MIAMI — In the First Part of this analysis, we provided an overview of the competitors in the large regional jet (RJ) and small mainline aircraft space. In the Second Part, we provided a comparative analysis of the products, beginning with their current order books and proceeding through capabilities and operating economics.

Oil prices drive risk aversion

Across this space, lower oil prices today (and potentially into the future) are pressuring sales. When oil prices are low, airlines are emboldened to wait longer to place replacement orders as their current fleet becomes more economic to operate. This mixes with the uneasy macroeconomic environment in the developing world and Europe (only the US and India are in decent shape, and the latter has an airline industry that is still dealing with over-capacity) to sap growth orders as well.

Asian Market Cools

Not just China, but all of Asia is important for these manufacturers. Unfortunately, like China a huge limiting factor is air traffic control and other ground infrastructure. Flight delays are rampant in Asia, and the problem is worst in China, where on time performance is routinely below 50%. Even the 100 frame order for the SSJ is at risk. Until Asian infrastructure constraints sort themselves out or are sorted out through investment in next generation air traffic control technology, the larger Airbus and Boeing narrow bodies will have an advantage in the region. Iran might be an exception to this. The domestic market is a good candidate for the CSeries and/or the E-Jets – Iranian carriers may order both in order to “spread the wealth,” copying the Chinese strategy to make sure that everyone is happy. But first the US Congress needs to uphold the Iran deal, which is not a sure bet. Iran is already looking hard at the SSJ as mentioned below.

It’s all about execution for Mitsubishi

For the moment, the MRJ’s biggest concern is contractual. Mitsubishi needs relaxation of scope clauses in US on the weight side (the MRJ is currently too heavy for existing scope clauses) as well as on the seat capacity side, where the MRJ could be operated at 76 seats, but is really optimized for 80-82 as mentioned previously. The timeline required for relaxation is sharp. Trans States and Skywest, who represent roughly 67% of orders and roughly 81% of purchase options for the MRJ, are scheduled to start taking delivery in 2017. Embraer needs scope clause relaxation for the E175-E2 as well, but can afford for the timeline to be shifted until 2020.

Beyond scope clauses, it’s all about execution. The MRJ is a good product in a market where they can make some cash; they just need to get to EIS smoothly with an airplane that works. Further orders are likely to wait until Mitsubishi shows that it can deliver on the MRJ’s promise. Once that’s in place, the MRJ will sell just fine. In terms of the current order skyline, many are from established customers. The Eastern Air Lines order stands out as risky because Eastern is a startup without proven business model in the US, which has been a harsh environment for startup airlines, where no US startup has survived since Virgin America in 2007.

Pilot shortage threatens to re-open EJet production gap

For Embraer, the E175 represents roughly 64% (168 orders) of the EJet backlog, which presents some skyline risk due to the deteriorating economic and structural conditions for regional carriers in the US. Unfortunately, pilot shortage is now a very real problem for these carriers. An example is Republic Airlines. In July, Republic thought Delta was going to cut its 42 E145s, freeing pilots who would fund additional 70 and 76 seat flying. But Delta chose not to eliminate the E145s (as was their contractual right), and Republic is facing the squeeze. More extensions to 50-seaters by the mainline carriers now that fuel is cheap, could make it physically impossible for US regionals to fly the E175s on order without increasing pilot pay, growth, or pass through rates to mainline carriers sharply (effectively economically impossible), which could reduce E175 orders. If E175 orders are even halved, it suddenly becomes very tough for Embraer to bridge production gap

Once Embraer bridges to the E2, it is smooth sailing. Until Bombardier figures out sales, the EJets E2 (especially smaller mainline jets) are in good shape. In terms of future orders, right now, the best bets are replacement orders from existing E-Jets customers, and new mainline orders from right-sizing US and European legacies, who together could easily push the EJets E2 to upwards of 1,000 orders.

Skyline risk looms for Bombardier

For Bombardier, there is lots of risk in its current backlog, mainly in the form of uncertain orders and commitments. Its largest customer Republic’s 40 CSeries were ordered for LCC Frontier Airlines, but Republic since sold Frontier while retaining those orders. It has no way of flying them (short of starting up its own airline), and is likely to cancel or sell delivery slots to other carriers. The risk for Iraqi Airways’ order for 5 frames can be summed up by 3 (oil) and 4 (ISIS) letters. The CSeries’ second largest customer, Ilyushin Finance Co. is susceptible to Russian macroeconomic and geopolitical risk, mainly because sanctions prevented Bombardier from giving Ilyushin Finance Co development bank aid. But at the MAKS 2015 air show, news broke that Ilyushin is looking to market the aircraft outside of Russia, and after the positive technical news out of Paris, people are more willing to consider asset backed financing for the CSeries. Amongst smaller customers, SaudiGulf Airlines and Malysia’s flymojo are startups, which is always risky. Porter’s 12 + 18 are also up in the air due to factors beyond Bombardier’s control (i.e. the fight over jet flights at Toronto Billy Bishop Airport)

China is a wild card for Bombardier’s future

One open question is whether China will consider a CSeries purchase after committing to the SSJ. The world’s second largest air travel market is an important demand center for most OEMs today, but for the CSeries, they’ve adopted a wait and see approach (minus Zhejiang Loong Airlines who committed to 20). This is partly due to ATC concerns, as China’s current airspace is heavily constrained (evidenced by abysmal on time performance figures. In the current Chinese marketplace, the CSeries might be too small. But China’s reticence likely is driven by other factors. In fact, China may well be holding off on a CSeries because it can use its financial scale to engineer a fire sale, either of the aircraft, or of Bombardier itself.

China’s aerospace ambitions are well known, but thus far its recent attempts at entering the commercial aircraft space, the ARJ 21 and the COMAC C919, have been lacking. China has the infrastructure and the raw materials/talent; it now needs the technical aerospace quality and expertise. Bombardier has that in spades, even if it is a financial basket case. Perhaps China is putting the squeeze on Bombardier before buying them at a discount. For non-Chinese orders moving forward, flexibility will keys, as the executives above the CSeries have previously turned town deals for having less than perfect terms). The new C-Suite folks in Toronto and Montreal appear to be far more flexible, but that hasn’t translated into firm orders yet.

Sukhoi maintains SSJ momentum

Despite Russian macroeconomic weakness and geopolitical volatility, Sukhoi will deliver 44 SSJs in 2015, and news recently broke that Aeroflot is looking to add 50 more SSJs to its fleet. Sukhoi also won a bunch of orders for the SSJ at MAKS 2015. Lessor GLTK firmed up 32 SSJ100s with 28 options, of which 15 aircraft will flow to SCAT Airlines of Kazakhstan and 25 will fly for Russian carrier Yamal Airlines. Another Russian carrier, Red Wings, purchased 2 new SSJ100s and wet leased an older SSJ to Cambodia’s Sky Angkor Airlines, who will also wet lease two further SSJs from Ilyushin Finance Co. before buying the aircraft outright. Other potential orders include the Jordanian government for VIP versions of the aircraft and Interjet with yet another top-up. News also broke at MAKS of serious SSJ interest from the soon-to-be opened Iranian market. Russian aircraft have bad reputation amongst the Iranian population, but Iranian airlines are eager for the SSJ, as Iranian domestic airlines Kish Air, Zagros Airlines, and Caspian Airlines all held negotiations with Sukhoi at MAKS. The primary driving factor for these airlines appears to be cost. Iran’s primary concern for domestic jets is cost. Sukhoi has also just won an order from a China-based lessor for 100 aircraft. But the SSJ might not be right size aircraft for China, especially with the domestically built ARJ21 in place.

Sukhoi is rapidly moving towards a future where sales for the SSJ are driven by the Russian sphere of influence, just as for other Russian-built aircraft. For example, along with additional SSJs, Aeroflot is going to buy 50 Irkut MC-21s, while jettisoning Western aircraft. Beyond Russian satellites, the SSJ also has potential for airlines looking to minimize capital costs, thanks to aggressive state aid from a Russian government looking to boost foreign capital inflows after the slide in oil prices and the relative collapse of the ruble. Sukhoi should be able to undercut the market by another 10-15% on an already cheaper product, which could close the operating economics gap with more efficient Western products.

New Metrics for Success

The sales pitch for these aircraft is being refined, with Embraer taking the lead. In recent months, Embraer has ramped up messaging on the merits of small mainline aircraft. You can read this article from Leeham News for more details, but basically Embraer is trumpeting its so-called New Metrics for Success. The basic idea is that smaller aircraft allow for a better ROIC than larger aircraft because they are more right sized than the larger 150+ seat Boeing and Airbus jets, which means less empty seats, and because they are cheaper than the Boeing 737 MAX and A320neo families, which lowers capital costs

Embraer research shows that many current 737/A320 family flights go out with 100-120 passengers on board, the sweet spot for the E190/E195-E2 (and to be fair the CSeries). While the smaller mainline jets produce less revenue than the bigger ones, they provide better yields and better return on capital employed (RACE). Embraer wants airlines to stop focusing on economic metrics like CASM and instead judge aircraft on RACE. It remains to be seen how much Embraer’s message will land (and if it does how much of the benefit will spill over to the CSeries), but the analysis of rightsizing capacity while boosting unit revenues is a trend that has powered the US airlines to record profitability. The rest of the world isn’t the same as the US structurally, but it stands to reason that the same trend may spread into other developed markets and troubled economies at the very least. This could be very good for Embraer and Bombardier

The 70-90 seat market is easiest to project, with one key exception. In the US, which stills the dominant market for the regional jets, pilot shortage is the elephant in the room. It’s already a concern at the regionals, as noted with Republic and Bombardier, and until the US airlines figure out a solution, it will only grow. When this intersects with low fuel prices and the long run contractual nature of the regional carrier industry, this could be a serious problem in the next 3-5 years.

MRJ and E175-E2 will split the market

Assuming that the market’s fundamentals don’t implode, MRJ is likely to split it with Embraer, as the CRJ is just no longer competitive. The CRJ may still win a few marginal orders however. Bombardier will compete on pricing and availability, as it has more flexibility to discount given that the CRJ line has long been paid off and it has plenty of spare production capacity. This could be attractive to cash conserving airlines, especially in the current fuel environment. The one exception to this analysis is if the scope clause weights don’t increase for US mainline carriers, in which case the CRJ-900 will be the only game in town (and Mitsubishi/Embraer will race to strip weight out of their airplanes). Additionally, if a hard seat cap remains in place, then the CRJ-900s relative economics look better without the 2-4 seat advantages for the E175/MRJ90 in the US. Over the next 20 years, we project roughly 750 additional sales in this space (beyond current orders). China’s ARJ21 has 342 orders, but its eight years late, obsolete, and frankly a basket case, and won’t sell much outside of China and its sphere of influence. Many of China’s large airlines only ordered the plane because of government diktat. ARJ21 program execution has been lacking, and China is one development cycle away from matching Russian technical quality, and probably two from matching the West (i.e 20-30 years).

E190-E2 a cut above CS100 and SSJ

On the smaller side of the mainline segment, Embraer is the clear leader, as its product is superior to Bombardier’s. We expect an order split roughly 2:1 in favor of Embraer over time with the E190-E2. Sukhoi will mostly win orders in the Russian sphere of influence and from airlines that are primarily judging products on capital costs. That’s true as long as sanctions stay at their current level or get better. If they get worse, then all bets are off, though Sukhoi is moving to more Russian (domestic) sourcing of parts to offset some of the sanctions risk moving forward. Over the next 20 years, we project roughly 900 sales in this space (in addition to current orders)

CS300 is the Top Dog

In 110-150 seat category, the CS300 is a superior product to the E195, but for existing EJets customers, that might not matter. In the long run, we expect Bombardier to hold roughly a 55-45% edge, and over the next 20 years, we project roughly 1,500 sales in this space, and a renewed prominence for small mainline jets in developed world airline fleets. Simultaneously Boeing and Airbus will cease to matter in the 110-150 seat arena. The A319neo has 49 orders, including 19 from Avianca who need their range performance for hot and high ops from Bogota, 4 for China Southern who need them for a similar mission profile in Urumqi. The 18 for Frontier are likely to be converted to the A320neo, and the 8 UFOs are still uncertain. The 737-7 has 60 orders, but from just 3 customers, 5 of which are from Canada Jetlines. It’s anybody’s guess as to whether they even get off the ground. Southwest has ordered 30, but they will probably convert upwards to the 737-8 unless they figure out some way to stem the growth in their labor costs: otherwise, the 737-7 no longer makes sense from a CASM perspective.