So far it has been an eventful year in the aerospace industry. We of course have the grounding of the Boeing (BA) 737 MAX, but in February Airbus (OTCPK:EADSF) also announced that the Airbus A380 program would be terminated effective 2021. For one of the biggest customers, namely Emirates, this had implications, but as we expected earlier for Boeing there would be implications as well.
In this report, we will detail what drove Emirates’ fleet changes, discuss the changes that are now confirmed via the Emirates annual report and we also discuss some unpleasant findings we encountered as we approached Airbus and Emirates to receive some clarification on some orders and tentative agreements.
Emirates changes strategy (2003-2014)
While the termination of the Airbus A380 program is the consequence of a failed business case, Emirates strategy and corresponding fleet requirements have likely pushed the Airbus A380 over the edge.
To get an idea on Emirates’ strategy we have to go 16 years back and keep in mind that state-owned Emirates was a very important part of Dubai’s growth puzzle supporting business travel as well as tourism and the growth profile at all times had to match Dubai’s aspirations and limitations.
In 2003, Emirates placed its first order for the Airbus A380 and Airbus A340. The airline would suffer delivery delays as the Airbus A380 ran behind schedule. The airline added capacity by leasing additional Boeing 777 aircraft. In 2006, Emirates also decided it would not take delivery of the Airbus A340 aircraft it previously ordered. This had everything to do with the launch of the Airbus A350 earlier in 2006, which would be vastly more fuel efficient in comparison to the Airbus A340, and the first deliveries of the efficient Boeing 777-300ER to Emirates.
In 2007, Emirates ended up ordering 70 Airbus A350 jets from Airbus with first deliveries scheduled for 2019. At the same time, Emirates remained committed to the Airbus A380 and Boeing 777-300ER. What became problematic for Dubai is that the Great Recession hit the real estate sector leaving even government backed entities vulnerable in 2009. The Great Recession led to a slow down in growth of passenger traffic at Dubai International Airport between 2007 and 2011. The debt crisis in Dubai’s real estate sector made the always ambitious Emiratis a bit more cautious and development of mega projects such as the Al Maktoum International Airport that should have a capacity of 160 million passengers was slowed down simply because that capacity wouldn’t be needed for years to come. Given that Dubai had to be bailed out there also wasn’t a lot of space for ambitious projects. Instead money was spent on expanding capacity of the existing airport where the use of bigger aircraft became an integral part of Emirate’s plan to realize growth.
As part of that strategy, the following orders, changes to (tentative) agreements were made while some noteworthy events impacted the strategy:
- Great Recession hits Dubai’s passenger growth between 2007 and 2010.
- A tentative agreement for 30 Airbus A350s and 30 Airbus A330s announced in 2008 was never firmed.
- In 2010, Emirates ordered 32 extra Airbus A380s bringing the total number of ordered Airbus A380 to 90.
- In 2013, Emirates ordered 50 Airbus A380s bringing the total number of ordered A380s to 140 and ordered 150 Boeing 777X aircraft.
- In 2014, Emirates cancelled its order for 70 Airbus A350s and firmed its order for the Boeing 777X.
- Oil prices tumble between 2014 and 2016.
What we observed is that as Dubai became somewhat more risk adverse when it comes to huge and complex projects such as the development of Al Maktoum International Airport, it went from selecting the Airbus A340 to the A350 to the A380 and Boeing 777X. To realize growth targets, Emirates started to use bigger aircraft such as the Airbus A380.
Changing segmentation (2015-2017)
There, however, was something playing in the background that would trigger a second turnaround in Emirates’ fleet strategy. In 2014, oil prices dropped and for airlines that tends to be a good thing. For Dubai, however, it meant that it suffered from a decline in demand for business related travel not only within the United Arab Emirates but also internationally as Dubai serves as one of the biggest transit airports in the world. This brought significant pressure on yield and in December 2015 Emirates started to configure their new Airbus A380s in denser configurations to focus on boosting its result with tourists filling the economy class seats. Simultaneously Dubai started focusing more on attracting cost conscious tourists.
So, Emirates had to look at improvements in the efficiency of the aircraft to improve yield. Due to the grim prospects of the Airbus A380, Engine Alliance, which up until that point was the turbofan supplier for the Emirates A380 fleet, didn’t want to upgrade its engine to the extent desired by Emirates. Rolls Royce, which had lost out on at least 140 turbofan orders when Emirates cancelled the order for A350 for which Rolls Royce is the sole turbofan supplier, was more willing to put effort in reducing fuel burn. Rolls Royce would end up winning the order to power part of the Airbus A380 fleet.
Source: Rolls Royce
The hit for Rolls Royce came when first deliveries were delayed over unspecified technical issues and post-service-entry. Emirates was not happy with the performance of the turbofan but it never became clear what the pain points were. For Emirates or any other airlines, adding a second type of turbofans is only worth it if the total costs savings (maintenance, operation and possible costs related to maintaining reliability and durability) exceed the introduction costs of a new propulsion system.
Eventually the first Airbus A380 with Trent 900 turbofans from Rolls Royce was delivered in December 2016 and it was expected that this would pave the way for an order for 30 superjumbos at the Dubai Airshow in 2017. As Airbus fully relied on Emirates for its A380 order book, the airline was seeking a production guarantee from Airbus for the coming 10-15 years which would mean that if Airbus ever fill the order book for the coming 10-15 years, Emirates still would be able to select the Airbus A380 to support growth from its new Al Maktoum hub. To get that point in 10-15 years, Airbus would require sales to new customers. If the jet maker would find those, it would boost the prospect for an updated Airbus A380 as the business case for the Airbus A380 would be validated. What Emirates basically said to Airbus was "Go find additional customers" and that was an almost impossible task. A deal at the 2017 Dubai Airshow for additional superjumbos was not signed.
From Airbus to Boeing and back (2017-2019)
Instead of Airbus taking the stage with Emirates at the 2017 Dubai Airshow, Boeing took the stage announcing a tentative agreement for 40 Boeing 787-10 aircraft with possibilities to convert some orders to the smaller -9. When finalized, it would be a major blow to Airbus. The use of smaller aircraft would fit in Emirates post-2021 requirements as its capacity requirements starts to ease after the Expo 2020.
Because Emirates tends to order from Boeing as well as Airbus, an agreement for an A380 order was expected nevertheless. That order came in 2018, when Emirates ordered 20 aircraft and acquired options for an additional 16. However, while Airbus and Emirates reached an agreement, Rolls Royce and Emirates couldn’t reach an agreement on price and performance of the Trent 900 turbofans. The result was that the Emirates order, seen as crucial for the superjumbo’s production life, became shaky once again. With a tentative agreement for the Dreamliner not being finalized and no agreement between Rolls Royce and Emirates, the Airbus A350 and Airbus A33neo came back in the picture. If an order for the A380 were to fall through, Airbus and Rolls Royce could offer a sweet deal to Emirates that would likely be way better than anything Boeing could offer on price point.
The reasons are simple:
- Emirates has been extremely supportive of the Airbus A380 program taking deliveries when other airlines deferred their deliveries.
- Airbus was determined to not lose an order for the Airbus A350 once again.
- Rolls Royce was determined to not lose out on a deal once again.
It really left Boeing in the cold. It now looks like Emirates staged an entire signing ceremony with Boeing to generate leverage in negotiations with Airbus, but there is very little the US jet maker can do about it. Emirates acquired itself the leverage to get the sweetest deal for the Airbus A350 and Airbus A33neo.
The airline had three sticks to beat with:
- The first stick is that the airline asked for something that was nearly impossible when ordering or planning to order additional Airbus A380s, namely a production guarantee knowing that no airline was interested in the Airbus A380. Absent of any commitment from other airlines, Emirates still ordered the A380.
- The second stick was the stalled negotiations with Rolls Royce.
- The third stick was a tentative agreement with Boeing.
Emirates positioned itself such that it could adapt its strategy to changing demand patterns, adopt the industry trend preferring twin-engine aircraft over quad-engine aircraft, and use smaller aircraft making it fleet more flexible allowing for more disciplined capacity deployment… at the lowest price possible.
Boeing 787 commitment gone and comment on tentative nature
One thing that we continuously emphasize especially right before and during air shows is the tentative nature of some agreements. When Airbus announced the agreement with Emirates for the A350 and A330neo I spoke with readers and members of The Aerospace Forum who were asking about the fall out in the order book of the Dreamliner. The fact, however, is that the tentative agreement was never firmed.
We’ve been following all aircraft programs from Boeing and Airbus closely for years now and there is one thing that readers should be aware of and that is that tentative agreements never go in the order book and a firm order can always be cancelled. When reviewing Emirates’ annual report, we also stumbled on something that suggested that the firm order that Emirates placed was not as firm as believed further strengthening our belief that just like the Dreamliner tentative agreement the Airbus A380 agreement was used as leverage for future negotiations.
Figure 1: Fleet information March 2018 as presented by Emirates (Source: Emirates)
We had a look at Airbus’ February 2018 order overview and there indeed was an orderfor 20 Airbus A380s. However, if we look at Emirates fleet information (Figure 1) from their annual report what drew our attention is that the Airbus A380 order that was said to be firmed in February 2018 was in the “authorised & not contracted” category in Emirates' annual report, which gives the impression that there is no firm purchase agreement and the “firm order” that was signed was actually still a commitment of tentative nature or slightly more than tentative.
AeroAnalysis compared this to Boeing’s order overview for the Boeing 777X and Boeing 787 to verify whether these future deliveries were included and what we found is that, as expected, the firm part of the Boeing 777X order is included in Boeing’s order book, but the tentative agreement for the Boeing 787 is not. This supports our view that tentative agreements do not end up in the order book. Another important observation is that while it was rumoured that Emirates had 60 options for the Boeing 787, there has been no such arrangement.
We reached out to Airbus to get some clarification on the matter; We wanted to know how it is possible that an order has been logged, but the customer itself still says there is no contract. We also asked Airbus to explain what it takes for an order to be logged. By e-mail, Airbus confirmed to AeroAnalysis that Emirates signed a purchase agreement and it requires a purchase agreement to add an order to the books.
A similar request was sent to Emirates to provide clarification how it was possible that the airline claimed it signed a firm order but still listed the orders as “not contracted”. Emirates Group Vice President of PR, Social Media and Internal Communications, Valerie Tan, refused to comment on the February announcement of a firm order and only confirmed that agreement announced in January was of tentative nature. As we pushed for transparency regarding the February 2018 order announcement, Emirates left our request for information unanswered.
The only reason we could think of for an order to end up in the order book but not being categorized as such by the customer is the inclusion of clauses that would create no direct obligation for Emirates as long as Airbus does not meet their end of the commitment and I’d believe that Airbus’ part of the commitment in this case would not be to just assemble, test and deliver the aircraft but also find customers for the aircraft. Another possibility is that the entire order would be considered to be contracted for if a deal was reached for the propulsion systems as well. AeroAnalysis doesn’t believe Airbus did indeed log a Memorandum of Understanding as an order. If they did that would be an incredibly bad thing that would remove all credibility to the company’s order book.
The timing of the cancellation is also interesting as it comes a year after the order was placed. Possibly, Emirates gave Airbus a year to bolster the order book, but the jet maker was unable and likely even unwilling to do so. Looking back, the order from Emirates in February 2018 has been more tentative than firm and less firm than an addition to the order book would justify though the criteria to add the order to the book had been met. Possibly there either were additional clauses to be met or the order hinged on a deal with Rolls Royce. Either way, it’s regretful that a company such as Emirates refuses to provide clarity on order announcements.
Figure 2: Fleet information March 2019 as presented by Emirates (Source: Emirates)
What we observed in Emirates’ latest annual report is that it changed the way it reports “orders” compared to last year. In previous years, Emirates listed “firm orders”. Last year, Emirates split its orders in “contracted for” and “not contracted” for categories and in the 2018-2019 Emirates bundled those two columns into future deliveries with no differentiation between tentative and firm orders. To me it explains why Emirates didn’t provide clarity on their fleet information: The way the airline tabulates its fleet and commitments is inconsistent at best and selective at worst.
Either way, what we are seeing is that Emirates future deliveries dropped from 262 to 234:
- Airbus A380 future deliveries dropped by 46 units.
- Boeing 777-300ER future deliveries dropped by 12 units to 0, signalling that Boeing has yet to cancel or convert 6 orders from Emirates.
- Boeing 787 tentative future deliveries dropped by 40 units to 0.
- Airbus A350 future deliveries increased by 30 units.
- Airbus A330neo future deliveries increased by 40 units.
What should be considered is that the future deliveries for the Airbus A350 and Airbus A330 are under tentative agreement. It’s likely that during this year’s Dubai Airshow this order will be firmed. Additionally, Boeing 787 future deliveries disappearing are not indicative of order book decline for the Dreamliner. For Boeing, losing the tentative agreement is painful. Tentative agreements lapsing is not uncommon and I think if you consider the Emirates’ current fleet and future deliveries, there is no reason to assume that Emirates won’t use the lapsed Dreamliner agreement to get a sweet deal from Boeing in the future.
Investors should be aware that tentative orders are not logged by jet makers and even firm orders are not as firm as they appear. While the Airbus A380 program cancellation is one that was expected, the order reshuffle is not one-dimensional. There are many things baked into Dubai’s (not just Emirates’ aspirations) that drive the Emirates fleet strategy and changes to that strategy. From efficiency to global crises to real estate shocks to oil price shocks to changing passenger mix to more disciplined deployment of cash and capacity... it all has affected the fleet decisions Emirates made over the past 16 years.
It’s clear that the Airbus A380 didn’t live up to expectations and Emirates was the only airline that could really absorb this aircraft in huge quantities, but to understand why the Airbus A380 really made sense for Emirates we have to go back a decade and take note of the financial difficulties that Dubai had during the debt crisis sparked more stringent cash and debt control that altered the need, timeline and appetite to invest in Dubai’s new mega-airport.
Figure 3: Oil prices between 2013 and 2019 (Source: Macro Trends)
An added layer to that is the collapse of oil prices in 2014-2016 which, even for Dubai that prides itself as being largely independent of oil money, had consequences as the high-yield business class segment usually filled by people from the banking and real estate sectors declined and one of Dubai’s big growth drivers, tourism, started focusing more on cost conscious travellers to maintain growth rates.
The Airbus A380 without commitments from Rolls Royce on lower engine related costs made less sense as a future fleet solution as oil prices despite being volatile are heading up again and after the Expo 2020 hosted in Dubai, growth at Dubai’s current airport will flatten somewhat. So, Emirates started looking at the smaller wide body aircraft Boeing and Airbus have on offer. Boeing seemed to be raking in an order for 40 Dreamliners, but in combination with added pressure from the Dreamliner agreement, Rolls Royce not meeting Emirates’ demands in negotiations and Emirates long-term support of the superjumbo, possibilities opened up for Emirates to acquire small wide body jets from Airbus at prices that were too good to pass up. I believe, that even without any issues with the propulsion system, Emirates is at a point where it needs to acquire smaller jets to grow efficiently and having supported Airbus’s miserable Airbus A380 program really gives them a strong lever to negotiate hefty discounts on the purchase of smaller jets. The reason to drop the Airbus A380 order are likely far bigger than stalled negotiations with Rolls Royce.
The tentative agreement disappearing from the Emirates annual report might be disappointing for Boeing, but it certainly is not the case that there are no possibilities for Boeing to sell more aircraft to Emirates. In the same way Emirates used the January 2018 tentative agreement for the Airbus A380 to get a sweet deal on the other Airbus aircraft purchases, Emirates might be looking for an equally sweet deal from Boeing for either the Dreamliner or the Boeing 777X and when that chance arises there is little doubt that also Boeing will bite.
At the IATA AGM, Tim Clark said Emirates remains committed to the Boeing 787-10. While they might still have intentions to buy the aircraft it still looks like the tentative agreement lapsed without a firm agreement being signed. As we pointed in mid-May to subscribers of The Aerospace Forum, there still are chances for the Dreamliner in the Emirates fleet. It’s just going to be tough to reach an agreement on price point.
For Airbus investors, the tentative agreement is good news as Airbus is taking back an order that it lost years ago. For Boeing, the tentative agreement for the A350 and A330neo means that if they want to sell the Boeing 787-10 to Emirates, they have to offer a very attractive price. Another possibility is that the company sells more Boeing 777X jets to Emirates, but the question remains whether Emirates will use the Boeing 777X as its growth vehicles or opts for the flexibility that the smaller jets offer. An investor won't see much of a difference in the charts; Since the announcement of the tentative agreement for the Dreamliner, Boeing shares gained 33% versus 37% for Airbus. Since February 14th when Airbus terminated the A380 program, Airbus shares gained 11% versus a 15% decline for Boeing shares. Price development, however, is not driven by these tentative agreements and are more closely related to the Boeing 737 MAX crisis and general market directions.
Single orders won't have a lasting impact on share price development, but to invest wisely in this industry one should once in a while be made aware of how complex and multi-dimensional the purchasing process is and what factors heavily affect fleet decisions. The aerospace industry moves slow at times, so having thorough looks at orders is of importance when you want to get a full picture and understand why certain order books are the way they are.
I continue to believe that as we head into the 2020s we will see what product airlines prefer, whether it is the Boeing 787 or Airbus A350, which are both smaller/medium wide body jets, or the Boeing 777X. It is expected that both jet makers will book meaningful orders in the years to come, so both jet makers should prove to be good long term investements provided that Boeing can fix its current issues.
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