06 May 2014
High-end business jets are a strong market. General Dynamics' first-quarter results, announced last month, show the continued evolution of the company from an almost pure-play defense prime to a company deriving nearly half (45%) of its earnings from Gulfstream Aerospace and Jet Aviation, two units that focus on manufacturing, completing, and supporting high-end ($26 million-plus) jets. As deliveries of Gulfstream’s ultra-high-end $70 million G650 continue to ramp up, and as the defense budget continues to come under pressure, Gulfstream’s percentage of GD profits will likely grow.
GD’s results reflect market trends that have been playing out over decades. About 10 years ago, Teal Group began charting our Guns-to-Caviar Index, a relatively simple measure of the value of the combat aircraft market relative to that for business aircraft. In 1989, the index stood above 8:1 in favor of combat jets. By 1999, business jets actually made up a larger market, a position they have retained since then for all but two years (2003 and 2004). While fighter demand is relatively stagnant, the business jet segment last year resumed its multi-decade growth.
Yet during the last five years the business aircraft market has exhibited profound bifurcation. The bottom half of the market (jets costing $3-25 million) has collapsed, falling by 57% in value of deliveries, with no signs of an imminent recovery. By contrast, the top half has grown by 19%, with all indicators implying further growth ahead.
Business aircraft now constitute two markets: The top half, once the same size as the bottom portion, is now more than three times as large. As the graph indicates, that top-half segment alone is now the same size as the combat aircraft market.
There are two key reasons for this bifurcation. The first is that top-end customers are much less likely to need credit for their purchases. Second, bottom-end customers tend to be more sensitive to economic downturns. But another reason is that top-end jets have better access to relatively inelastic (and lucrative) government and military demand. Thus GD/Gulfstream continues to do very well with military derivatives of its high-end jets, with applications from head-of-state transport to airborne early warning radar aircraft.
Defense company diversification has a checkered past; former Lockheed Martin CEO Norman Augustine quipped that it was “unblemished by success.” Yet these business jet market trends make GD’s 1999 acquisition of Gulfstream about the smartest diversification move in industry history.
GD is not the only company to benefit from high-end business jet market exposure. Dassault has been searching in vain for a first export order for its Rafale fighter, and domestic procurement is stuck at 11 per year and may fall further. Thus the company’s Falcon unit, the only business jet company that builds exclusively top-half jets, is its strongest asset. Similarly, Bombardier's beleaguered commercial aerospace unit stands in contrast with its very successful Challenger and Global business jet series. In 2017, the company’s Global 7000/8000 will enter service, a belated but impressive response to the G650. And Airbus and Boeing have successfully entered the high-end market over the past 15 years with business jet derivatives of their large commercial jetliners.
But then there is the bottom half of the market. Cessna, for example, builds only small- and medium-cabin jets. Textron enjoyed strong results from Cessna after its acquisition in 1992, but since 2008 the division’s position has deteriorated profoundly. Textron’s acquisition of Beechcraft, completed in March, produced the new Textron Aviation unit, but represents a doubling down on this depressed segment. The best the combined entity can hope for is that a belated recovery will begin in the next 12 months, and that output will match the towering record of 2008.
Yet even if the bottom segment recovers, high-end business jets, in the long run, likely will continue to outperform any other sector of the aircraft market. These aircraft market trends reflect strong corporate profits and a growing ultra-high-net-worth-individual population. They also reflect government economic policies that favor wealth creation (or wealthy people, depending on one’s political viewpoint). And finally, they show that part of the business jet market is much less elastic in terms of spending behavior. Many top-half customers, it seems, will pay almost any price to get the most capable and prestigious product available.