Rolland Vincent

Today, the vast majority of business aviation market indicators are trending positively. This is a welcome development after a prolonged and mostly flat recovery from the U.S.-led Great Recession, which officially ended more than nine years ago.
The U.S. and Europe are the base for 74 percent of the world business jet fleet, and these economies are growing.&nbsp;Since first-quarter 2010, the U.S. economy has expanded for 34 consecutive quarters year-over-year (YOY), including at a rate of 2.8 percent in the second quarter. Since fourth-quarter 2013, the 19-country Euro Area economy has grown for 19 consecutive quarters, including at a rate of 2.5 percent in the second quarter. The latest forecast for 2018 from The Economist (Aug. 9, 2018) is for U.S. GDP to grow by 2.9 percent and the Euro Area GDP by 2.1 percent. These are good numbers that provide the basis for optimism, especially about the near-term future.
The Dow Jones is at previously unimaginable levels at this time.&nbsp;The stock market is always prone to jitters, but very few if any were seriously predicting that the Dow would be at 25,000—let alone 15,000—after the crash that began in September 2008. U.S. after-tax corporate profits, another key indicator of corporate performance and health, jumped 15 percent to $2 trillion on an annualized basis in the first quarter, its highest-ever levels. As two of the most widely watched metrics, the Dow Jones Index and U.S. corporate profits have both correlated well with business jet sales in the past.
Collectively across the “big five” business jet OEMs—Bombardier, Dassault, Embraer, Gulfstream, and Textron—new business jet orders and backlogs increased in the first half, reversing a trend of book-to-bill performance of less than 1-to-1 that had been under way for several years.&nbsp;Although the rate of uptick in new orders was relatively modest, this is one of the key industry metrics that we have been monitoring for many years that has finally begun to swing into positive territory.&nbsp;These same OEMs and their aero-engine and supply chain partners continue to invest heavily in new products that are just now coming to market after years of financial and human capital investment.
Preowned business jet retail sales (whole aircraft and leases) were strong in 2017, up 9.5 percent YOY with more than 2,700 preowned retail business jet transactions recorded by JetNet.&nbsp;Preowned for-sale inventory has just slipped below 9 percent of the in-service fleet, the lowest reading we have seen in memory.
The business aircraft sales market has been very active, and new U.S. tax and accelerated depreciation laws introduced in late 2017 provide additional incentives for deals (for both preowned and new business aircraft) to be written in 2018. Rational buyers and their brokers/dealers are actively searching worldwide for any remaining quality assets. Serious buyers are realizing that they must move quickly if they find an aircraft that meets their criteria—and pay the price that the seller is asking.
Meanwhile, the sentiment of customers is as strong as JetNet iQ has measured in eight years, with about 70 percent of business aircraft owners/operators indicating that the market is past the low point in the current business cycle.&nbsp;Optimists currently outnumber pessimists by almost five-to-one. The percentage of customers indicating that they are highly likely to purchase a new business aircraft in the next 12 months increased noticeably between the first and second quarters.
Given all this good news, there are still some areas of concern. The health of business aviation markets is ever-changing, and conditions are difficult to predict. Here are some of the things I am monitoring.
Most economic forecasters are signaling that U.S. and Euro Area GDP growth rates will slow in 2019, to the range of 2.5 percent to 2.7 percent in the U.S., and between 1.9 and 2 percent in the Euro Area.&nbsp;This is disappointing but not surprising given rising international trade tensions, waves of tit-for-tat tariffs, the looming and unresolved Brexit situation, and growing uncertainty about the continuity of long-established multilateral security relationships.&nbsp;
U.S. GDP growth in the first half was accelerated by lower tax rates and full expensing of investments, higher government spending, and a surge in exports ahead of tariffs that took effect near midyear.&nbsp;According to the Congressional Budget Office (CBO), the net impact of the 2017 tax cuts is a $1.6 trillion increase in federal government debt in the 2018 to 2027 time frame, adding 16 percent to its previous baseline.&nbsp;Total U.S. debt has now surpassed $20 trillion, which is larger than the country’s annual GDP.&nbsp;Interest expense for servicing the debt was $260 billion in 2017 and is set to increase significantly with rising interest rates.
Trade tariffs have begun to affect consumer costs and international trade/travel patterns, both in the U.S. and elsewhere.&nbsp;Signs of change are already apparent in a drop-off in international travel to the U.S. Compounded by a fall in the value of the Chinese currency, Chinese travel to the U.S. has already slumped by more than 8 percent YOY from March through August, and forward bookings are off 10 percent for the balance of the year. These are the sorts of signals of changes that can have far-reaching implications for a variety of travel-related industries.
With consumer activity accounting for 70 percent of the U.S. economy, price inflation is an important driver of daily economic activity.&nbsp;After inflation, take-home earnings actually declined in 2017 across the U.S. for a group of 116 million full-time wage and salary workers, despite a tight labor market and 4 percent official unemployment. As has been the pattern in the past, tariffs will increase the cost of doing business and will ultimately be passed down to the consumer in the form of higher prices. Consumers will naturally react to higher prices by seeking higher wages and by cutting back on spending, which will slow down U.S. economic growth.
The risk of an inverted U.S. yield curve—where short-term interest rates are higher than long-term rates—is now real.&nbsp;These inversions have been accurate predictors of the last seven U.S. recessions, with a delay of about a year. With the U.S. Federal Reserve signaling that it is likely to increase interest rates at least two more times this year to counter inflationary pressure, the likelihood of an inverted yield curve is becoming a real possibility, and with it the challenge of a possible U.S. recession as early as 2019. This would be a real setback for the recovery of business aviation markets, after a prolonged period of relatively slow, single-digit-percentage growth.
After a banner 2017, preowned business jet markets have since gone thin and flat, with transaction volumes in the first half of this year unchanged from the year-ago period.&nbsp;With less than 2,000 business jets for sale worldwide, the for-sale fleet today represents just 8.9 percent of the fleet. Of this, just 18 percent was delivered new in the past 10 years.&nbsp;More than half of the for-sale jet inventory is now more than 20 years of age—an asset class that is not where most wise investors are likely to put their hard-earned money.
New business jet deliveries in the very light jet through large, long-range jet segments shrank 7 percent YOY in the first half (excluding single-engine Cirrus Vision jets and twin-aisle Boeing and Airbus bizliners). Nevertheless, there is actually some good news here, in that the swoon in factory output this year is largely due to the transition to new models at several OEMs.&nbsp;Delays in certification and production ramp-up are shifting the new delivery outlook to the right, implying that deliveries will be even more back-end loaded this year than in the past. There is no doubt that many buyers are simply waiting on the sidelines until these new aircraft are certified and in production.&nbsp;
Despite atmospheric corporate profits and stock market valuations, and low costs of borrowing, business jet orders have not followed in lock-step as they seemed to do before 2008. Aircraft utilization rates are relatively flat, and are only back to 2003/2004 levels in the U.S. despite a 58 percent increase in the fleet over the same time period.&nbsp;Aircraft residual values fell sharply in the last several years and remain low.&nbsp;Values for many popular five-year-old models are down 30 to 40 percent from their original retail prices, and the gap between new and preowned prices continues to discourage sales. This problem will continue to take more time to correct and rebalance.
Rolland “Rollie” Vincent is president of Rolland Vincent Associates, a Plano, Texas-based aviation consultancy with a focus on market research, strategy, and forecasting.&nbsp;He can be reached by <a href="mailto:rvincent@rollandvincent.com">email</a> or telephone at (972) 439-2069.

AINsight: Where’s the Bizjet Market Recovery?

Analyst takes a cautious view of the future.

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