Six Things To Expect As Plane Makers Enter A Harrowing Downturn

It’s been a long time since we’ve had a jetliner market bust cycle. Other than the 737 MAX production stop, we haven’t seen topline output fall since 2002-03. Before that, this industry had been defined by serious downturns every seven years, an unpleasant pattern that stretched back to the start of the jet age in the 1950s.

Yet as a result of this remarkable 16-year run, there’s a new generation of managers who’ve never experienced anything like what we’re about to see. For them, and as a reminder to industry veterans, here’s my guide to six things we can expect.

Backlogs don’t mean what you think they mean. In fact, “Firm Commercial Backlog” is one of the most dangerous phrases around. Consider the last bust cycle. In January 2001 there were 3,200 jetliners on backlog. In January 2003 there were 2,700 jets on backlog. That modest reduction was more than accounted for by deliveries. Only 80 cancellations were recorded in 2002-03, so the core backlog remained intact. Yet production rates fell by 30%. Airlines deferred en masse, and the backlog did nothing to protect the industry.

Business jet backlogs are equally unreliable. Until the fourth quarter of 2008 Cessna planned to build 525 Citations in 2009, up from 467 in 2008. In November, it cut the number slightly, to 495. In January 2009 it cut 2009 production to 375 jets, and in April this number was cut again to 290 to 300. Yet Cessna's backlog didn't change much with these announcements. In late 2008 the company said it had a $14.5 billion backlog. At the end of the first quarter of 2009, the company announced a $13 billion backlog.

For much of this year, deliveries are somewhat protected: finance and lease arrangements are in place, and pre-delivery payments have been made that cover much of an ordered jets’ total price, particularly for twin aisle jets. But 2021 and 2022 will see production rates slashed, and a 12,000 jetliner backlog will not provide much help, if any.

Countercyclicality is good. Every few years, the industry remembers that having a balanced portfolio for counter-cyclicality is a good thing. This time, of course, commercial folks are reminded why military work is so useful – it’s the closest thing suppliers and primes have to a safe haven.

In the context of newly-created Raytheon Technologies, this reality means the timing is great for United Technologies, and terrible for Raytheon. But a year ago any consultant or observer would have advised Raytheon to seek commercial work for long-term growth.

Vertical integration is a bad idea after all. In good times, it’s tempting for a prime to own more of its supply chain. There are drawbacks, but vertical integration allows primes to keep more revenue and profit in-house, and to keep technologies proprietary. But in a downturn these vertical units morph into serious overhead.

Boeing will be interesting to watch here. In the past decade they’ve announced major vertical initiatives in avionics, actuators, auxiliary power units, aerostructures, and more. But in a downturn, these units will represent high fixed costs. In other words, the company might have forgotten that downturns are a key reason to outsource – outsourcing allows fixed costs and risk exposure to be spread among a large group of partners, rather than concentrated in-house.

All downturns are different. This one is particularly different. Even longtime industry veterans haven’t seen anything like this. It’s not a typical buildup of excess supply, with a demand drop triggered by an exogenous shock. Rather, much of the world’s economy has entered what Paul Krugman terms “a medically-induced coma.” For the past 50 years, airline traffic has never declined by more than about 3% in a given year. But thanks to that coma, most estimates put this year’s traffic drop at around 40%.

With a drop like that, there should be demand for very few jets next year. The only reason Teal Group’s forecast isn’t lower is that the comatose economy depends on government assistance, some of which will go towards the aviation business (both airlines and manufacturers).

Strangely, this is the first pandemic-related downturn. The jetliner industry wasn’t meaningfully impacted by SARS, MERS, or any of the other previous diseases. Whether or not that traffic downturn is even worse than 40% depends on the virus. And speaking of which….

The virus gets a say, too. In fact, It’s in charge. Industry observers and forecasters can be forgiven for measuring this downturn against previous ones. But again, this one is different. Whenever anyone says this will be a V-shaped or U-shaped or L-shaped cycle, they need to explain their assumptions about how the pandemic itself will play out. Without this, forecasts are meaningless.

For example, most scientists think an effective vaccine is around eighteen months away, with additional time needed for distribution and whatever else. That means no air traffic recovery for around two years, and no deliveries recovery for at least three years.

If anyone thinks a recovery will be faster, they need to explain their thinking – are they expecting a proven, post-infection therapeutic drug? Are they expecting herd immunity to take hold, or for the virus to somehow burn itself out? And, until a vaccine arrives, there is the strong likelihood of recurring outbreaks and recurring travel bans, meaning any traffic recovery will be slow, with periodic setbacks.

Be prepared to be wrong. A lot. False start recoveries, unwarranted doom and gloom (“nothing will ever be the same again!”), and all kinds of wrong prognostications are part of the boom and bust cycle. We’re changing our jetliner forecasts every week, and what seems smart and sensible one week can seem foolish the next week.

So, for those who’ve never been on this involuntary roller coaster ride before, well, the long-term lesson that matters most is that no market is an indefinite straight ride up.