The 2021 SpeedNews Commercial Aviation Industry Supplier Conference in LA this month provided many executives and advisors the first opportunity to gather again since COVID-19 shut down the sector a year before.

Aviation Week Business Editor Michael Bruno talks with Richard Aboulafia of the Teal Group, Ron Epstein of Bank of America and Kevin Michaels of AeroDynamic Advisory about the state of industry, the future, and the past.

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Rush transcript:

Michael Bruno:

Welcome to the Aviation Week Check 6 podcast. I'm Michael Bruno, senior business editor, and I am at the SpeedNews Commercial Suppliers Conference. And I am giddy with joy because I am literally staring at Richard Aboulafia from the Teal Group, Kevin Michaels from AeroDynamic Advisory, and Dr. Ron Epstein from Bank of America. Gentlemen, I'm just glad we could all get together. It's nice to see you.

Ron Epstein:

It's great to be here. Thanks.

Richard Aboulafia:

This is the best. It's so good to see you again and everyone. It's fantastic.

Michael Bruno:

It is. So let's dive into it. We're most of the way through the conference this week. We've heard a lot. It's been a couple of days, a lot of presentations, a lot of people talking. I want to start with a general feeling as to what the state of the commercial aviation industry is from what you're hearing. If you could choose one or two words, what would you say is the zeitgeists here? Ron?

Ron Epstein:

Yeah. I'd say optimistic. I mean, the one statistic that kind of jumps out to me is, there seems a broad consensus that the industry could be back to 2019 air traffic levels by, call it late 22, mid 23 or something like that. That's what the consensus here seems to be.

Michael Bruno:

Depending on the platform, depending on the market, that kind of thing, but a general optimism. Richard, what do you think?

Richard Aboulafia:

Yeah. A strong agreement, cautious optimism. We've never seen such a profound bifurcation between unprecedented traffic drops, but the economy holding up. But usually they kind of travel [together]. You see an economic disaster coupled with a traffic disaster here. We only had one, bizarrely enough. So I think there's a feeling that this things returned to life so will the great machine that is this industry.

Michael Bruno:

Kevin, what do you think about what the crowd here is thinking?

Kevin Michaels:

I think bifurcation, the word Richard use and stole, I was going to use that word. But it is clear that there's a bifurcation between domestic and international travel. So when we talk about RPKs coming back, that's the mix. But I think the theme is that domestic travel is going to recover much faster. US and China domestic travel is 55% of all domestic RPKs. And in domestic travel, it's going to be back probably 2022. And that probably underpins some of the announcements we've seen from Airbus about rate increases.

Michael Bruno:

Well, let's get right into it. Let's talk about those rate increases because I think that's the gorilla in the room that everybody's got an opinion about one way or another. I believe we have heard some skepticism from the supplier audience about rate increases. Gentlemen, would you agree, disagree?

Ron Epstein:

Yeah, I think that's right. And they should be skeptical, right? I mean, it's their job. If they just take the OEs at face value, then they're taking risks that maybe they don't want to. However, I would say if we're talking about the Airbus rates that got thrown out there particularly the target in 2025 and you think about the success that Airbus has had with A321 plus the A320, those numbers might not be all that optimistic, right? I mean, if you think 10 to 15 of those per month could be AA321s, then you're talking 55-60 A320s out in 2025. That doesn't seem all that aggressive, honestly.

Richard Aboulafia:

I'll give Kevin back custody of bifurcation. I'll go with a K-shaped here. You're seeing these K patterns everywhere and it's true for the rates. I feel generally for reasons Ron just said, better about the Airbus rates than I do about the Boeing ones in a very large part because of the 321 where Boeing doesn't seem to be competing very effectively. But you're seeing this K shaped pattern everywhere, as Kevin said, domestic international, scheduled versus bizav. I mean, the K's are just showing up everywhere on the landscape.

Kevin Michaels:

I think what I would add to that is, so whilst there's more optimism about our traveling rates, at the same time the supply chain is completely unprepared. Completely unprepared. And when you talk to suppliers, and I know you're going to ask us about this, but when you talk to suppliers and especially smaller suppliers, the long lead items required even for what Airbus is talking about next year, they don't have the working capital, a lot of them, to order it. And they don't have firm purchase orders from Airbus. So is Airbus going to walk the talk and come through with purchase orders? Because the supply chain is weakened, as we all know. And I know you'll ask us but the constraints of working capital and human capital are going to really boil up.

Michael Bruno:

Absolutely. So let's go there. We hear a lot of talk about liquidity concern in the supply chain, particularly at the lower levels, tier three, tier four below. There's a belief that the OEMs and the tier ones can get capitalized. They are capitalized and can go get more if they want. They can sell stock if they had to if they ran out of all other options. But the lower levels, they need money, they're not getting it, or at least it's going to be harder for them to get it. At the same time, human capital issues, there were a lot of layoffs, a quarter, a third, maybe half of particular workforces. Hiring them back is more difficult. Ron, I'm looking at you and I'm thinking choke points. The top tiers, do they get just how fragile the supply chain is feeling right now?

Ron Epstein:

I hope they do, right. I mean, my single biggest worry about the industry now is the supply chain for all the reasons you mentioned. It's kind of like a huge ramp. The capital base, the bricks and mortar are there but the people aren't. So you're sort of re-ramping up in an industry that just got decimated. How are you going to get the people back? So I worry about it huge. Raw material, inflation the whole thing.

Michael Bruno:

So Kevin I want to go to you on raw materials. You had alluded to that before. We're hearing about rising prices of the raw materials. There's the fear of inflation. Inflation shock could be coming back. Maybe some say it's a short-term thing, but when you look at all the money in the marketplace, a lot of people are afraid it could be a long-term. That's really disruptive to the buying an airline business model and partying for an aircraft. Just how much consideration should the whole industrial base have for rising material costs and inflation and those concerns?

Kevin Michaels:

Yeah. It's interesting when the OEMs here said, well, we're not concerned about raw material prices because we are hedged. We have long-term agreements and prices out. But the smaller suppliers don't necessarily have those agreements. Boeing has an arrangement in its supply chain with aluminum and titanium through TMX aerospace where there's longer-term pricing, so you can get that preferential. But for everything outside of that or if you're in Europe or that you don't have that, you're very exposed. So it's definitely something to worry about. And again, it's yet another headwind for potentially the smaller suppliers. Being asked to order in advance when they don't have working capital and buying at the wrong time when there's inflation in the products they're buying.

Michael Bruno:

So several other issues I want to go through but I got to pick on one that I think looms in the background. Richard, we're coming to this conference and there's been a big change or a big announcement at Boeing. Mr. Calhoun's tenure has been extended for quite a while. And so I do think that there are suppliers kind of wondering what direction is Boeing going? And we talked a little bit here at the conference about a new aircraft, whether they should, whether they shouldn't. A lot of people think they should. It's a question of timing though. Maybe its more importantly, when do they do that? Did you learn anything from this conference that surprised you about maybe what Boeing will decide to do or what you hope they decide to do?

Richard Aboulafia:

Well I think there's a very broad consensus among attendees at the conference that they really need to do something. I think that's pretty clear looking at the numbers and I think most suppliers are mindful. And customers, suppliers, financiers, they're understandably wary of giving a very strong position to Airbus in terms of their pricing power and whatever else. I totally understand that. I think the one thing that really hits people was that, okay, Calhoun's in charge here. That's very clear. Which means he owns this problem. Whether they solve this problem in two, three or six years, it is very much his problem. He is in charge of this supertanker and steering it.

Richard Aboulafia:

It also sounds however like they would rather delay it as long as possible for obvious reasons, financial reasons. And there's talk of, well, is the 321 really a fragmentation machine or is it just a capacity up gauge device? And how do we really know? It's like watching a military power kind of lose its edge. Well, should we respond to that attack or should we just wait until the attackers start lobbying canister rounds down the HQ? I mean, come on, do something. So I'm a little concerned on the basis of how Boeing is reacting to the consensus view ethic.

Michael Bruno:

And Ron, I would say there's still widespread expectation or at least a belief that Boeing... expectation on Wall Street that Boeing has to do something. And wouldn't it behoove them to announce it sooner rather than later, particularly if you have a supplier base that's a little fragile?

Ron Epstein:

Yeah. For sure it would. It's interesting, we've surveyed investors in the past and generally speaking, investors aren't always in the throughs when airplane companies launch new airplanes because that means significant investments. In this case, what was interesting about half the investors that we surveyed said they would be supportive of it. There's this concept in the investment community, in your terminal value, right, and this becomes a terminal value question. If Boeing ends up only having, call it 35-40% of the narrow body market, how does that impact the long-term value of the company? And you're exactly right. I mean, when everybody is talking about Boeing when they're down, well just get the news out there. Do it. Do it now. Get it in the market. Do what you got to do and it's up from here. So yeah, I'm with you 100% that its better to do it sooner than later.

Michael Bruno:

So unfortunately I got to get close to the end of this podcast, but there's... I'm struck about the other big issues and we didn't spend a lot of time at the conference talking about things like a grand WTO agreement maybe between Europe and America, Airbus and Boeing. We didn't talk very much about China trade war even though that looms greatly in the background. We did talk a little bit about inflation. We didn't talk very much about bankruptcies, I think, in the supplier base mainly because a lot of people haven't seen very much so far, but you hear constant fear that that wave could be coming. So gentlemen, I want to go around to each of you and say, of those other big subjects, which ones are you eyeing and what are you watching that'll come directly back and effect the supplier base that's here at the conference.

Ron Epstein:

Yeah. The most important thing I'm keeping my eye on is China and the whole geopolitical situation with China. I mean, that impacts everything from the certification of the MAX, 787 deliveries, future airplane orders. Is the industry on a path or you're going to see a bifurcation? China into its own world or not. And so China is the number one thing I'm keeping an eye on.

Michael Bruno:

Kevin.

Kevin Michaels:

I'm keeping my eye on the second and third tier suppliers, especially in light of the optimism about rates and single hour rates. I think we're in far more bankruptcies over the next year. The bankruptcies are in front of us, they are not behind us. They are in front of us. And the greatest working capital requirement is on a ramp up. It's not when you're winding down. So suppliers have survived through government support programs, burning down WIP [work in progress], burning down their working capital. And they've had very gracious vendors that have not called them in and called them on covenants. What happens now when they say... they go back to their forging supplier and say, I need forgings, I need access to working capital. How do you get that now? And I think that's what... The wave of bankruptcies is in the future.

Michael Bruno:

Kind of like squeezing blood out of rocks scenario is what comes to mind. [crosstalk 00:13:30].

Kevin Michaels:

It is. And the human capital part of it, not to pick on any particular supplier but remember, what was the Achilles heel before the crisis? It was investment castings, forgings. Precision Castparts has cut half of its workforce. You don't hire people to make investment castings off the street. And so as you come back online, a lot of those Achilles heels, they're going to reemerge. They're still there. As Ron says, this crisis is the great amplifier. And those pain points that were there, they haven't been addressed.

Michael Bruno:

Could be looking bigger. Richard, take us out. What are you watching as we come out of the conference?

Richard Aboulafia:

Well I agree completely with Ron, it's China but I can't say that because he did a great job describing all the issues with China. So I'll just focus on something else that I think is almost as important, which is an awareness of how much of a benefit to the industry the easy cash, low interest rate environment has been on so many different levels, whether it's service of airline debt, financing new jets, obviously lower cost of production and even the ability of governments to intervene in a difficult picture of the economy. And of course with that appreciation comes an awareness of vulnerability that, hey, if anything changes in the world of inflation that results in higher interest rates and whatever else, then obviously conditions could deteriorate. I think there's a broad awareness of that.

Michael Bruno:

Well, we got a lot to think about coming out of the conference. Ron Epstein, Richard Aboulafia, Kevin Michaels, thank you very much for joining and it's great to see you.

Ron Epstein:

Thanks. Thanks for having us.

Richard Aboulafia:

Great to see you.

Kevin Michaels:

Thank you, Michael.

Michael Bruno:

Come back to aviationweek.com to check out the rest of our Check 6 podcasts and we'll see you on the next edition.