As a traveler, you probably never think about the age of a plane you’re getting on. But as an investor, did you know that aging air fleets may present a buying opportunity? David Mau, Portfolio Manager, TD Asset Management, talks to Sara D’Elia on why shares of airline manufacturers like Boeing and Airbus might continue to outperform.
As a traveler, you probably never think about the age of a plane you're getting on. But as an investor, did you know that an older fleet could be a buying opportunity? My guest says airline manufacturers, which have performed well recently, can continue to outperform. Joining us to explain is Dave Mau from TD Asset Management. Thanks for being here.
Before we get into your analysis on fleet, I want to ask you, I've had a number of guests on the show talk about how they're bullish on airlines. But you like OEMs. What are they, and what's attractive there?
Well, OEMs are the manufacturers of these large commercial aircraft. These are your companies like Boeing and Airbus. And the thing to know about this market is that it really is a duopoly. There's really only two major competitors in this space. So if you're an airline and you're looking to buy a large commercial passenger plane, chances are you're going to be buying either a Boeing product or an Airbus product.
To answer your question about why we like the OEMs, it's pretty simple. The outlook for global passenger air travel is very positive. And as a result of this positive outlook, what we're finding is companies like Boeing and Airbus, they can't produce enough planes to meet demand. And this has resulted in pretty large order backlogs over the last few years that are worth hundreds of billions of dollars. And in the case of Airbus, their backlog is worth over $1 trillion.
It sounds like things like competition, demand, and where they are in their business cycle make both names attractive. But what about some of the broad themes in air travel right now. What are you seeing there?
Yeah, sure. So we think that over the next 20 years the world's going to need about 40,000 new planes. And that's going to be driven by two factors. The first one is the natural replacement cycle for the existing fleet. So a typical airplane has a useful life about 20 or 30 years. So about 20,000 new planes are going to be required over the next, call it, 15 to 20 years, just to maintain the current size of the existing fleet.
Now, the second factor that's going to drive growth in this market is, as I mentioned earlier, the positive outlook for passenger air travel. And let me put some numbers to this for you. In 2016 about 3.8 billion people globally got on a plane to go somewhere. This number is estimated to almost double by 2035 to about 7.2 billion people.
There's two reasons for this. The first one being, more people are traveling, and that's because the cost of air travel has come down pretty meaningfully over the last, call it, decade or two. The second reason is that the number of people who can actually afford to travel is growing very quickly. And a lot of this growth is coming from emerging economies, particularly in areas like Asia.
You mentioned earlier the backlog, which I want to ask you about, does that worry you at all? And really, do you think they're going to be able to address the demand needs? And if they don't, could we start to see players in those emerging market spaces, like in China and Russia? Will they start to soak that up?
Yeah, so in terms of the order backlog, what this means for the order book is that at Boeing, Boeing has taken orders for 5,900 new planes that they haven't produced or delivered yet. This number is slightly higher at Airbus. It's about 7,200 planes that they have on their order book that they haven't produced and delivered.
And you actually say that means how many years of orders?
Yeah, so in terms of production levels, that's about nine years of production at current levels. So yes, there's an order backlog. But are we worried that there's going to be new competitors entering the market? At the moment, no. There is one company in China that's a state owned enterprise that has been active recently in developing and testing new commercial aircraft. But we think that's probably at least 10, if not 15 to 20 years away from being a real viable threat.
As an investor, assuming I wanted to play the space and I'm looking at either Boeing or Airbus-- I'll start with Boeing-- what are some of the risks to consider? Is it things like their ongoing dispute with Bombardier?
No, we don't think Bombardier is going to have a huge impact. The segment that they operate in is kind of a smaller plane segment, so typically planes with 130 seats or less. And that's not a big part of the overall market. And in fact, just recently Bombardier has entered into a joint venture agreement with Airbus to build and sell their C-series jets. So for all intents and purposes, Bombardier's aerospace business is now part of Airbus.
So what are the key things to watch then? Is it really the demand piece? Or what about airlines potentially-- what if they start to cancel orders?
I think the things that investors should look out for first is the price of oil. Because one of the big reasons that airlines want to replace parts of their existing fleet is because the new airplanes that are coming into service now have much greater fuel efficiency, and that really helps their bottom line. So if you see the price of oil fall dramatically, airlines may feel less urgency to replace their existing fleet with new planes.
It sounds like the battle with Bombardier-- not a big deal. The oil piece could be. Is there anything else you're watching?
Yeah, so this may sound a little bit obvious. But in a recession, airlines and OEMs may see a disproportionate hit to their stock prices. That's because air travel is very much a discretionary item. And the first things that people tend to cut back on in tough economic times is vacations or air travel. And for companies, the first thing they tend to reduce when they're in a recession is business travel.
David, sounds like you've given us both positive and negative. On the positive side, things like demand, competition, operating environment, where they are in their business cycle-- all good things. But on the negative side, things like price of oil, recession could be headwinds for them. Thanks for being here.