Plane Makers See The Ground Coming Up Fastby
The mood at Boeing Co. airplane plants in Seattle was already glum. With recession battering its airline customers, Boeing cut production of its 737 jet in October and is planning to slash 757 output in 1993. Now, the world's biggest plane builder has announced more bad news: Profits fell 9% in the third quarter. Even more ominous, its treasured backlog of commercial jets slid $4 billion in just three months, to $88 billion. The news jarred analysts and prompted an Oct. 26 sell-off of Boeing stock.
Wall Street had better prepare for more grim news--and not just from Boeing. Around the world, the commercial aircraft industry is in a dizzying tailspin. The three major manufacturers--Boeing, Airbus Industrie, and McDonnell Douglas--are slashing production rates. Engine builder Pratt & Whitney is laying off workers. Leasing giant GPA Group PLC of Ireland is struggling to dump plane orders that it can't afford and is also battling rumors of possible insolvency. Some observers even think McDonnell Douglas Corp. may be squeezed out of the jetliner business.
By now, things were supposed to be getting better. Aircraft executives thought airlines would be working through their financial woes and looking to add capacity in 1993. Instead, loss-plagued carriers are canceling and stretching out orders. Some 1,000 of the world's 9,000 airliners sit idle in desert parking lots in Arizona and California--200 of them fairly new planes. Even David Jennings, Airbus' normally optimistic marketing vice-president, sees no pickup before late next year. Others are far less sanguine. The slump could stretch into '95 or '96 and force further production cuts, predicts Paris consultant Bertrand d'Yvoire, president of Consultair.
DESPERATION. Executives at major U.S. airlines say pessimism is the order of the day. Unnerved by consumers' reluctance to fly at anything but fire-sale prices, by low pricing from airlines operating in bankruptcy, and by a decline in the world economy, the big three U.S. airlines are approaching desperation. "We're losing our shirts--and so is everyone else," says Executive Vice-President Robert W. Baker of American Airlines Inc. And with 662 planes--the world's largest fleet, roughly the size of the British Airways, Air France, and Lufthansa fleets combined--American's troubles alone are enough to infect manufacturers. Says Baker: "In my view, the aircraft manufacturers must be prepared to go through 1994 and 1995 without building very many airplanes."
Aircraft manufacturing has long been a boom-and-bust business. Airlines order planes when times are good--and start taking delivery when times turn bad. But this bust, which began in mid-1990, is particularly worrisome. During the last bad period, in 1981, makers of aircraft engines at least had a military buildup to balance weakness in the commercial arena. D'Yvoire at Consultair notes that the current recession is the first time since World War II that world airline traffic actually declined. And he says there has never been such a period of "crazy ordering" as the stampede to buy planes in the late 1980s. At the height of the fever, in 1989, airlines ordered 1,588 planes. So now, carriers are scrambling to reverse their earlier folly by canceling or pushing orders as far into the future as they can.
The three largest U.S. airlines have already announced cuts in capital spending for the next few years totaling $15 billion. The carriers won't rule out additional cuts. But even if passenger travel picks up, or if airlines succeed in raising fares, that won't automatically help manufacturers. Thomas J. Roeck Jr., Delta Air Lines Inc.'s chief financial officer, says Delta plans to "age the fleet" to improve its balance sheet. Between 1992 and 2001, the average age of a Delta plane will jump from 9.2 to 10.8 years. And "hush-kits" are now competing with plane orders. Just a year ago, says Roeck, Delta intended to buy new, so-called Stage 3 aircraft to meet federal noise regulations. Now, Delta plans to outfit Stage 2 aircraft with hush-kits--which bring older planes to regulation standards for just $3 million, vs. $40 million or so for a replacement plane. American and United Airlines Inc. say they're looking at hush-kits, too.
BROADER CUTS. Boeing will cut 8,000 jobs by yearend, roughly half of them because of production cuts on the 737 and 757. Airbus has slowed its own assembly lines three times in 1992 and postponed the launch of its new A319. Douglas is expected to make production cuts of 40% on its MD-11. Engine maker Pratt recently announced planned layoffs of 4,800. But Salomon Brothers Inc. analyst George Shapiro says manufacturers are still "too optimistic" and predicts further slowdowns. Although cuts so far have affected narrowbody planes, both Shapiro and D'Yvoire say weakness in Europe and Japan could force manufacturers to make fewer of the expensive widebodies, too--particularly Boeing 767s and possibly 747s.
The excess capacity is hitting players across the board. Next to Douglas, Irish leasing giant GPA Group may be the most severely affected. Last June, with $12 billion in aircraft orders on the books, $5 billion of that scheduled for delivery within two years, high-flying GPA desperately needed cash. But when the company attempted a $750 million initial public offering, investors in the U.S. and Britain gave an embarrassing thumbs-down. GPA was swimming against the tide: The market for IPOs had gone bust, and the airline industry was severely depressed. But institutional investors especially shied away, believing GPA was dangerously exposed to credit risks. The bulk of its customers are startup airlines in developing countries. Now, it is battling rumors that it will need bankruptcy protection to restructure its purchasing obligations. GPA Vice-Chairman James M. King calls such stories "a complete load of rubbish." Most experts concede the idea is farfetched, since big lenders have too much at stake to allow a bankruptcy. GPA already has unloaded $5 billion of its $12 billion in purchase obligations. But the company remains embroiled in a nail-biting series of negotiations with aircraft manufacturers, banks, and shareholders. Even with a brighter long-term future, GPA will emerge greatly reduced in size and without the flashy 25% annual earnings growth of recent years.
SOME ARE SAFE. Fokker may emerge in a different form, too. The worsening global airline situation has pushed the Dutch aircraft maker into a cash bind. Fokker put off a needed share offering last spring because it thought a deal for Deutsche Aerospace to purchase 51% of its shares was imminent. Fokker claims now that the deal is in the final stages of negotiation, but at a price roughly $130 million lower than estimated last July. If the deal doesn't happen, Fokker may have to tap the Dutch government for a loan.
For Boeing and Airbus, the pain is less severe. Should Douglas quit making jets, both of them will gain significant market share. Moreover, both manufacturers' backlogs are buoyed by a continued influx of non-U.S. orders. "An awful lot of people in this country think the world stops at each ocean," says Jack E. Howard, Boeing's director of market research. "A few years ago, we figured out that wasn't true." In 1970, he says, 70% of Boeing's backlog was with U.S. customers. This year, however, more than 60% of new airplane orders came from overseas. He notes that Boeing is enjoying strong growth in the Asia-Pacific region. Japan Air Lines Co., despite the tough times, hasn't deferred any orders. And orders from Chinese and Southeast Asian carriers are pouringin. Last May, Malaysia Airlines ordered 17 737s.
Once the current slump ends, experts see a return to normal growth and big business in replacing widebodies. With its A340 and A330 reaching the skies in 1993, Airbus is well positioned for that. Orders for Boeing's 777, which will roll off the assembly line by 1995, are doing reasonably well. But Boeing is still worried. Although it maintains a solid 50% to 60% market share and is the lowest-cost producer and the only profitable maker in the business, the behemoth is turning itself inside out to prepare for the future. Last year, close to 100 of its top executives flew to Japan on study missions, and this year the company is quietly forcing all managers to undergo an intensive six-day course in "world-class competitiveness."
PAIRING OFF. That sense of urgency is no doubt reverberating throughout the industry. Even after things pick up, manufacturers face new and awesome challenges in the years beyond. Jim Beyer, editor of Avmark Newsletter, predicts that several years down the road, "the Russians might come in as No. 3." And as Asians account for an increasing percentage of world aircraft purchases, countries in that region won't remain content just to buy.
Asian producers will seek to work increasingly with U.S. and European aircraft makers as partners. But some industry players, including Boeing, fear the day may not be far off when companies in Japan, Taiwan, Korea, and elsewhere could band together in a new pan-Asian challenger similar to the European, government-backed Airbus consortium. The world's airlines wouldn't mind the extra competition at all. But it could spell a new round of tough times for an industry that already has its share of headaches.