Airlines & Commercial Aerospace Outlook: What’s Different And Why It Matters
This episode of Cowen’s Thematic Outlook Podcast Series is a discussion on commercial aerospace recovery with Helane Becker, Cowen’s Airlines, Airfreight, & Aircraft Leasing Analyst, and Cai Von Rumohr, Aerospace, Defense Electronics, & Government Services Analyst and host, Bill Bird, Head of Thematic Content.
Global air traffic remains well below pre-pandemic levels after experiencing the biggest decline in history during the pandemic. Moreover, while U.S. traffic has made a comeback, non-U.S. traffic has a long way to go to return to pre-pandemic levels. Add to that tight capacity, changed post-pandemic consumer behaviors, and aircraft replacement demand factors and we see a strong case for better-than-appreciated airline revenue growth and a longer-than-typical commercial aerospace recovery.
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Transcript
Cai Von Rumohr:
So I think people don’t really realize that this is the biggest down cycle of all time.
Bill Bird:
Hi, everyone. My name is Bill Bird, Cowen Head of thematic content, and I’m joined by Helane Becker, Cowen Senior Research Analyst for Airlines, Air Freight, and Aircraft Leasing, and Cai Von Rumohr, Cowen Senior Research Analyst for Aerospace, Defense Electronics and Government Services. Today’s topic is the outlook for airlines and commercial aerospace, and today’s episode’s a real treat because our guests are the longest tenured analyst in this space.
Helane and Cai recently teamed up to publish two related Ahead of the Curve series reports, which take a comprehensive look at airlines and aircraft supply and demand factors. The reports make the case for better than appreciated airline revenue growth, supported by tight capacity and greater post COVID travel. Cowen sees airline traffic and capacity trends along with replacement demand factors contributing to a strong extended upswing in commercial aerospace through 2025. Helane and Cai, thanks for joining us today.
Cai Von Rumohr:
Great. Happy to be here.
Bill Bird:
With that as prelude, let’s jump right in. Cai, let’s start at a high level. What do you believe is different about the current airline and aircraft recovery versus prior cycles and why does it matter?
Cai Von Rumohr:
So I think people don’t really realize that this is the biggest down cycle of all time. This is a cyclical growth industry where in a normal year, you know, might average four, maybe 5% traffic growth. In bad years, you’d be down two to 3%, and by bad years, that’s 9/11, that’s the Gulf War, that’s the financial crisis of 2008. And after bad years, you normally come back with a bounce of a mid-single digit bounce. This time we were down in 2020 by over 65%. That’s a staggering number. And while we’ve recovered nicely in ’21 and ’22, today we still are down about 25% on a global basis, so we should have a strong recovery in ’23. And it seems increasingly unlikely that we will be back on a global basis to 2019 levels until at least 2024.
Bill Bird:
Helane, as Cai mentions, airlines have historically been a cyclical industry. In your research, you seem pretty positive on the outlook for airlines. Why aren’t you more concerned about a weakening consumer and a possible 2023 recession?
Helane Becker:
Thanks, Bill. It’s great to be here with you and Cai, and I think those are really great questions, and that’s one that I’m getting from investors all the time. And here’s our thought, airlines have been in a recession since the pandemic started. Cai mentioned we were down 70%, we were actually down 96% in the worst couple of days of April 2020, a decline of 96%, April 16th and that compared to, we had about 85,000 people traveling, compared to normally in 2019, two and a half million people a day traveling. So we were back to levels not seen since the 1950s.
And now, fast forward to 2022, we are fully back to 2.4 million people per day, and that’s with international down 15 to 20% and business down 20%. International outbound from the United States, fully recovered. September, we were actually up 3%. October was flat. November was up a couple of percentage points, so we are back, US citizens traveling outside the country.
Where we see the weakness is international inbound, which is down by about 25%, but you would expect that given the strength of the dollar. And also international doesn’t include a lot of Asia, which is lagged and a lot of it is still closed. So we think, as countries in Asia start to reopen, there’s pent up demand, as there was in the US in 2021 and in Europe earlier this year, and we think travel will recover in that region. Also, because of the 12 plus hour time change between the United States east coast and Asia and the west coast it’s even bigger, think Japan, 12 hours from New York, think Australia 15 hours. It is really difficult to do Zoom meetings with that kind of a time change. Somebody has to be willing to meet at midnight or one in the morning, 10 o’clock at night. A lot of people just don’t want to do that. So we think that the time change and the cultural preference for in-person meetings will fuel, no pun intended, increase travel in 2023.
And we also think we’ll see an increase in what we’re calling Blbisure travel, B-L-B-I-S-U-R-E. This word, I think I created but I’ve seen it around, business and leisure combined. People take a business trip and then they tack on a few leisure days to sight see, which they never would’ve done in the past, but now they can work from anywhere, and with the time change work in their favor, they can do that. So I think when you put that together, the fact that we’ve already been there, Cai mentioned how bad it was, we’re seeing that recovery. We’re back even with the declines that I mentioned. Domestic leisure, very strong. We were up 40% earlier this year. Now we’re up about 20. So we’ve already seen that decline and yet, revenue growth is significant. We are above 2019 revenues at this point in time. So on a fully forward basis, I think we’re going to have a… I’m never this positive, but I think we’re going to have a good year.
Cai Von Rumohr:
Okay, let me just add one thing to Helane’s point, which is that the US market is back, but China is still down substantially. Europe is down. Latin America is down somewhere in the mid-teens. And so, on a global basis, we still have a long way to go to get back in terms of air traffic, and that’s part of our reasoning as to why this is going to be a long cycle.
Bill Bird:
Thanks for that clarification, Cai. Very helpful. Cai, given Helane’s outlook for airline demand and leisure travel as she says, and your work on some of the replacement cycle factors on the aircraft side, which areas of the airline and commercial aircraft industry are you most likely to see a benefit from the pattern of recovery that you envision, and what do you see as some of the biggest risks to a recovery?
Cai Von Rumohr:
So I think near term you’re going to see the biggest recovery in terms of the aftermarket. We’re getting strong traffic growth and so we should see strong unit growth in terms of repairs. We’re also seeing an aging fleet because deliveries are not keeping up with what people expect they’re going to be. Older planes take more maintenance. And thirdly, pricing power. These are basically systems and the manufacturers can raise prices. And in fact, as an example, RTX raised prices 12% approximately, effective October. They normally only raise in January and they normally raise five to 6%. So those are the pluses.
Longer term, we think OE should benefit because we don’t see overall global traffic growth keeping up with capacity. I think it will keep up with capacity into 2025. And you add in climate concerns, basically, the three ways you can deal with that without buying current planes is via hydrogen, via synthetic aviation fuel, via electric. None of those are going to make a dent in this problem near term, hence, the airlines who are concerned about carbon emissions are more likely to buy new planes to do that. And the area we think they’ll buy the most new planes are wide bodies because as international traffic comes back, that will cause a resurgence in wide body demand. And the population of wide body planes is older than narrow bodies, so there’s a greater need for replacement.
Bill Bird:
Cai, I want to come back to climate concerns in a moment, but let’s talk about an issue you just raised, which is constrained capacity. Can you talk about some of the factors that have constrained aircraft production and airline supply?
Cai Von Rumohr:
Yeah, the biggest factors have been castings and engines and really it’s labor availability and not that there aren’t people to do the job, it’s that in the downturn the more experienced workers, retired or many of them did, and now you have a younger workforce that needs more training to get up to the same level of productivity. We think this is going to continue probably until 2023, and it has a big impact on the aircraft business as well, Helane’s. As an example, the number of planes delivered in 2022 is likely to be about 15% below levels they expected going into the year. Some of that is the 787’s problems, but most of it is the supply chain issue.
Bill Bird:
And Cai, how long do you expect the supply chain delays to last and why?
Cai Von Rumohr:
Well if you look back over the past 50 years, we’ve never seen a supply chain glitch of this magnitude, and I think it’s going to probably will go through most of ’23. I don’t think we’ll be fully back to normal until ’24, maybe a bit later. But I think the severity is going to abate at some point. But the November numbers were still pretty weak for both Boeing and for Airbus, so we’re certainly not out of this yet.
Bill Bird:
So fewer plane deliveries are translating to fewer flights and higher airfares. Helane, what are we learning about airline pricing power at this stage?
Helane Becker:
Well, we’re seeing good airfares and people are complaining to me quite a lot. We think that the pricing power they’re gaining is a combination of people returning to travel and wanting experiences. Ticket prices normally follow fuel prices up and down with about a three to four month lag. Airlines sell 60% of their seats within 90 days of travel, yet, they report load factors 80% plus, meaning 20% or more of seats are sold within 30 days of travel. There’s a very small percentage of seats, and that’s mostly for long haul international, that are sold more than 90 days out.
Airlines are also seeing an increase in paying passengers, buying up into premium economy seats or business class. Before 2020, paid load factor in business class for the largest airlines was the less than 50%. It was mid-30s. Right now, it’s more than 70%. So people with status are rarely getting upgrades anymore, and they don’t want to chance not getting the upgrade so they’re buying into the extra legroom sections of the cabin. And that obviously, has huge positive implications for airfares.
Then international, to Cai’s point earlier with this long runway of opportunity for international travel, international price points are generally higher than domestic price points. Even discounted international tickets are higher. So, we’re seeing this shift in mix, a combination of… And there’s three things going on there. One is increasing international travel. Second is the shift in purchasing power from the back of the plane to the middle or front of the plane, where ticket prices on average are higher. And business travel, even though I said earlier business travel is only 80% recovered, it’s recovering. And even though we don’t think it’ll get 100% of the way back in 2023, we do think it will continue to improve because we think people want to meet in person. We really do think they’re Zoomed out. And as this international recovery gets underway, especially in Asia, we think we’ll see more travel and going west, going east to Europe, to Africa. We’re seeing that. We can talk about that if you want. But we think all that combined to generate higher average ticket prices, which will generate higher revenue for the airlines.
Bill Bird:
Helane, you’ve published a lot on the pilot shortage and that is, of course, been a major constraint for airlines. Can you talk a bit about what precipitated it and what are the prospects for alleviating it?
Helane Becker:
Yes, thank you so much for that question. We initially wrote about looming pilot shortage in 2014, December 2014, so almost a decade ago that we started talking about this. Mandatory retirement age for airline pilots is 65, but many retire at 62, and the pandemic came along three years ago and exacerbated the problem.
To explain what happened, in 2009, there was a plane crash outside of Buffalo, New York that took the lives of 49 people: 45 passengers, four crew members. The aircraft stalled during landing on final approach and the cause was listed officially as pilot fatigue. That’s important to remember. Pilots were attempting to land, however, after the flight had been delayed for hours and there was a storm in the area. During the flight, snow and ice built up on the wings and the pilots were unable to land the plane safely. In 2013, after four years of investigation, the FAA decided under pressure from Senator Chuck Schumer’s office and the families of the victims, to change the requirements necessary to become a pilot. And they also changed the rules associated with hours of duty.
On the hour rule, the FAA now limits flying during the day to 16 hours, overnight to 13 hours, and pilots have to have a rest period between, I guess, between duty periods of 10 hours. So if you finish flying at 8:00 at night, you can’t get back in the plane until the earliest 6:00 in the morning. And just in general, the airline day is 7:00 AM to 7:00 PM. It’s a 12-hour day. Yes, I know there are flights earlier than 7:00 and after 7:00, but that’s generally the day that 12-hour period.
Flight attendants also have to have at least 10 hours of rest now, up from nine previously. So the typical pilot does a four-day on, four-day off schedule. If bad weather means flight delays, the pilot’s timeout. And if there isn’t a reserve pilot available, and for most of the year there hasn’t been, the airline cancels the flight. Just to do the hours of duty rules, the industry needed to hire more than 5,000 pilots, so that was back in 2014.
Fast forward, right after they made the decision, the FAA decided that instead of a mandatory 250 minimum hours to become a pilot, pilots would need 1,500 hours so that’s obviously, a huge increase. It takes about five years to get that level of experience. It also costs close to $250,000, and it started the industry on the road to a pilot shortage. And then pilots, this decade, was always going to be about pilots reaching retirement age.
You may recall, people forget this part, but you may recall that during the pandemic there was no guarantee the airlines would get financial aid from the government. And so those early days, end of March, April, beginning of May, the airlines with the exception of United, encouraged pilots who were intending to retire between 2020 and 2022 to retire immediately. And so there was this huge wave of pilot retirements back then and the industry did not have experienced pilots to backfill, and slowed the training down. When the pandemic started to end and people rushed back to the air, most of the airlines didn’t have enough staff to handle it.
And remember the other thing people forget is, people get COVID, right? Just you might have COVID. I might have gotten COVID during this period but so did crew members, and they were calling in sick and there were no pilots in reserve, which was a problem, so they canceled flights. The result was the mess we saw earlier this year, and a lot of angry customers. A lot of business travelers went back to Zoom and Teams meetings. They just didn’t want to deal with the delays. And the airlines responded by increasing hiring, proposing higher pay rates for pilots, reduced capacity plans for the rest of the year.
And again, that brings us back to the question. I know this is a long answer, but this is really important. It brings us back to the point you asked earlier about why I’m so confident the airlines are going to generate higher revenue. They canceled so many flights and they can’t bring them back until they get through the training bubble, until they get through the hiring bubble, and that’s a second half ’23, first half ’24 event at the earliest. And so it takes three to four years to resolve the pilot issue. And while this is going on, you’re going to see especially, service reductions in small cities, and that has huge negative implications for those cities. Because without a robust air transportation industry, you can’t have a robust economy.
Bill Bird:
Let’s shift gears and talk about inflation. Cai, what impact do you see higher oil prices and inflation having on airlines and the aircraft food chain as a whole?
Cai Von Rumohr:
So higher oil prices, obviously, mean higher operating costs for the airlines. They don’t like that. That encourages them to buy equipment. Historically, the decision to buy equipment is a function of two things: oil price levels and also, interest rates. If you go back to 1979, we had a big surge in oil prices, but we also had interest rates going up to 18% so the expected replacement cycle didn’t happen.
Interest rates have moved up, but they’ve moved up from ultra low levels, whereas oil prices are high, and then you add in the climate issue. And so we think that there’s definitely aircraft demand. And you asked earlier about what risks are there, I would say, if interest rates spike up sharply, if the economy goes into a super recession, those would be risks. But if the Fed continues to increase rates by 50 basis points, while that’s still a shock maybe to the economy, I don’t think that would shut off aircraft demand.
Bill Bird:
Helane, what about airline industry consolidation, do you think we’ll see more consolidation among airlines in the US, and what about elsewhere in the world?
Helane Becker:
Yeah, so I think there’s three areas where we’ll see consolidation in the US, among the regional airlines. Mesa Air Group recently, narrowly, missed a bankruptcy filing when they got American Airlines to wind down their capacity purchase agreement and focus all their flying with United. Had American not agreed to do that, Mesa would surely have run out of cash and had to file, so you’ll see some of that.
Second in Europe, where there are three elements at play. First, the war is impacting fuel supplies. Second, consumers are worried about high energy costs this winter, so they may not have the money to travel. And then third, this started in France, with the EU giving permission to the country’s plan to require all flights under two and a half hours to stop and be replaced by train, what we call flight shaming. And if that continues, some of the smaller European airlines are going to fail. And then finally in Asia, we’re likely to see airline consolidation because the region has been just slow to reopen, and so we think that it might be a tough winter for them.
Bill Bird:
And Helane, as a follow-up to the last question, do you think the Sprint Airlines JetBlue merger will be approved?
Helane Becker:
So the managements of both airlines are very enthusiastic and they think the merger will be approved. So I think some of it depends on whether the judge and the American JetBlue, Northeast Alliance case rules in favor of the DOJ. If the DOJ wins, maybe they’ll be more inclined to approve the merger. If the DOJ loses, I think they’ll want to win. Also, I don’t think the merger is as consumer friendly as JetBlue wants everyone to believe. JetBlue wants the aircraft and the pilots, for sure, that’s really what they want out of Spirit. And they intend to spend four to 500 million making the Spirit Aircraft look like theirs, which means taking seats out of the planes, and I mean, think about it, fewer seats means higher ticket prices, which seems consumer unfriendly to me.
And I also think they’re looking at moving the combined aircraft around the country, so they would eliminate duplicate flying in some markets and put the aircraft into others, which would also limit competition. For example, JetBlue and Spirit both fly Boston to Orlando. JetBlue has eight non-stops and a host of one-stops, and Spirit has four overlapping non-stops, to, obviously, four of the JetBlue. So on a combined basis, they could probably reduce the 12 flights a day to eight or nine, and move the other aircraft into another market. But again, it gets back to higher ticket prices, and so I think we’ll see. They think the merger will close in the first half of ’24, so we certainly have a long way to wait before we see what happens.
Bill Bird:
Let’s talk about ESG. Helane and Cai, you both published a tremendous amount on this on EVTOL, ESG and the Air and some other things. What impact, if any, are climate concerns having on airlines and aircraft demand?
Cai Von Rumohr:
You know about 10 years ago, airlines didn’t really care that much about climate. It wasn’t an issue, and now all of them are talking about carbon neutrality by 2050. The domestics are talking about using 10% of their fuel from synthetic aviation fuel. And the issue is that the solutions longer term, hydrogen, electric and synthetic aviation fuel are not going to make a dent near term. Liquid hydrogen is basically very difficult to store and, it and electric both have the problem that you probably can’t design a plane with hydrogen or with electric and have it go very far. Therefore, EVTOLs are only focused on inner city markets and shorter routes.
What that means for the airlines is, if you want to get improvement in terms of your carbon creation, you, basically, got to buy a newer plane where you have about 20% improvement, and it really bolsters replacement because the older planes have greater carbon emissions. And if you think about it, because you have essentially a less growth in the wide body fleet and the planes are older, you can get an even bigger bang for your buck. And looking forward, you’re going to see more of the sales of planes before replacement. And if you look at Boeing in 2015, I think they had estimated 45% of new plane sales were going to be for replacement. Their current estimate is 52%. So, basically climate’s having a big impact because the big long-term solutions just aren’t going to work near term.
Helane Becker:
I’ll just add a couple of points. First, 20% of flights are responsible for 80% of emissions, and those are the ultra long haul international flights. I’ll also point out that a 787 is 25% more fuel efficient than a 767, and Cai just mentioned that the airlines are replacing them. United ordered a 100, 787s to replace 120 older aircraft, 767, 757s and some 777s in there. So you get more fuel efficiency and that’s hugely important.
Obviously, for the airlines on the sustainability side, they committed to net zero, as Cai points out, by 2050 and they’re doing what they can: carbon credits, carbon offsets, carbon recapture and sequestration, SAF. We talked about ordering more fuel efficient aircraft and then experimenting with the EVTOLs, but that’s ground replacement.
Where they’re getting a lot of bang for their buck is ground handling, shifting to electric ground handling equipment at the airports starting in California, and so I think that’s really important. On the consumer side, I don’t really get the sense that consumers are focused on ESG, specifically. As far as investors go, I think they’re starting to think about it and talk about it. But in Europe where we started to see this trend in 2018, there’s kind of been a lack of discussion. And the other thing, I think, Bill, that I thought during the pandemic, everything would go on hold with ESG. That it was kind of faddish for peak, right? That it was a 2019, this is the peak kind of fad that we all should talk about, and that’s not what happened. In fact during the pandemic, it accelerated. And then coming out of the pandemic, having more fuel efficient aircraft, more seats per departure, that’s hugely positive and that will help the industry in the second half of the decade as these new aircraft come on stream.
Bill Bird:
Helane and Cai, throughout the year, you host a lot of events and conferences related airlines and aerospace. Looking ahead, what are some of the marquee events you’d highlight or expert calls that you plan to host?
Cai Von Rumohr:
So the first one is February 15th and 16th, we have our Aerospace and Defense Conference in Washington, DC, and this year we’re going to have pretty much all the companies, Boeing, most of the major suppliers. We’re going to have Richard Aboulafia, who’s one of the key gurus in terms of aircraft demand. And we’re going to have a number of panels on EVTOLs, the whole issue of certification, the issue of who are the guys who are going to be using the planes, how are they going to use them. So there’s really going to be a very broad program, in terms of what’s happening in commercial aerospace.
Helane Becker:
And then for me, I’ll moderate one or two of those panels that Cai refers to in February. May 11th, we have our London one-on-one day. This will be, I think, the sixth conference we’re doing in London. September, the Wednesday through Friday after Labor Day, so I think that’s around the eighth. I’m not sure when Labor Day is. I should know, but I don’t. We have our Boston Global Transportation Conference and that’ll be our 15th Annual Global Transportation Conference, and we’ll be back in-person in Boston. So those are the key things that we’re doing.
Bill Bird:
As we wrap up today’s podcast, I want to thank Helane and Cai for sharing their insights, and our listeners for taking time out to be with us. Be well and see you next month.