Wednesday, April 06, 2016

Turbulence for corp jets makes investors queasy

Turbulence in the business-jet market is rattling some investors, and even status jets like the Gulfstream G650 are showing signs of the stress as more go up for sale.

While the large-cabin business segment appears to be the weakest, the small and midsize business jets appear to be holding up better. Analysts say demand in Europe remains flat and emerging markets such as Brazil and China are still in a major slowdown, although deliveries in the U.S. are starting to grow again.

"There's clearly more weakness at the upper end, which would be for the most part Gulfstream and Bombardier," said Cai von Rumohr, an analyst at Cowen & Co. As a result, he said, if things worsen there's a possibility Gulfstream parent General Dynamics "might be looking at flattish profits next year."

Analysts say lower oil prices also are to blame for the business-jet malaise because some countries that would benefit from higher oil prices or energy-related corporations are cutting back on business-jet purchases. On the other hand, lower oil prices are helping the commercial aircraft space.

Overall, the number of used business jets on the secondary market as a percent of the active fleet in February reached levels not seen in roughly two years, Goldman Sachs reported last week. It also highlighted how "new business aircraft to market on a trailing 12-month basis are the highest they have been since 2009 — setting up supply/demand challenges."

Shares of two major U.S.-based business jet manufacturers — Gulfstream's General Dynamics and Cessna's Textron — are lagging the broad market this year. In the same period, Embraer SA also is underperforming, while Canada's Bombardier and France's Dassault Aviation are holding up better.

For Textron, the company earlier this year forecast 2016 earnings would fall short of Street estimates due in part to weakness in its aviation and Bell commercial helicopter segments. Textron's Cessna Aircraft business makes Citation jets, such as Latitude, a roughly $16 million mid-size business jet, and it has the newer Longitude business jet that has a longer range and is priced at around $25 million

Brazil's Embraer is facing tougher price competition in the regional jet business. Embraer is looking for margins to be down this year and they are competing with Bombardier, which itself is struggling. Bombardier's U.S.-listed stock price has lost nearly 50 percent in the last 12 months and has looked to Canada's government for financial help for the company's delayed C Series jets.

Meantime, Gulfstream is seeing more of its G650 going to the secondary market, meaning customers can essentially get the aircraft quicker and potentially pay a lower price, too. Gulfstream's strategy has been to slightly increase the production of the G650 while at the same time delivering fewer G450s and G550s, which are older planes with generally softer prices.
"Used G650 pricing has dropped back to in line with new after being well above," UBS analyst David Strauss said in a research note to clients on Monday. "We believe the used business jet market serves as a leading indicator of the new business jet market."

Gulfstream delivered its first G650 in 2012, and the product quickly earned a reputation as a new status symbol for corporate chieftains. Through mid-March, Gulfstream had reportedly handed over 158 of the aircraft. The long-range jet lists for between $65 million to $70 million. More than half of the orders for G650s last year were from North America.

Ascent Flightglobal Consultancy's senior analyst Daniel Hall estimates around 15 to 20 of the G650s are currently for sale in the secondary market — possibly more. Just six months ago, about 10 aircraft were available and about five a year ago, he said.

Deutsche Bank analyst Myles Walton highlighted the inventory and price risk for Gulfstream/General Dynamics in a March 24 research note entitled "13 percent of G650s available for sale (and rising)." He then downgraded the aerospace and defense company's stock rating from a buy to a hold, leading to a nearly 4 percent decline in the stock that day. The stock has retraced some of the losses but still is in the red for the year-to-date period through Monday.

In his downgrade comments, Walton said: "The continued downward asking price will start to impede on new G650 orders — if not cancellation activity."

"We haven't seen much cancellation activity and perhaps won't given sizable customer deposits; however, the inventory climb implies OEM production may be 20-30% above actual demand over the medium-term," he added.

General Dynamics declined requests for an interview but the Gulfstream division issued a statement: "With respect to the G650 and G650ER, we have a strong, diverse and firm order book for these airplanes, and we continue to see demand for the aircraft and a growing backlog that extends into 2018. The G650 pre-owned market is one of the strongest in the industry."

Gulfstream also indicated that the G650 that sold below its original purchase price was a test airplane, insisting that the "majority of the pre-owned G650 aircraft are selling at a premium above the original purchase price."

Despite headwinds from the Gulfstream business jet segment, Cowen analyst von Rumohr recommends General Dynamics stock and currently has it rated a buy. "While there are clearly risks, the discount that the stock is selling at — around 25 percent discount to other defense big caps — is more than it should be given the risk that you're looking. They've also been pretty aggressive in buying their shares back so far in the first quarter."

Also, late Tuesday Guggenheim Securities initiated coverage of several defense primes with a buy rating, including General Dynamics.

In a note, Guggenheim analyst Roman Schweizer said: "We view GD as having excellent positioning in segments with growth (shipbuilding and ground combat), but it may have a bumpy flight plan in the commercial business jet market and more competition in defense communications, electronics and services. This counter-cyclical balancing act has us cautious as the transition in Gulfstream production occurs and key Army and Navy programs gear up."

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