This article is the final in a 6-part series examining how the drivers of value…
Demystifying Aviation Economics
By Steven Wood, Monday, March 25, 2019
Demystifying Fuel Burn
This article was written on a transatlantic Air France flight on a Boeing 777-300 aircraft. It’s one of the least efficient flights across the pond, and is a dying breed – at least until the 777X launches in the early 2020s. My colleague Kveta and I have been trying to demystify fuel burn dynamics on the transatlantic route for nearly a year now. Despite everyone knowing nameplates and engine-makers, actual comparable fuel burn statistics are notoriously opaque and kept close to vest. We’ve finally accumulated enough data to give us something close to the view that large airlines have when deciding which planes to order for their evolving fleet. Why focus on the transatlantic route? It’s one of the most competitive medium-range markets in air travel, and most routes are now able to be flown by the new single-aisle aircraft being launched.
This past decade has seen a complete overhaul of the entire range of aircraft, with completely new designs like the A350 and B787, and the more familiar older planes which have had new engines attached, with some new materials and slight changes to the design. As planes were upgraded, their flight ranges were extended at the same time fuel efficiency improved, and the manufacturers (OEMs) managed to jam more seats in the airframes.
While narrow-body or single aisle planes traveling transatlantic routes is nothing new, with a plethora of new options to consider for intercontinental flights, there are now many different ways to skin the cat efficiently. Despite the narrow-body jets being relatively unattractive from a long-haul fuel efficiency perspective, budget airlines removed first class and were able to pack quite a bit more seats on the plane, lowering unit level economics to being competitive with the best wide-body planes today. Over the past four years, according to the International Council on Clean Transportation (ICCT), usage of narrow-body planes on the transatlantic route has more the tripled to nearly 40% of capacity.
With the introduction of Airbus’ new longest range narrow body, the A321neo-LR, not only did these lower cost airlines have an ability to build a fleet, but they could do so with more affordable unit-cost economics. Yet, as it took us a while to learn, before any analysts go ahead and compare narrow-body fuel burn metrics to wide-body metrics, they must remember, that the fuel needed for such a much longer flight significantly alters the fuel burn metrics of single aisle planes. These flights are around 4x the length of the typical narrow-body flight and the plane is significantly heavier for the first three quarters of the flight than comparing a plane to the unit-economics of a shorter-haul flight. Interestingly, using fuel burn data from the A321ceo along with data from airlines and Airbus on the newer model, the A321neo-LR isn’t actually more fuel efficient than wide body planes per-seat-per-kilometer, as we would have guessed at the beginning of this study. While it comes within grasp of the newer more efficient wide-body / twin aisle aircraft that have been launched in the last couple of years, in a two-class seat configuration, it actually isn’t at a competitive advantage.
Exhibit 1: Transatlantic Fuel Burn
Data sources: Airbus, Boeing, Aspire Aviation, Leeham News, Fuelplanner.com, Haw Hamburg, The International Council on Clean Transportation
Fuel burn data is very difficult to find, much less compare. OEMs routinely say their air-frame is the most efficient, and they compare apples to oranges routinely. They do not fool lessors or airlines with this obfuscation, they only fool the public and Wall Street. Exhibit 1 uses the same two-class seat configuration to show the per-seat fuel burn on flights that are 3-4.5k nautical miles long (5-8.5km). These are very often the East Coast US flights to continental Europe or UK, the very flight your author is on right now. Fuel burn metrics for all aircraft will be lower than exhibit 1 for traditional short-haul flights.
The narrow-body A321neo carries an advantage for low-cost-carriers (LCCs) because they remove first class and jam more seats in the planes, making the per-seat unit economics superior to a 2-class wide-body airframe. Yet they can do the same with a wide-body plane, as Norwegian’s 344-seat 787-9 set a new standard for fuel efficiency as the absence of classes allows it to jam 128 more passengers on the jet than British Airways does on the same airframe. Yet for large carriers with two-class layouts, exhibit 1 is what their commercial teams are looking at when they place orders for planes. Boeing has increased production and cut the price for its 787-9 to make up for the worse per-seat fuel economy metrics, which has also boosted profit, as it lowered the depreciation charges per plane. Boeing has been aggressive at capitalizing development costs for the 787 and has kept these costs on its balance sheet, despite SEC investigations into its accounting practices on the airframe. Two weeks ago, we outlined to our investors a novel insight we have recently had regarding the 787 program. For competitive reasons, we prefer this to remain close to vest at this time, but the insight would explain Boeing’s seemingly irrational behavior on the 787 program.
Rather than take our word for the unit-level economics, let’s see what airlines have actually flown across the pond in 2017, thanks to researchers at The International Council on Clean Transportation (ICCT). Using data they obtained on actual flights flown by all carriers, the A330 was the clear leader in capacity. Of the newer generation planes, the A350 quickly shot up beyond the B787 despite it only being the second year of production for the airframe, versus the 787 in its seventh year of production at the time. The team from ICCT compared the capacity evolution from 2014 to 2017 and found that narrow-body planes, the A350 and the A330 were the only planes that took capacity share away from The 747, 767, 757, and A340, which unsurprisingly all lost capacity share over the three year period measured. With increased availability of A350s, A321neos, and now with the introduction of the A330neo, we would expect these capacity shares to continue to transition away from the older wide-bodies.
Exhibit 2: Transatlantic Capacity by Airframe
Source: The International Council on Clean Transportation
These medium-range fuel burn metrics come at a very interesting time. Airbus now has a backlog of over six years of production on both its key wide-body programs, and stands one or two major orders away from raising production on these Rolls-Royce exclusive jets. Yet, these orders have not been as forthcoming as either Airbus or Rolls would have suspected at this point, the beginning of the A330neo’s life.
Exhibit 3: OEM Order Books
We believe Boeing’s highly anticipated new midsize airplane (NMA) is the primary reason behind the cautious order pattern on the A330neo. Boeing has promised up to 30% better unit economics for its NMA plane vs. its 757 and 767 series. Should the plane be able to leapfrog the current class of unit-level economics, airlines don’t want to be stuck with A330neo orders. The A330neo is an interesting middle-of-the-market aircraft. It is not capable of flying the longer ranges of the A350, B787 or B777, yet is less efficient than single-aisle planes for short haul routes.
Interestingly, Rolls-Royce recently pulled out of the contest to power the NMA, as it said its engine would not be sufficiently mature for the launch under the timetable envisaged by Boeing. It separately said its Ultrafan engine, which will further lower fuel burn by over 10% from the current generation, will be sufficiently mature by 2022. We believe this means, much like its more recent past, Boeing has a very aggressive timetable for the NMA launch. If the plane were to launch in 2026, like most journalists and analysts are expecting, the window of success for the NMA would be fairly limited. By late 2020s, the current generation of wide-body planes will be re-engined with more fuel efficient engines like the Ultrafan. Even if the 30% fuel improvement on the 757 was achieved by Boeing on the NMA, the next generation B787 and A350 would completely eliminate any fuel advantage the NMA could capture for a few years. For this reason, both GE and Pratt & Whitney have limited their engine bids on the program to only one of a sole-sourced arrangement, given anxiety around the number of orders such a program would receive.
737 Max-8 Wreckingball
And then, unfortunately, a second 737 Max-8 has crashed due to the flight control system. Boeing is intensely competitive. Both the 787 and A350 were announced and launched within a year of each other, yet Airbus waited until December 2015 until its program was sufficiently mature to allow deliveries. Boeing, on the other hand, accelerated the development path and launched in fall of 2011. After its very accelerated launch, the program faced in-flight fires related to the batteries used on board, causing a chaotic launch for Boeing.
The OEM repeated this hat trick of a botched launch with the 737 Max-8, except now its myopic focus on cash-per-share and shareholder return has been maintained at the expense of the lives of two full planes of passengers. The Seattle Times recently did a brilliant exposé on the haphazard certification Boeing conducted on the 737 Max-8 in an equally embarrassing reveal for the Federal Aviation Administration (FAA). Boeing ran the certification program in an aggressive manner in order to not lose market share to the A320neo, which was due to launch before the new next generation single aisle for Boeing. Thus, profitability and market share were prioritized over safety. It’s disturbing to say the least. In a white paper to be published later this year, we’ll show how behavior similar to Boeing’s has been destroying the long-term viability of much of corporate America. Emphasis on short-term quarterly profits correlates inversely to long-term share price performance. It also correlates inversely to safety for passengers, or so it would seem.
While the global grounding of the 737 Max-8 fleet can most likely be fixed by a software update on the planes, we believe the fiasco will have long-lived repercussions for Boeing and the certification process at the FAA. We do not believe an early decade launch of the NMA will be possible without the lax certification process it relied upon for the 737 Max-8. Accordingly, we join Leeham News in speculating that the program may never happen at all. Or, if it does, the timetable has undoubtedly been pushed back in the aftermath of the 737 Max-8 crisis.
We can draw a few conclusions from a delay or deferral of the NMA program. First, Rolls-Royce will perhaps again be a contender on the program if the timetable has been pushed back beyond 2022 for entry-into-service. Second, without a transformational new plane in the mid-market, we believe orders for the A330neo should pick up as Boeing’s plans become more clear, perhaps as soon as this summer at the Le Bourget air show in Paris.
Contrary to >95% of opinions in aerospace industry, the wide-body market is not as weak as it once was a few years ago. The block hour utilization of Rolls-Royce’s fleet of large engines just hit an unprecedented level, and the retirement rate across its fleet of nearly 5k large engines hit a record low in 2018. Part of this retirement rate is affected by the Trent 1000 fan blade issues it has been struggling with all year. Now that its new fan blades are certified, the issue has been partially contained and part of this low retirement rate could normalize in 2019. Yet even backing out the planes used to satisfy the needs of these affected customers, the retirement rate is still near historic lows.
Exhibit 4: Rolls-Royce Large Engine Retirement Rate & Hourly Utilization
We have been closely following the aviation industry only since 2013, and are by no means experts. In fact, we’re still novices to be sure. But when >95% of the opinions, particularly of the “experts,” in any field agree on anything, we are normally well-served by taking the other side of the trade. We refer to this as maximizing the “expectations gaps,” in the fundamentals of our portfolio. While Rolls-Royce is no longer a despised name, the industry segment it dominates is still highly out of favor. Extrapolating recent events at Boeing and Rolls-Royce, we wouldn’t be so sure the stormy clouds will persist for very much longer.
To read more research about our investment in Rolls-Royce, investors should see our recent update from this month entitled “Mind Another Gap.”
Disclaimer:
This article has been distributed for informational purposes only. Neither the information nor any opinions expressed constitute a recommendation to buy or sell the securities or assets mentioned, or to invest in any investment product or strategy related to such securities or assets. It is not intended to provide personal investment advice, and it does not take into account the specific investment objectives, financial situation or particular needs of any person or entity that may receive this article. Persons reading this article should seek professional financial advice regarding the appropriateness of investing in any securities or assets discussed in this article. The author’s opinions are subject to change without notice. Forecasts, estimates, and certain information contained herein are based upon proprietary research, and the information used in such process was obtained from publicly available sources. Information contained herein has been obtained from sources believed to be reliable, but such reliability is not guaranteed. Investment accounts managed by GreenWood Investors LLC and its affiliates may have a position in the securities or assets discussed in this article. GreenWood Investors LLC may re-evaluate its holdings in such positions and sell or cover certain positions without notice. No part of this article may be reproduced in any form, or referred to in any other publication, without express written permission of GreenWood Investors LLC.
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