By: Carter Copeland
Aerospace cycle concerns are reemerging; we’re not worried: In our report from last week, we alluded to a growing debate around the aerospace cycle. Concerns around the strength of the cycle are more pronounced today than we can recall in the last 12-18 months and generally center around 1st/2nd derivative changes in closely watched data series, most notably air traffic and airline profits. Over the last 5-10 years, we’ve experienced similar periods of time where cycle concerns drove multiple compression and share price underperformance for BA and AIR. 2012 and 2015/2016 stand out the most as periods where fear/concern was elevated, but fundamental concerns never manifested themselves in a meaningful way. Similar to what we wrote back then, we continue to believe that the backdrop for the industry remains unwaveringly strong in absolute terms, and that a focus on incremental changes is likely to mislead folks.
Air traffic has been incredibly strong for the last decade: Over the long-term, aircraft production schedules will track closely to trends in air traffic. The 7+% traffic growth that we’ve experienced since 2010 is high by any standard (vs. history and Boeing’s own internal forecasts) and the relationship between global traffic growth and global GDP growth (>2.0x correlation coefficient since 2003) is the strongest it’s been since the dawning of the jet age in the 1960s. This has been driven by the declining cost of air travel as well as the globalization of demand. Even with Global GDP declines that are 5-6x what the IMF is expecting for 2019, air traffic would remain in the 4-5% range, very healthy, especially once considering the above-trend growth that the market has experienced for the last several years. It’s simply difficult to see air traffic growth falling below trend for any extended period of time and we’re more likely to have continued above historical average growth as emerging markets continue to mature.
Temporary slow-downs in air traffic growth unlikely to impact supply/demand dynamics: We expect supply growth over the next several years to be somewhere in the 5.5%-6.0% range. Given the outsized demand vs. supply growth that we’ve seen since 2010 (leading to backlogs stretching 5+ years of production), we think that the market can absorb any material slowdowns in demand without having to make material changes to production schedules. The outsized traffic and backlog growth that we’ve seen relative to production points much more to a market that continues to be undersupplied vs. oversupplied. Widebodies are most at risk for a flattening out of production but are much less important to the earnings algorithm for BA/AIR than the narrowbody programs.
Airline profitability is another area of concern: Airline profitability has also materially improved and decoupled from GDP growth in recent years. We’re not necessarily expecting this trend to continue, but even material declines in aggregate profitability would still leave airlines better off than they have been historically.
Don’t miss the forest for the trees: Overall, too much focus on incremental changes in cycle-related data series misses the bigger picture; industry fundamentals remain strong by any historical standard and BA/AIR stand to capture large financial gains over the next several years.