June 7, 2016: Single-aisle production rates of 57/mo at Boeing and 60/mo at Airbus are reasonable when achieved in the near term but more problematic in 2019. Wide-body production rate hikes are risky.
This is the conclusion of a short research note issued June 1 by Wells Fargo Securities.
“Higher Rates Sustainable,” WFS writes. “Aircraft deliveries have historically been cyclical, yet Boeing and Airbus have had flat-to-rising deliveries for 12 years–and both forecast higher near-term deliveries. The bottom line is that the OEMs’ forecasts can be reasonable in our view, assuming aircraft retirement levels and/or traffic growth are above historical rates. Therefore, we expect higher deliveries over the next several years, but think it is unlikely that the full 35-40% A320/737 production increase currently envisioned by the OEMs will be achieved by 2020.”
“Based on near-term traffic growth estimates and the historical 3.6% annual removal rate, 2016-17 delivery projections are clearly supported,” WFS writes. “In theory, to bring deliveries into balance would require aircraft removal rates of only 2.4% this year and 3.4% in 2017. While the monthly delivery rate increases over the next several years, it does not quite reach the OEM-forecasted 117 per month (57 for Boeing + 60 for Airbus).”
“Wide-body delivery estimates appear to be at greater risk than narrow-bodies. If annual removal rates stayed at the 5%+ level as in 2015, it could bring the requirements closer to the production rate announcement, but it would require a sustainable retirement rate well above the historical 3.6% level. We think wide-body concerns are broadly recognized,” WFS says.
Wells Fargo writes that Gross Domestic Product and traffic growth, long the staples used by the OEMs for projections, continue to be crucial factors going forward. But fleet retirements are a major variable.–and “highly sensitive.” Writes WFS:
For historical data we queried Ascend for annual deliveries and year-end in-service fleet totals; from this we imputed annual aircraft “removals.” These removals consist mostly of aircraft retirements, but would also include passenger aircraft that were converted to freighters; planes that transitioned between “stored” and “in service” (net); parked airplanes; and other events such as incidents that cause the plane to be removed from service.
For both narrow-bodies and wide-bodies, we found that over the past 25 years the average annual removal rate was 3.6% of the fleet. This seems reasonable based on a typical useful asset life of around 25 years. We believe that near-term delivery forecasts by Boeing and Airbus suggest a slightly lower narrow-body removal rate (2.5%-3.0%) but a somewhat higher removal rate for wide-bodies (5%). Given some of the anecdotal evidence we have witnessed (example: AerCap recently sold a 2006-vintage A340 widebody for part-out), we believe the assumption to continue 2015 trends falls within historical ranges. Longer term, our baseline model calls for a 3.5% retirement rate for narrow-bodies and ~4% for wide-bodies.
Now having estimates for fleet growth (Section 2) and removals, we can back into new delivery estimates.
The key insight – albeit not a new one – is that new delivery forecasts are highly sensitive to the removal-rate assumption. We note the wide historical range for the annual removal rate: between 1% and 9% for both narrow-bodies and wide-bodies. With an in-service narrow-body fleet of about 14,000 aircraft, a mere 0.5% change in this assumption represents 70 airplanes – or over 7% of our 2016 737/A320 forecast.