On your marks…

Dino D'Amore
By Dino D'Amore May 12, 2014 15:36

On your marks…

We all knew there would be red ink in the race for market share, we just did not think it would extend to engine OEMs too.

A few years back someone asked me what they need be worried about, the crux of my reply centred on price wars in both the airline and MRO markets.

In the MRO market we have all known for some considerable time that the OEMs have forced virtually all independents to become, well, affiliates of the OEMs and to an extent this has created some harmony on the surface. Below the surface though, especially in the engine overhaul market, there is outright war going on. Right now certain engine OEMs are at war with what little remains of the independent MRO sector. Independents are going to airlines and offering them very good prices on maintenance contracts based on using DER parts, that are, in certain cases seen by Airline Economics (and freely admitted by the MROs), offered at a loss. But then the OEM is coming in and offering an even lower price using OEM parts! Not only are the engine OEMs running a loss on these maintenance contracts, they are also then being held to account by the airlines. What for? Well in four cases that we are privy to the airlines have taken the OEM quote, compared it against other aftermarket agreements and then gone back and forced the OEM to compensate them for the “overpriced” maintenance carried out previously. Some engine OEMs are running their aftermarket agreements at significant loss just to knock independents out of the market and now they are taking on an even larger loss as contracts are being retrospectively re-priced downward. Great news for first tier airlines; bad news for OEM shareholders. But is this not anti-competitive behaviour?

All airlines getting engine maintenance quotes right now need to be sure to match them off against an independent and an OEM to get best prices and then they need to compare these prices against previous agreements in place. There is money to be made out of the OEMs here for the airlines.

One cannot help but think that in the not too distant future second- and third-tier airlines are going to be stuffed on cost of parts for engines as they will have no other options left open other than a monopoly of OEMs controlling everything across the total life of an engine. This in turn could lead to mid- and late-life aircraft prices tumbling, but it will, in any event lead to engine maintenance costs increasing. If the select few partially-independent aircraft MRO specialists are driven out of the DER repair space, maintenance costs within the next five years will increase significantly. Our information suggests that 11% would need to be added to many engine aftermarket agreements going through at this time in order for them to be in profit. I wonder who among you thinks for one moment that when there is no one left to challenge the engine OEMs they will not simply increase their prices so that the aftermarket business runs in the black. We past the warning signs years ago we are heading for the end of the road and we are going to reach it within five years.

Meanwhile the problem of overcapacity in the APAC market continues to grow. With every aircraft delivery and with every aircraft on order with airlines and lessors being taken into account, it is certain that the lessors can kiss goodbye to the hope that they would reach 50% market share any time soon. Unless of course many of those aircraft on order with the likes of Lion, AirAsia and other APAC low costs end-up coming into the hands of the lessors.

Singapore Airlines, after reporting a sharp widening of fourth-quarter losses, stated that the overcapacity problem was getting out of hand. It cited AirAsia as one of the main reasons for its flow of red across the books as operating losses grew by S$16m (US$13m) to S$60m as yield fell.

On a full-year basis, Singapore Airlines reported a 13% increase in operating profit to S$259m, on a 1% increase in revenues. However, exceptional items such as impairment charges for four unsold cargo aircraft pushed profit down. The 40% share in Tigerair is not helping matters either and the case for non-core airline holding weighing on the books is going to get a whole lot worse in the short term as they enter the Indian airline market. Especially now that AirAsia has been granted its licence to move into that market at the same time.

There are simply too many aircraft on order and too little infrastructure to handle the same across the APAC region and I seriously doubt that there will be the passenger demand, certainly within the next five years, to fill theses deliveries. Take China as an example – the market has not performed as we were all lead to believe it would, mainly because infrastructure did not keep pace, and in China remember they can build infrastructure far faster than any other developed nation by a factor of 10 times faster if we compare Hong Kong to the mainland for example. And so we must ask: If China could not keep pace, how can other nations? I would also add to the argument that the Chinese high-speed rail network will have a far greater impact on projections than previously forecast and Indian hopes of emulating this Chinese success look set to bring serious competition to Indian airlines that previously did not exist.

So with 25 new airlines launching in the APAC region, 15 of them in China, we have to wonder where the passengers are going to come from. I am sure the potential passengers are out there but this is not an ideal world and airlines will use price to capture market share and that means losses even if they fill aircraft. At least they will be able to get engine parts on the cheap from the OEMs!

Dino D'Amore
By Dino D'Amore May 12, 2014 15:36
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