Business Jet Market Appears To Be
Improving as Economy Recovers
Aviation Week & Space Technology
10/06/2003, page 63
Anthony L. Velocci, Jr.
New York
Sales of new and used aircraft are rising,but a market rebound
may prove elusive
Conflicting Signals
The long-awaited turnaround apparently underway in the U.S. economy
is setting the stage for a recovery in the demand for business jets,
with some tantalizing signs that market conditions are improving.
If that is the case--and make no mistake, there are conflicting
signals--don't expect a flood of orders or a spike in delivery requests
in the near term.
The inventory of used business aircraft continues to hover near
historical highs, and price pressures show little indication of
improving anytime soon--meaning it's still very much a buyer's market.
"I've seen some of our competitors agree to deals I never would
have imagined," Raytheon Aircraft Co. (RAC) Chairman and CEO
James Schuster said. Moreover, sales of new fractional shares remain
weak. And because of the much slower growth in fractional ownership,
original equipment manufacturers (OEMs) may face the prospect of
more canceled or deferred deliveries in coming months, according
to UBS analyst David Strauss and some industry observers.
Despite these sobering market realities, there is reason to be
encouraged.
Some manufacturers report a significant uptick in orders; buyer
interest started picking up last spring, when the U.S. enacted favorable
tax incentives for the purchase of capital goods. Under the new
"bonus depreciation rule," 50% of the purchase price of
a new business jet can be written off in the first year of ownership.
"I'm seeing some of the signs we were watching for, including
some sense of confidence among buyers," Gulfstream Aerospace
President Bryan Moss said. "The pipeline is starting to look
better, and the number of sales proposals, demonstrations and orders
are starting to pick up. More people seem to have enough confidence
in their organization to throw off the uncertainty of their business
and commit to a business jet, and to me that's the encouraging thing."
At Cessna Aircraft, Roger Whyte, senior vice president of sales
and marketing, said his company is recording enough improvement
"across the board" to allow the company to raise scheduled
production of some models. In addition, Whyte said order cancellations
and deferrals have "slowed to a trickle." He added, "We'll
produce more in 2004 than we were planning."
With the higher number of orders, Cessna expects to manufacture
about the same number of aircraft next year as it will in 2003,
instead of reducing rates. Other OEMs also anticipate holding the
production line steady through 2004.
While the growth in fractional ownership (both shareowners and
the fleet) has slowed tremendously, it is still continuing to expand.
No less important, the number of used aircraft for sale in August
declined for the second month in a row, and pricing, though very
low, remained stable, Strauss noted. He suspects that much of the
improvement in the used market at the end of summer reflected pent-up
demand from buyers who had been waiting for the market to firm up.
"Look for follow-on activity through September and October
as an indication that the market has truly bottomed," Strauss
said.
Dassault Falcon is among the OEMs that have seen a significant
decline in their used jet inventory. "The number of 900EX aircraft
we have on hand has dropped by about a third in the last few months,"
said John Rosanvallon, president of Dassault Falcon, which is operating
at about 60% capacity compared with three years ago. Cessna's used
inventory has dropped by a similar amount in the last 12 months.
"It's slowly declining and is now down to a manageable level,"
he said.
Another important indicator is that aircraft in service generally
are being utilized, unlike the last big slump in the early 1990s
when large numbers of business aircraft were simply parked. "Hourly
utilization of the fractional fleet also has held up," Whyte
said.
The number of used business jets for sale remains very high,
but most are more than 10 years old, revealing a pool of new
aircraft substitutes smaller than it may appear.
Encouraging indicators notwithstanding, most industry officials
aren't exactly gushing over what may turn out to be only a tenuous
recovery.
"Are we experiencing a blip that was sparked by the tax bill's
bonus depreciation rule, or are the improvements we're seeing sustainable?"
wonders Edward Bolen, president and CEO of the General Aviation
Manufacturers Assn. (GAMA), an industry trade group based in Washington.
"The bleeding seems to have stopped. I'm not sure if what I'm
picking up is optimism, but there does seem to be a sense across
the industry that we may be in the early stages of a recovery."
That seems to be Honeywell Aerospace's interpretation of current
trends. The turbofan engine manufacturer, which supplies myriad
subsystems for business jets, officially released its twelfth annual
Business Aviation Outlook on Oct. 5. The study points to continued
recovery in order levels over the next 12-18 months--assuming U.S.
economic growth holds steady throughout that period.
Strauss believes the dramatically slower growth in fractional ownership
could be just as pivotal. In fact, he thinks it may actually threaten
the nascent recovery of the business jet market.
From the mid-1990s through 2000, the rapid rise in fractional ownership
sales was a powerful stimulus to business jet production. As its
popularity accelerated, annual growth reached an astounding 30-35%.
Today, the demand for fractional ownership accounts for about 15%
of annual deliveries of new business jets.
Now fast-forward to late 2003.
At the current rate, Strauss expects the fractional market to add
500-600 new shareholders in 2003. However, that represents less
than 13% gross shareholder growth per year. At its peak in 2000,
fractional ownership grew by 1,050 new shareholders in that one
year alone. As of the end of August, there were nearly 4,400, with
each shareholder holding an average of 1.38 shares.
As for the fractional fleet, at the end of August it stood at 796
aircraft, or about 6% more than a year earlier. That compares with
the1996-2001 period, when the fleet expanded six-fold.
The problem is what Strauss calls "shareholder churn"--the
number of shareholders lost versus the number of shareholders gained.
"Fractional providers are losing existing shareholders at unprecedented
levels," he said. Historically, the ratio has been on average
0.20 lost for every one gained. At the end of the August, the ratio
was more like 0.61, which was near an all-time high.
According to Strauss' analysis, Bombardier Inc.'s Flexjet lost
1.74 shareholders for every one it gained in the first eight months
of the year. Raytheon Aircraft's Flight Options is doing only slightly
better, with a churn rate of 0.85, which means it is losing nearly
one shareholder for every one that it gains. NetJets, the 800-lb.
gorilla among fractional ownership providers, has the highest retention
rate, with a below-average churn rate of 0.40. (NetJets claims a
market share of about 72%, up from around 54% two years ago.)
The reason for the decline is that customers are seeing big drops
in the residual values of their fractional shares, Strauss explained.
"A lot of shareowners' eyes have been opened to the fact that
they can lose a lot of money, because they weren't expected to take
this kind of hit," he said. In many cases, shareowners are
being offered 50 cents or less on the dollar. The Citation 5 Ultra,
Beech 400A, Lear 31 and Global Express are among the aircraft that
have suffered the biggest drops, according to industry officials.
Bottom line: The net growth rate in the number of new shareowners
(5-6% now and a projected 7-8% long-term) is insufficient to support
the existing schedule of new aircraft deliveries, Strauss said.
"EXPECT MORE cancellations of new business jets scheduled
for delivery. The fractional ownership market would need to grow
by at least 25% a year just to absorb what's in the OEM backlog.
After the market recovers, a more realistic rate of growth is 10-15%,
which means fractional providers will need less than 50% of what's
in manufacturers' pipeline." Currently, fractional ownership
accounts for about half of the orders in OEMs' backlog and 15-20%
of scheduled deliveries.
All three segments are experiencing weakness in new fractional
share sales, according to J.P. Morgan analyst Joseph B. Nadol, 3rd.
On a 12-month average basis, midsize aircraft are down more than
50%, followed by 16% and 10% declines in small- and large-cabin
jets, respectively. "Since the midsize aircraft segment has
the largest exposure to the fractional market, with 16% of aircraft
deliveries going to fractional operators, this is an ominous sign
for this part of the market," he said.
Strauss believes the next year or two will be crucial for fractional
providers, with major implications for the OEMs. Numerous contracts
will be coming up for renewal, he noted, so the challenge will be
to convince as many customers as possible to retain their shares.
Rosanvallon is optimistic. "I have no major concerns in that
area," he said. "I'm confident that as the rest of the
overall business jet market recovers, fractional will recover with
us."
Perhaps. In any case, NetJets Executive Vice President Kevin Russell
said no one should be surprised that fractional ownership providers
have faced a stiff headwind, just as the OEMs have. "Every
business performs on the basis of the strength of the economy, and
fractional ownership is no different; we've felt the impact of the
recession in the U.S. and political unrest in other regions."
Of all the fractional providers, Strauss expects NetJets to be
the most rational and to cancel or defer some scheduled deliveries.
Russell would only say that the company is in constant discussion
with OEMs on which aircraft to bring into the fleet and which to
"push out."
To help pick up the shortfall in net shareholder growth, NetJets
early last year introduced its Marquis Jet Card for businesses and
individuals who want the benefits of its fractional ownership but
whose flying requirements are less than 50 hr. a year. Essentially
a 25-hr. pre-paid lease costing $109,000, the "card" provides
access to the entire NetJets fleet of aircraft. Russell said it
has been "a huge success," with nearly 1,000 cardholders.
Citation Shares, a partnership between Cessna Aircraft and Tag Aviation,
has introduced a similar program to help pick up the slack. "It's
taken off in a big way," Whyte said.
Steps taken by OEMs to weather the storm have been more basic--a
relentless effort to improve operating efficiency and cut costs.
"We're continuing to address our manufacturing infrastructure,
which will be an ongoing process for the next couple of years,"
said Schuster. Raytheon Aircraft hopes to move into the black by
the end of the year.
THE COMPANY IS outsourcing more subassembly work, and management
is seeking further gains on top of substantial improvements in inventory
levels, line shortages, first-pass rejects and manufacturing overhead.
The mainstay of RAC's strategy, however, has been to emphasize quality,
service and support of its aircraft. "It has become what differentiates
the various products as each segment has grown more competitive,
and I preach it every day," Schuster said.
While Gulfstream doesn't consider its manufacturing process "broken,"
management remains very focused on reducing the number of hours
required to build and outfit its jets.
A strategy that has proven to be especially effective is "rolling
back" into the production line various activities that used
to be done at Gulfstream's completion centers. Altogether, about
350 tasks were designed into the production phase, according to
Chief Operating Officer Joseph Lombardo. The strategy allowed the
company to standardize much of the interior of aircraft without
sacrificing customers' desire for a customized product. The result
was higher overall quality and a dramatic drop in the time it takes
to complete a finished aircraft--17 weeks, with the goal of 14,
versus the previous 28-42 weeks. "The strategy has freed up
capacity and helped us further reduce our manufacturing costs,"
Lombardo said.
While managing through the current slump hasn't been easy for any
of the OEMs, it probably would have been far worse for Gulfstream
had it not acquired Galaxy Aerospace two years ago, which produced
the G100 and G200 (formerly the Astra SPX and Galaxy, respectively).
"It has allowed us to compete at more price and performance
points and not forfeit opportunities to reach customers getting
into business aviation," Moss noted.
