In this episode of RBC’s Industries in Motion, Ken Herbert (Aerospace & Defense Analyst) and James McGarragle (Canadian Airlines & Aerospace and Diversified Industrials Analyst) discuss with Walter Spracklin (Canadian Research Management and Co-Head of Global Industrials Research) their positive outlook for the business jet industry, including an overview of the market and leading manufacturers, the increase in demand for business jets resulting from the COVID-19 pandemic, current positive demand trends and supply chain constraints, and ESG considerations.

Walter Spracklin:

Welcome to the Industries In Motion Podcast from RBC Capital Markets, where we'll be exploring what's new and what's next in today's fast-moving markets and industries. My name is Walter Spracklin, Canadian Research Management and Co-Head of Global Industrials Research at RBC Capital Markets. Please listen to the end of this podcast for important disclaimers.

I'm pleased to be joined by Ken Herbert, RBC's US Aerospace and Defense Analyst, and James McGarragle, who covers Canadian Airlines and Aerospace and Diversified Industrials. Today, we'll discuss the outlook for the business jet industry. Ken and James recently published an in-depth industry primer including market analysis, which increases our conviction in the long-term demand trends and opportunities for leading manufacturers. James and Ken, let's kick it off with an introduction to the world of business aviation. Give us a lay of the land.

James McGarragle:

Yes. Thanks, Walter. For some background and to provide some context for our conversation today, the Global Business jet fleet stands at approximately 22,000 aircraft with the United States holding the majority of these jets, accounting for roughly two thirds of the total. The business industry is therefore largely concentrated in North America, which leads in deliveries at 64%, followed by Europe at 14%, and Asia Pacific at 11%.

Looking at deliveries, over the past three decades, the business jet industry has seen an average of approximately 720 aircraft deliveries each year. That marks a significant sustained demand for private aviation for high net worth individuals and corporations. Customers who purchase business jets typically have an average net worth of around $1.1 billion. And on average, the typical business buyer is a self-made entrepreneur in the financial sector with most of their assets in public and private investments, justifying the need for the flexibility and speed of business jets for their corporate activities. Business jets are generally classified into five categories, although for simplicity, they're frequently referred to in three groups: light, mid-size, and large.

Walter Spracklin:

Great. Ken, who are the key players?

Ken Herbert:

Thanks, Walter. The largest original equipment manufacturers, or OEMs, in the business jet market are: Bombardier, Textron Aviation, which includes the Cessna brand, Embraer, Dassault Aviation, known for the Falcon Jets, and Gulfstream Aerospace. These manufacturers account for the bulk of the industry deliveries. Among these, Gulfstream Aerospace, which is a subsidiary of General Dynamics, boasts the highest revenue and the largest order backlog with an emphasis on premium high-end market segments. Certain OEMs, such as Gulfstream, Bombardier, and Dassault command higher billings per unit with figures surpassing $45 million per jet with more of a focus on the midsize, large or long-range segments. Whereas Textron and Embraer, which concentrate more on the light jet market, have lower buildings per unit at approximately $22 million and $14 million respectively.

Walter Spracklin:

James, how has the demand for business jets changed in the wake of the COVID-19 pandemic?

James McGarragle:

Yeah, the pandemic had a major impact on the industry with private jets becoming much more popular. So before the pandemic, only about 10% of wealthy people used business jets regularly. But then with all the worries about COVID-19, and dealing with crowded airports, and also the lack of business and first-class capacity as planes were parked, people with the financial means who never thought about flying privately began to do so. Important to fly here though is that as business and first-class capacity has come back, business jet utilization has settled at an elevated level compared to pre-pandemic levels.

Walter Spracklin:

Ken, what are the current trends in business jet sales and ownership?

Ken Herbert:

So current market trends are showing a preference for large, long-range aircraft favored particularly by ultra-high net worth individuals, governments, and fleet operators as these buyer groups are typically less sensitive to public market volatility and therefore more likely to proceed with deliveries. Supporting this trend, Honeywell's projections indicate a robust inclination toward these types of aircraft estimating they will comprise 37% of total deliveries and contribute to 68% of the total value in the aircraft market over the coming decade.

James McGarragle:

Concurrently, the fractional ownership model witnessed substantial growth driven by companies moving away from private flight departments in favor of more versatile flying solutions. The top 30 fleet operators accounted for approximately 29% of all hours flown in 2023 with NetJets, Flexjet and Vista Global leading in terms of hours operated. Meanwhile, Wheels Up experienced some financial challenges stemming from aggressive expansion efforts leading to route reductions, whereas VistaJet adapted to changing demand by focusing on their super midsize and ultra long range jet offerings. The lighter jet segment, however, witnessed declines in branded charter operations attributed to an influx of new entry level clients.

Walter Spracklin:

Okay. Let's zero in on the key findings from this report that makes you positive on the sector going forward. Ken, let's start with you and then over to James.

Ken Herbert:

James McGarragle:

It's also important to note, the fleet of business jets is currently the most aged it has been in over 20 years underpinning the need for new jet acquisitions and the anticipated uptick in production rates. Used inventory levels are trending around 7% of total fleet, which is significantly below the typical range of 11% to 14% of fleet prior to the pandemic. We expect the market to experience strong, continued demand and price stability for business jets, particularly the larger models that are experiencing the most significant scarcity across the three primary jet categories.

Additionally, having backlogs that extend for 18 to 24 months offers manufacturers clear visibility into future revenue streams. The net positive of supply chain issues has been to keep the pace of production and delivery increases slower than the OEMs might otherwise like. This has helped with the improved perception of discipline by OEMs, which was lacking in prior cycles.

Walter Spracklin:

That's great. Ken, how do you see supply chain constraints impacting the industry going forward?

Ken Herbert:

Although the demand has begun to stabilize, thereby reducing some of the strains on the supply chain, the ongoing scarcity of technicians and components still constrains the pace of production. Shortages in engines, parts and avionics persist largely due to complications like the worldwide shortage of semiconductors, disruptions among suppliers and a surge in demand. Labor deficits remain a primary concern as the industry has seen the departure of skilled workers during the pandemic resulting in quality assurance problems at certain supplier sites.

Walter Spracklin:

Okay. What gets you guys most excited about the business jet industry right now?

Ken Herbert:

Services.

James McGarragle:

Services.

Ken Herbert:

Original equipment manufacturers, or OEMs, are expanding their internal service departments to capture a bigger piece of the maintenance, repair, and overhaul market for their aircraft. This strategy is driven by tougher and more expensive requirements for certification, which cause airplanes to stay in use longer, increasing the need for upkeep. We're seeing fewer planes being retired, which implies that they're flying for more years before being taken out of commission. The longer these aircraft are flown, the more maintenance and service they will need.

James McGarragle:

Key is that sales of replacement parts and aftermarket services are not just crucial for keeping older planes in good condition, they're also very profitable. This means it can significantly enhance the earnings of OEMs. Given that the average business jet is just above 18 years old, there's potential for more comprehensive maintenance work and the larger invoices that typically accompany the upkeep of these aging planes.

As we touched on earlier, there's been a notable increase in demand for large, long-range jets. These aircraft are making up a larger part of the fleet leading to an increase in the typical spend on upkeep because they have more intricate and significant maintenance needs. Also, both commercial fleet operators and defense clients are flying their aircrafts more often, which means they need to service and replace parts more regularly, which we'd see as a tailwind for OEMs. Just last week we saw General Dynamics and Bombardier report very strong services growth of high double digit year-over-year.

Walter Spracklin:

And now there are important ESG considerations to keep in mind regarding business jets. What are the primary concerns here?

James McGarragle:

Business jets contribute a mere 0.04% of global emissions. However, they do generate significantly higher emissions per passenger being five to 14 times greater in comparison to commercial aviation. Because of that, they have become focal points for environmental activism. Strides in sustainable aviation fuel, investment in carbon offset programs and innovation in cleaner technologies are being pursued to diminish the environmental impact of private air travel.

Walter Spracklin:

Okay. Wrapping it up, what impact do you see emerging technologies having on the design and operation of business jets to be more environmentally friendly? Ken?

Ken Herbert:

Walter Spracklin:

Speaker 4:

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