A report by Wedbush Equity Research
Posted by- Neelam Mathews
March 26, 2012
Checks Indicate Chinese Aftermarket Demand Holding Up, Freight still Struggling
• In light of increased concern with the 2012 growth outlook in China, we conducted a number of specific checks to determine the impact on the demand for commercial aerospace aftermarket parts and services. So far, the macro issues in China have not had a negative impact on 1Q 12 aftermarket parts demand. It is true that the Chinese market for aftermarket parts demand will see slower growth in 2012 (~10%-12% as compared to ~20% in 2011), but recent issues have not yet changed the outlook for firms relative to expectations at the end of 2011. Remember China accounts for an estimated 8% of all commercial aftermarket parts shipments.
• Any slowdown in aftermarket activity will be initially felt in engine and airframe markets. We have heard that engine is currently somewhat softer now than it was last year (in line with expectations), while airframe has remained steady. However, the backlogs at Chinese MRO shops are still very strong (most sold out through 2012), with slightly more caution on the full year outlook, with deferred maintenance still having a positive impact. China continues to face headwinds from increased labor rates, but the general consensus is that there is more than enough lean opportunity in the Chinese MRO sector that it will offset continued labor rate increases at least for the foreseeable future. Moreover, while there is an abundance of excess parts in China, even with lean initiatives we do not expect this will negatively impact future parts demand.
• Internal 2012 revenue growth forecasts for Chinese MROs remain intact. Fuel and cargo remain the key challenges to achieving MROs 2012 growth forecasts, while the resilience of the commercial transport market remains the source of strength and something that MROs have become more comfortable relying on. The bankruptcies and difficulties from some of the cargo carriers have had an impact; however we have heard that demand from the commercial passenger side has been more than enough to recoup any of the lost slots from the cargo carriers thus far.
• Over the last 5 years, the correlation between the change in Chinese air traffic and the change in PMI data is very low, suggesting that a slowdown in Chinese manufacturing is not necessarily a predictor of commercial aerospace fundamentals. This does not mean the aerospace industry is immune to a Chinese downturn, but it does suggest that there will likely need to be more external factors to drive the industry down in China than lower manufacturing or macro concerns.
• On the original equipment market, we believe the order books for both Boeing and Airbus in China are secure. Further, China actually accounts for 7% of the total industry backlog, 6% and 8% for Boeing and Airbus, respectively. We believe that the emissions trading scheme (ETS) implemented in Europe is a risk for Airbus near-term, but long-term we do not think it will impact our positive original equipment outlook.
• We believe the recent announcement between Bombardier and Comac regarding the CSeries and C919 is significant. We had expected closer cooperation. Comac brings in capital and potentially more customers, which is what the CSeries needs. Bombardier brings certification and systems integration experience, which are two key areas of weakness for Comac. We still do not expect to see the C919 enter service until closer to 2020, but we believe this announcement is a significant step forward for both programs.
• We are not yet revising our 2012 aftermarket outlook, but we are increasingly cautious on the growth prospects. We continue to expect parts growth in the ~8% range (approx. 5% from volume and 3% from pricing), after growth of ~12% in