, “We’ll still be adding to our backlog, rather than seeing it diminish.”

Further bolstering the single-aisle and widebody backlog is the fact that about two-thirds of orders for the larger airplanes come from Middle East customers who to date are showing no signs of financial hardship.

Royal Jet already operates five BBJs and expects to make additional acquisitions over the next six to 12 months. “Our main business is with wealthy individuals and government officials and we’ve actually seen demand increasing.”

Everybody’s Working With a Different Crystal Ball

Industry analysts admit that the OEM backlogs have never been larger or stretched so far into the future, both for aircraft already in production and aircraft yet to be certified. And how those backlogs will hold up depends on how much deeper the current economic crisis will go, and for how much longer.

Last summer, OEMs appeared to be counting on these substantial backlogs to carry them through the economic crisis. Six months later, there are confirmations of layoffs, aircraft production cutbacks, order cancellations and scheduled delivery-date deferrals. If anything, the “doom and gloom” merchants appear to be overpowering the “light at the end of the tunnel” group in terms of expectations.

According to consultant Foley, “Eventually the smart money will opt to keep their out-year delivery slots in hopes that the dust will have settled from the current economic situation.”

Saying in a recent analysis that investors who believe the worst is past might be too optimistic about the depth and duration of the downturn, Foley described aircraft backlogs as a critical factor. “But backlogs aren’t money in the bank,” he warned.

Foley pointed out in November that the production ramp-up over the past several years is another factor that will deplete the backlog at a faster rate than might be expected. And he added that the typical progression payment structure means OEMs won’t see an order cancellation until these later, and larger, payments come due and the customer is unable to pay. “We won’t know the full extent of the order fallout for another year.”

Foley said OEMs have consistently denied that there was more speculation in this market than there has been at any time in the past. However, he reported, “There were reports of some buyers paying a $10 million to $20 million premium to purchase delivery positions of big-cabin aircraft from those who bought early in the cycle.” That demand, he said, did not escape the eye of speculators, and Brian Foley Associates had clients “vetting the idea of buying blocks of aircraft with no intent of ever taking delivery.”

Further, he said, there were instances of bona fide customers buying multiple aircraft with the intent of keeping only one and flipping the other positions to help offset the cost of the keeper.

Meanwhile, he concluded, “Orders are definitely being cancelled, and will continue to be cancelled into the next year as progress payments come due.”

Depending on the contract, some position holders might not be able to defer delivery dates, said Comstock. “There are buyers who are accepting the airplane and asking the seller, ‘Can you unload it for us?’”

Will those hefty backlogs outlast the economic crisis? That depends mostly on how long the crisis lasts, and analysts are hedging their bets, predicting it could be a year, 18 months, maybe even two years before the recovery begins.

Aradian’s Rogers (the broker with three new G550s for sale early last month and no buyers) is not optimistic: “Two years into this current backlog, the OEMs might well find themselves with a lot of non-refundable deposits and ramps full of new airplanes.”