NEW YORK--(BUSINESS WIRE)--The annual air show last week in Europe generated a significant amount of information regarding the commercial aerospace industry, most of which supported Fitch Rating's current outlook, while also reinforcing some longer term concerns. Fitch's stable outlook for the sector has not changed, but the likelihood of higher production rates in several years has increased, as the demand for new aircraft outstrips the supply of available delivery slots. Fitch believes further hikes in production rates could raise the risk of supply chain pressures. The following are some observations on several key credit topics.
Orders and Commitments:
With aircraft order backlogs at record levels (approximately 12,000 at the end of May), production execution is the key driver of Fitch's aerospace ratings at this time rather than additional orders. Nonetheless, new orders and commitments at the air show exceeded Fitch's expectations, adding to the existing large backlog. The headline number for new business at Airbus ('A-'/Stable Outlook) and Boeing ('A'/Stable Outlook) was 752 aircraft, but only 278 were firm orders (154 at Boeing, 124 at Airbus), with the remainder being commitments. Assuming the commitments are executed as firm orders, the industry is on track to grow the backlog again in 2015.
The orders and commitments came from airlines outside North America and lessors, with narrowbody programs accounting for more than 80% of the new business. On a program basis, the current A330 and 777 programs received several orders which could help sustain production rates as the programs transition to follow-on models. Also notable was Volga-Dnepr Group's commitment for 20 747-8 freighters; production rates for the 747 have been under pressure, so this order gives the program some support as the cargo market recovers. However, Volga-Dnepr's deliveries are reportedly spread over seven years, so Fitch expects additional orders are still needed to sustain the 747 program.
Production Rates:
The narrowbody orders and commitments are causing Airbus and Boeing to consider raising production rates beyond existing plans for the A320 and 737 models. During the show there were reports that Airbus was exploring the possibility of raising rates above 60 per month; Fitch expects Boeing could also explore production at these levels. Airbus's existing plan is to increase A320 rates in stages from the current 42/month to 50/month in early 2017. Boeing's existing schedule is to step up 737 rates from the current 42/month to 52/month in 2018. Production rates beyond existing plans would not be an immediate credit concern given they would likely not take effect until the end of the decade, but they would raise several issues. These issues would include the amount of additional investment required by the manufacturers and suppliers, the time period during which the market could sustain production rates at or above 60/month, and the impact on lease rates of existing aircraft.
Supply Chain/New Engine Ramp-ups:
Fitch has been cautious about the ability of the supply chain to manage significantly higher production rates, and the talk of further increases raises Fitch's concerns. A focus area is the engine sector, which is supporting higher narrowbody production rates while transitioning to two new technology power plants, the PurePower geared turbofan from United Technologies ('A'/Stable Outlook) and the LEAP from CFM International (a joint venture between General Electric and Snecma). The magnitude of the new engine ramp-up was illustrated by both companies in presentations last week. For example, GE noted that LEAP production will be approximately 100 units in 2016 and will rise to approximately 1,900 by 2020.
Aircraft Finance:
With the Fed poised to begin raising interest rates, airlines and lessors are likely to take advantage of funding opportunities in the currently strong aircraft finance market. Fitch expects a steady flow of aircraft-backed capital markets transactions through the summer, including deals pre-funding deliveries into 2016.
Bombardier and the CSeries:
Bombardier ('B+'/Negative Outlook) continues to be one of the highest profile credits in the aerospace sector, and Fitch considers the CSeries aircraft to be the most significant factor for the company's ratings. The CSeries had a mixed show in Fitch's view. On the positive side, the company said that the aircraft is exceeding performance targets. Also, certification before the end of the year is apparently on track, and the aircraft flew at the show for the first time (and was noticeably quiet). On the other hand, there was some general discussion of adding a third model, which would likely increase development costs. Although there were no CSeries orders at the show, Fitch considers the certification and initial production of the aircraft to be more important credit considerations than orders at this point. Fitch believes the company has sufficient orders for the first few years of production, and new orders are more likely after the aircraft is delivered and meets expectations once in service. In addition to the CSeries, key items to watch at Bombardier are the results of the review of Bombardier Commercial Aircraft's operations and the planned IPO of the Transportation segment later this year.
New aircraft development:
No new aircraft programs were launched during the show, but several potential new models were discussed. Boeing is reportedly discussing with clients the development of a 757 replacement which would fit in its portfolio between the 737 and 787. There were also reports that Airbus is considering stretching and re-engining the A380, which has struggled to attract new orders over the past 18 months. The company's management indicated in a presentation that a decision could be made before year-end. Given comments at the air show, Fitch expects these developments will likely move forward, although their introduction is likely beyond Fitch's forecast horizon.
Additional information is available on www.fitchratings.com
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