Regional Jet Showdown in Japan, China and Russia

EMFIS.COM - 04/03/08
Emerging economies are preparing to compete in a swelling market for regional jets.  The term regional jet or RJ refers to a range of short-haul turbofan powered aircraft whose use throughout the world has expanded tremendously since 1978.  Industry insiders estimate this market segment will demand between 2,600 and 6,000 aircraft over the next two decades.  The real question for investors is if the new emerging players can effectively compete against entrenched aircraft manufacturers in this market.

Entrenched Interests

For years, the regional jet market has been dominated by two manufacturers.  Brazil’s Empresa Brasileira de Aeronáutica SA, or Embraer, has been in competition with Canada’s Bombardier Aerospace for this segment of the jet passenger aircraft market for many years.

The Embraer ERJ-145 was launched at the Paris Airshow in 1989, taking its first flight in 1995, and has undergone multiple revisions since then.  In 2003, Embraer entered a joint venture under the name Harbin Embraer with Harbin Aircraft Manufacturing Corporation in China, and began assembling premanufactured kits in China.  This jet family is largely being supplanted by Embraer’s E-Jet family at present.  Orders for the ERJ-145 line are down, and E-Jet orders are up.  Embraer’s E-Jet family was launched at the Paris Air Show in 1999, entering production in 2002.  This jet family consists of several variants, and is presently the most popular family of regional jets.

Bombardier Aerospace is the closest competitor to Embraer with their Canadair Regional Jet (CRJ) family of regional jets.  The CRJ launched in 1992, and is widely used around the world today.  The CRJ aircraft come in a variety of models, and have been upgraded numerous times over the years.  The most recent of these is the CRJ1000, launched in February 2007 and scheduled to enter service late in 2009.  Bombardier started a new family of jets called the C-series, and then folded it in January of 2006.  In January of 2007 they restarted the program, but have yet to announce when production of the new jets will begin.

Russia’s Sukhoi Superjet 100

Russia’s Sukhoi Civil Aircraft was the first jet manufacturer in an emerging economy to announce plans to compete in this jet market segment.  Sukhoi first showed its Superjet 100, formerly known as Sukhoi Russian Regional Jet (RRJ), to the public on September 26, 2007.  Deliveries are scheduled to begin in 2008.

The plane is delayed at this point, having missed its December target to start test flights, and Sukhoi faces multi-million Dollar fines if they fail to deliver on schedule.  Evgeny Shago, an expert at Ingosstrakh Investments, revealed that "the Aeroflot contract with UAC includes extremely serious fines for late delivery as well as for failing to meet acceptable quality standards. Their contract is worth US$800 million and we can expect the fines to total up to 20% of that. Such a sum threatens the profitability of the entire Superjet project."

Sukhoi’s jet is projected to have a 10-15 percent lower operational cost than its Bombardier and Embraer competitors.  Priced at about $28 million, the Superjet 100 will also be about 18-22 percent cheaper than its competitors.  The jet is of an advanced design, and meets all the major aviation standards.

The Superjet 100 has garnered 73 orders and 46 options, mostly from Russian customers.  Sukhoi hopes to market approximately 700 of the aircraft in North America, Europe, Latin America, Russia and China.

China’s ACAC ARJ21

China’s AVIC I Commercial Aircraft Company (ACAC) is the second player to announce entry into the regional jet marketplace with their ARJ21 regional jet.  ACAC began final assembly of the aircraft in March 2007, and the maiden voyage was scheduled for March 2008, but the flight was delayed.  Final certification from the Civil Aviation Administration of China (CAAC) and first deliveries to customers are expected in the third quarter of 2009.

The ARJ21 has delayed its maiden voyage, and there is some uncertainty about exactly when the plane will be ready.  ACAC has announced that the maiden voyage will be delayed by at least six months, and expects the flight to take place in September or October of 2008.  Some of the project’s key suppliers were unable to complete equipment testing to meet the requirements of ACAC on schedule.  The company now has only 12 months to complete the certification process.

ACAC already has a number of orders and options for the ARJ21, with a total of 181 domestic orders at present.  The company is attempting to market the aircraft overseas, having signed a deal with China National Aero-Technology Import and Export Corp to help market the planes overseas.  GE Commercial Aviation Services is the first foreign company to order the plane, with 5 orders and an option for 20 more.

Japan’s Mistubishi MRJ

Mitsubishi Heavy Industries Ltd (MHI), has announced plans to enter the regional jet marketplace.  The company will establish Mitsubishi Aircraft Corp as a joint venture with Toyota Motor Corp, Mitsubishi Corp, Mitsui & Co Ltd, Sumitomo Corp and the Development Bank of Japan.  Mitsubishi Aircraft will build the Mitsubishi Regional Jet (MRJ).

The MRJ is still in the development phase, and will likely deliver the first aircraft in 2013.  It is a compact jetliner designed to compete with the regional jets from all the other firms already mentioned in this column.  The MRJ will be about 20 percent more efficient than competing aircraft from Embraer and Bombardier, and will use advanced lightweight carbon fiber technology.

Mitsubishi Aircraft Corp will be capitalized at ¥3 billion (US$30 million) as of April 2008, with a plan to increase the capital to ¥100 billion in a year as business operations develop.  "Development costs are expected to reach ¥150 to ¥180 billion," President Tsukuda said. "In addition, investment in the volume production facility is likely to be tens of billions of yen."

All Nippon Airways Co Ltd (ANA) announced on March 27 that they would order 15 of the aircraft, with an option for 10 more.  Mitsubishi is also attempting to sell the jets to Japan Airlines and to Vietnam Airlines, though no orders have been placed at this time.  The MRJ will be the first Japanese commercial jet produced since 1973.

Market Size

In this industry, there seems to be a lot of disagreement about exactly how much demand there will be for regional jets over the next two decades.  Mitsubishi sees it as a market for 5,000 aircraft.  Embraer and Bombardier estimate demand at about 2,600 to 4,300 aircraft.  Sukhoi expects demand for up to 5,500 regional jets.  ACAC estimates demand at about 3,000 aircraft, with one-third of the demand from the Chinese market.

The regional jet market is already dominated by Embraer and Bombardier.  In the 1970’s there was a major commercial jet shakedown with several companies competing for dominance.  In the end, only Airbus and Boeing survived the market fight.  There are several unanswered questions about the size of the market, but regardless of the total size, there is the additional question about how many products can compete in this market.

Will there be room for 5 major competitors in the regional jet segment in 2013 when all are producing aircraft?  If not, who will survive?

Forecast and Conclusion

We at Emfis see the Mitsubishi project as the most likely to fail at this stage, and the ACAC project as the most likely to succeed.  Each of these projects faces its own problems and challenges, but we believe that ACAC will be the big winner among emerging market aircraft manufacturers in this segment.

Mitsubishi seems most likely to fail for several reasons.  First and foremost is the simple fact that they will be the last company to enter this expanding market segment.  Sukhoi and ACAC are years ahead of Mitsubishi, and by the time the first MRJ rolls of the line, a fair number of competing planes will already be in the skies.

The second most obvious problem for Mitsubishi is the fact that they have far fewer orders for their aircraft than their Russian and Chinese competitors.  Of course, this could shift rapidly between today and when the first MRJ rolls off the assembly line, but again, this will be a game of catch-up for the MRJ.

The final reason is Mitsubishi’s record in delivering large scale projects.  Mitsubishi’s F-2 fighter jet, developed for the Japanese air force was a costly failure for Japan’s Defense Ministry.  The company’s return on equity is 3.5 percent, considerably lower than 11 percent at Kawasaki Heavy Industries.

In the end, the thing that the MRJ has going for it is advanced technology.  It will be a more technologically advanced aircraft than its competitors.  But we at Emfis feel this is not enough to overcome the other shortcomings of the project.

The ACAC ARJ21 seems the most likely success in this market for several reasons.  One of the biggest strengths for the project is the simple fact that about 25 percent or more of the regional jet market over the next 20 years is in China.  The country needs new aircraft, as the influx of wealth into the massive Chinese population has created a booming travel industry.  We believe that Chinese airlines and other regional partners of the Chinese airlines will be more likely to purchase aircraft from China than from foreign competitors.  Simply looking at existing orders for regional jets confirms this.

Another big strength for the ACAC project is that it has experienced fewer difficulties as it prepares for its maiden voyage.  The six month delay is a problem for the company, to be sure, but in comparison to the longer and more costly delays with Sukhoi, only a minor issue.  The company can still ship on time, while it looks like that may be out of the question for their Russian competitor.

Sukhoi lies in the middle ground here, and the future of the project is more difficult to determine.  We at Emfis recommend caution here for investors, and believe that a wait and see attitude is best with regards to Sukhoi.  The delivery deadline is very near, and so are the massive fines the company could be subjected to.  We recommend waiting for the outcome of the deadlines and potential fines.  Once the first jets begin to be delivered, and any fines are overcome, this could be a very profitable venture for Sukhoi.

Should the Sukhoi venture fail, then the outlook for the Mistubishi project may improve.  If the Sukhoi venture succeeds, Mitsubishi will likely find itself in a much more competitive market.  Therefore, we at Emfis believe it wise to observe the outcome with Sukhoi before making investment decisions regarding the Mitsubishi MRJ.

The regional jet market is of great interest right now, as competition expands and heats up.  We expect the emerging market competitors to provide Bombardier and Embraer with fierce competition.  With more advanced, more efficient, newer and less costly jets to compete against, the established Western companies may find their markets shrinking as airlines order increasing numbers of aircraft from the East.


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