All over the world, more people are getting onto more planes to go to business meetings, take vacations, travel to see family and friends, than ever before. The number of passenger miles flown has doubled every 15 years for decades.1 Air travel, at this 4.7% annual rate, is growing significantly faster than the world economy in general, and is expected to continue doing so for at least another 20 years. 1,2
As investors, how can we potentially benefit from this steady growth trend? To find the opportunities, we might ask, what are some of the chokepoints along this value chain? For instance, every passenger who takes a flight goes to an airport and gets on a plane. Are airports, airlines or aircraft manufacturers a good investment? Of these, aircraft manufacturers as a group have provided investors with the highest returns on their invested capital, at a rate of 9.5% annually over the past 10 years.3 Within the segment, Airbus and Boeing have produced even higher returns. When one looks at the structure of the aircraft industry, this begins to make sense.
The aircraft manufacturing industry is very concentrated, with few players, and in the wide body portion of the market, Airbus and Boeing have what amounts to a duopoly. This gives them significant pricing power with their numerous clients--the airline companies that compete with each other to attract passengers. The effective duopoly also gives them tremendous negotiating power with their numerous suppliers.4,5,6
Reputation for Safety a Major Competitive Benefit7 And this too makes sense. The process of designing and manufacturing, testing, and bringing to market an aircraft is exquisitely complex and financially demanding. Very few companies in the world have the technical expertise to do it. Fewer have the ability to obtain the regulatory certifications that are needed at each of the design, production and testing phases, a process that typically takes several years.8,9 The deep pockets needed to participate in an industry with such a long cycle for such an expensive product are another restrictive factor.
The most difficult hurdle of all is the conservatism of the ultimate buyers, the airlines. A plane crash, in addition to the severe human toll, can destroy an airline’s business. When buying new planes, an airline has a nearly insurmountable bias toward buying them from the manufacturer whose planes they are already flying safely. This “safety circle” wraps virtuously, and almost exclusively, around Boeing and Airbus. It is reinforced by the network effect of service infrastructure and personnel who know how to work on Airbus and Boeing aircraft in every airport where they land.
We have owned Airbus in our International Growth portfolio since May 2009, when the financial crisis pushed the shares down into our price range. Since then, the company has provided us with a 23% annual return on our capital. Whether this rate continues remains to be seen. But we are happy to own Airbus in our portfolio. We believe that air travel will continue growing faster than the world economy in general, and we believe that Airbus has the potential to maintain a dominant position in that value chain.
- a, bSource: Statista https://www.statista.com/statistics/269919/growth-rates-for-passenger-and-cargo-air-traffic/
- ^Sources: World Bank and the International Monetary Fund (IMF) http://www.worldbank.org/en/publication/global-economic-prospects https://www.imf.org/external/datamapper/NGDP_RPCH@WEO/OEMDC/ADVEC/WEOWORLD
- ^Source: Credit Suisse HOLT®
- ^Source: Reuters, “As Boeing, Airbus factories hum, suppliers get rattled,” March 3, 2014. https://www.reuters.com/article/us-boeing-suppliers-insight/as-boeing-airbus-factories-hum-suppliers-get-rattled-idUSBREA2212J20140303
- ^Source: Financial Times https://www.ft.com/content/e0d51872-516c-11e6-9664-e0bdc13c3bef
- ^Source: Puget Sound Business Journal, “They're going to change the game: Boeing calls supplier meeting to reveal new terms for all future interiors work,” October 5, 2018 https://www.bizjournals.com/seattle/news/2018/10/05/boeing-supplier-meeting-new-terms-interiors.html
- ^Source: Business Insider, “These 5 planes are trying to end Airbus and Boeing's dominance in the skies,” April 4, 2018 https://www.businessinsider.com/airbus-boeing-airliner-china-russia-craic-comac-2017-5#bombardier-c-series
- ^Source: AINonline, “The aircraft certification process,” December 18, 2006, 5:41 AM https://www.ainonline.com/aviation-news/aviation-international-news/2006-12-18/aircraft-certification-process
- ^U.P. Breuer, Commercial Aircraft Composite Technology
As of 9/30/18, Airbus was 1.38% of Oppenheimer International Growth Fund’s portfolio.
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