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Welcome to the nineteenth annual Teal Group Business Jet Overview. Over this month and in the August issue of World Aircraft Sales Magazine- we will look at the market- where it’s going and the players involved. We’ll offer our forecast- including assumptions and segment details and then we’ll give our assessment of the manufacturers and new product development prospects. But before anything- we have an introductory section which may be helpful.

Richard Aboulafia   |   1st July 2009
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Richard Aboulafia Richard Aboulafia

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12-768 business jets forecast over 10-year period

Welcome to the nineteenth annual Teal Group Business Jet Overview. Over this month and in the August issue of World Aircraft Sales Magazine- we will look at the market- where it’s going and the players involved. We’ll offer our forecast- including assumptions and segment details and then we’ll give our assessment of the manufacturers and new product development prospects. But before anything- we have an introductory section which may be helpful.

Want to spend more time with friends or family? You can avoid reading this overview by looking at the charts and remembering the following points:

Business aircraft for sale have been hit harder by the economic crisis than any other aerospace market. After unprecedented growth- the market is falling at an unprecedented rate. All meaningful indicators – utilization- prices- used aircraft availability- and corporate profits – indicate a prolonged and painful down turn. Financing business jets is also more difficult than financing jetliners. Delivery numbers are falling fast- and we won’t see a recovery to the 2008 peak level for many years to come.

• Our forecast assumes a three-year downturn. The key demand drivers – economic growth and corporate profits – will only recover in late 2010. It will take some time to reduce record inventories of available jets for sale. This means new business jet deliveries won’t start to recover until 2012. The trough year of our forecast – 2011 – will see business jet deliveries reduced by 40% relative to 2008. Our forecast then calls for a five-year recovery period with 10% growth per year starting in 2012.

• Using these assumptions- we forecast production of 12-768 business aircraft worth $195.9 billion (in 2009 dollars) over the next ten years. This includes 9-300 business jets worth $153.9 billion- 575 corporate versions of jetliners and regional jets for sale (RJs) worth a combined total of $29.6 billion- and 2-893 business turboprops worth a total of $12.4 billion.

• Of the traditional business jets- over 50% of these (by value) will be Class Four and Five (high-end) models. At the other end of the spectrum- we are down-grading Very Light Jets (VLJs) from “oversold” to “irrelevant.” Our forecast includes just 2-272 of these- including 1-095 Mustangs- 915 Phenom 100s- and 262 HondaJets (and nothing from anyone else).

• For comparison- the last ten years (1999-2008) saw production of 10-568 business aircraft worth $159.2 billion (also in 2009 dollars). This includes 7-696 jets worth $134.5 billion plus 381 jetliners and RJs worth $14 billion and 2-491 turboprops worth $10.7 billion.

• For further comparison- last year’s Teal Group forecast called for 18-401 business aircraft (including 14-289 jets) worth $270.6 billion in 2008-2017. This market has taken a very heavy blow. Our last forecast also stated “We’re still concerned about using these unusually good times as a forecasting base year.” This has proven to be a serious problem in most business aircraft forecasts over the past two years- including ours. When the market resumes its growth- it will start from a much lower base.

• Looking at traditional business jets- Gulfstream and Bombardier will be the market leaders (24.8% and 23.2% respectively- by value of deliveries)- followed by Cessna (19.2%) and Dassault (16.8%) at the second tier. Hawker Beechcraft will have 8.8% and Embraer 6.4%. Honda will have the remaining 0.8%. These figures exclude turboprops- jetliners and corporate regional jets for sale.

• While Embraer and Honda are successfully entering this market- we do not see any other new players emerging. The sudden market crash- the stigma currently associated with business jet use- and a pattern of new business aircraft company failures will deter funding for new concepts and start-ups. New players may acquire existing assets- however- particularly if any assets are put on the market with distressed price tags. In fact- given uncertainties at Hawker Beechcraft and Cessna’s parent company Textron- there are strong prospects for major industry restructuring in the months ahead. As a company that derives the bulk of its revenue from defense- General Dynamics has an advantage as a buyer in this market.

• The downturn threatens new product development at the established manufacturers- too. Several important new products have been shelved or delayed- most notably Cessna’s Columbus- Hawker Beechcraft’s Hawker 450 and Dassault’s Falcon SMS. Two manufacturers have begun shifting product development cash to different priorities – Bombardier with its CSeries jetliner- Embraer with its KC-390 military transport. This implies a de-emphasis of this once-crucial growth market.

• With few hopes for new market entrants- and reduced expectations of new product development at the established manufacturers- the market will benefit less from new technology stimulants. For the next few years- however- Gulfstream’s G250 and G650 are proceeding as planned. Also- we expect the market’s return to growth after 2011 will embolden manufacturers to increase new product development funding.

• Some good news: We do not believe the current anti-business jet cultural environment will persist as a long-term damper on demand. Preference for- and acceptance of- business aircraft will return when world economic growth resumes. Also- the past 13 years have seen business aviation transformed from a backwater market to a key part of the aerospace industry. This transformation will not be reversed. Even at the low point of our forecast- the business jet industry will be well over twice as large as it was in any year prior to 1997.

As the world economy struggles to recover from the massive financial shock of late 2008 and early 2009- the business aircraft market has found itself in free-fall. After growing at a record 17.1% compound growth rate between 2003 and 2008- business jet deliveries look set to fall at an even faster rate.

There are few hopes of a recovery any time soon- and signs point to a three year down-turn. The only consolation is that the fundamental drivers behind this market’s transformation – it has almost quintupled in size since 1995 – remain intact.

By any measure- the leading indicators of business jet demand are in terrible shape: Many world economies are shrinking- with the US suffering a -6.1% drop in the first quarter of 2009- following a -6.3% drop in the last quarter of 2008. There are fewer high net worth individuals – two-thirds of Russia’s billionaires in 2008 are no longer billionaires.

Worst of all- corporate profits- the indicator with the closest correlation to business jet demand- are slumping. From an annualized peak of $1.7 trillion in the third quarter of 2007 US corporate profits fell to $1.3 trillion in the fourth quarter of 2008. Most forecasts call for a more serious drop in 2009. Typically- deliveries of new jets begin to fall about 12-24 months after profits fall. This market cycle looks set to fit the pattern.

The indicators of market health are in terrible shape too. Business jet utilization in the US- as measured by cycles (take-offs and landings)- has been falling by double digit rates for eight consecutive months. March cycles were down by a disastrous 30% relative to the previous March. Used aircraft pricing is down across the board.

Availability has reached record levels- with 16.2% of the fleet (well over 2-000 jets) up for sale as of April. Typically- when 13% of the fleet is on the market- it’s a clear sign of a serious market downturn. The current level is unprecedented and indicates a severe oversupply problem. However- one possible explanation of this high number is that companies and individuals are putting their aircraft up for sale as a demonstration of frugality- either to politicians or to stockholders- but with no actual intent to sell the plane. That’s the only possible silver lining in a dark cloud of numbers.

Meanwhile- backlogs- long vaunted as a large cushion for the manufacturers against any serious downturn- have been proven to be completely meaningless. All manufacturers had been reporting backlogs ample enough for several years of full production- yet all have announced production cuts for this year or next. Clearly- backlogs offer no guarantee that a broad section of customers won’t defer.

Cessna provides the best illustration of backlog weakness: Up until the fourth quarter of last year the company planned to build 525 Citations in 2009- up from 467 in 2008. In November- it cut the number slightly- to 495. In late January- it cut anticipated 2009 production to 375. In April- this number was again reduced to 290-300. Notably- Cessna’s backlog didn’t change much with these announcements. In late 2008 the company said it had a $14.5 billion backlog. At the end of the first quarter of 2009- the company announced a $13 billion backlog.

Orders had slowed to a trickle- so the only changes were due to deliveries of existing orders and a relatively light number of cancellations (92 net in the quarter). This means these massive production rate plan reductions have been almost purely due to deferrals- against which backlog announcements are meaningless.

These market health indicators and delivery outlook numbers are truly dire. But only two possible events threaten the future of the business aircraft market: an end to world economic growth- or an end to the link between that growth and business jet utilization. The first is a very remote risk. The second is an easily overstated risk.

First- there is no disguising the magnitude of the world economic downturn. Until April- the International Monetary Fund had tentatively forecast that the world would grow at a 0.5% pace in 2009. But that has since been revised- with expectations of a -1.3% shrinkage. This means that 2009 will be the first year without world economic growth since World War Two. It’s quite possible that the world faces a prolonged period of structural readjustment- or that it is reaching the limits of growth. Several prominent economists and commentators have stated the risk of this development at about 20%. But nobody believes that a depression of this magnitude is a baseline scenario.

Second- it’s clear that the business jet industry is facing cultural headwinds. Key politicians in both US political parties have criticized business jet users- and there have been some high profile events that have cast a pall over business jet ownership. The CEOs of Chrysler- Ford- and General Motors came under heavy criticism for taking private planes to Washington to plead for aid money.

GM promptly terminated leases on seven Gulfstream jets. Similarly- Citigroup- the recipient of billions in US Government funding during the financial crisis- was pressured to cancel its order for a Dassault Falcon 7X. “The notion of Citigroup spending $50million on a new corporate jet- even as it is depending on billions of taxpayer dollars to survive- does not fly-” Senator Carl Levin (D-MI) said on his Web site. Citigroup also put two older Falcon 2000EXs on the market- although this might be an example of jets that are put on the market- but with no actual intent to sell. Not long after- both Cessna and Hawker Beechcraft began advertising campaigns intended to defend the image of corporate aviation. Cessna President Jack Pelton pointed to the pressure on executives to avoid private aviation- saying “That stigma is a factor we’ve never experienced in the past.”

Yet it isn’t really clear that the market hasn’t seen this cultural antipathy before. History is replete with anti-business jet pronouncements during recessionary times. In 1987- the movie Wall Street was widely viewed as putting bankers and their private jets to shame.

In the last downturn- one newspaper article commented that “sales of business jets- once the ultimate status symbols- have cooled with the US economy… The sleek stratospheric board rooms have come to represent corporate greed for some- and for others are simply no longer affordable.” (USA Today- Feb. 11- 2003). That was a few months before the greatest growth spurt in business jet market history.

Nobody can say where the world is headed in terms of economic recovery. But one thing that is becoming clear is that the cause of this downturn – a devastating near-collapse of credit markets and financial liquidity – was a discrete event. There might be additional similar shocks ahead- but the crisis that led the world’s economy to its current condition ended sometime in the first quarter of this year. That means the world will gradually resume growth sometime in 2010.

One alternative scenario posits that a sharp economic drop will be followed by an equally fast recovery. Possibly- this will involve inflation- which could hit the economy as a vast amount of government spending combines with an extremely loose fiscal policy. This would cause a rapid recovery in business aircraft market conditions- but it would likely produce anemic growth rates after that initial recovery.

A third alternative would be a decade-long depression. This would produce a “swimming pool” market trend- with a market drop followed by a long flat bottom. But as discussed above- nobody regards this as a baseline scenario.

Assuming that our baseline scenario is the correct one- we can expect the economy to remain in recession through 2008- 2009 and 2010. This means business jet market conditions will stay poor through 2010- or early 2011- with no deliveries recovery until 2012. If the number of available jets keeps rising beyond the present 16.2% of fleet- and if those jets are actually on the market- it might take an additional six months for new deliveries to recover as the market absorbs all of the used planes.

But making the assumption that the credit shock has produced a downturn that’s relatively “front-loaded” (i.e.- with the sharpest market drop felt initially)- a forecast of a 40% peak-to-trough ratio seems appropriate. This market drop is in line with past downturns- only longer.

Although business jet ownership and utilization has been equated by many with excess and abuse- the extraordinary transformation of the business aircraft market over the past 14 years has been closely linked with corporate profits. And the composition of these profits indicates encouraging trends too.

It is impossible to state empirically that one type of profit is more conducive to business jet demand than any other. But it’s notable that manufacturing profits have made the strongest leap of all the business sectors. According to the US Bureau of Economic Analysis (BEA)- US manufacturing profits leaped from $53 billion in 2001 and $48 billion in 2002 to $317 billion in 2007 and $240 billion in 2008. The strength of the US economy in 2003-2008 had almost as much to do with manufacturing as it did with financial services.

Profits in the financial services segment were stronger but flatter- going from $228 billion in 2001 and $276 billion in 2002 to $450 in 2007- and $309 billion in 2008. There’s a very strong likelihood that US and other developed country manufacturers are prospering because they are transforming themselves into product integrators. That means they are farming out labor-intensive production to work in developing countries- keeping higher value integration- development- and marketing for themselves.

The establishment of new facilities in less developed areas increases the attraction of private aviation. And of course the profits that result from a successful new manufacturing strategy is also good for business jet demand. This hypothesis is boosted by business jet demand in Europe. Just as US companies are likely to transplant production to Latin America- European manufacturers are looking to new European Union Entrants in Eastern Europe- as well as Turkey- for lower-cost manufacturing.

These Eastern European countries lack the excellent public infrastructure – airlines and trains – that have traditionally hobbled business aircraft demand in Western Europe. Companies setting up shop in Eastern Europe are increasingly looking towards private aviation. In 2001- only 10.7% of the global business jet population was domiciled in Europe. In 2008- Europe’s share of the fleet was nearing 15%.

Meanwhile- economic development in emerging markets is gradually boosting business jet demand from customers in many of those countries too. Relatively high commodity prices are further increasing demand- particularly in Latin America and the Middle East. Markets outside of the US accounted for 23.5% of the fleet in 2001- rising to 30% in 2008. In 2008- most business jet manufacturers reported a majority of sales from outside the US.

Asia remains largely quiet as a source of demand- for reasons of geography- politics and excellent airline service- but there are signs that this could change. Due to its economic growth- poor infrastructure- and great geography- China could emerge as a huge market as its air space rules are liberalized. But as of 2008- the country has only about 20 business jets in civilian use.

If demand in China grows- the rest of Asia could easily follow. This is particularly true since many Asian manufacturers in higher cost economies such as Singapore- Japan- and Taiwan look to China as a source of lower cost manufacturing sites. Basically- Asian businesses located in high-cost manufacturing countries could emulate their US and European equivalents- looking to private aviation as they follow an integrator model of manufacturing.

In short- despite the current grim market conditions and negative short-term outlook- there are solid reasons to assume that this market will recover and resume its growth in the future.

Next month- we’ll look more specifically at the outlook for the different aircraft categories and the major players in business jet manufacturing. Mr Aboulafia can be contacted at raboulafia@tealgroup.com - www.tealgroup.com

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