June 15, 2017

Civilian Aircraft Warranties:

The manufacturers of large commercial airliners seem to have lower warranty expense rates than the companies making smaller business jets or regional jets. Is that because their products are built better or is it a function of how most aircraft warranties are provided to customers in sections?

As we discovered several years ago, there seems to be an inverse relationship between the size of a civilian airplane and its warranty expense rates. Basically, the bigger the aircraft a company manufactures, the lower its claims and accrual rates. The smaller the aircraft, the higher its claims and accrual rates.

We last wrote about the world's largest civilian aircraft manufacturers in an August 6, 2015 newsletter, so we now have seven additional quarters of data to add to those charts. And we still see the same effect in the relationship between the size and expense rate of the products they make.

We have warranty expense data from seven of the world's top commercial airplane, business jet, and general aviation aircraft manufacturers: Boeing Co., Airbus Group N.V., Bombardier Inc., Dassault Aviation Group, General Dynamics Corp., Textron Inc., and Embraer S.A. That's three from the U.S., one from Canada, one from Brazil, and two from Europe. There are additional manufacturers in China and Russia, but they don't report their warranty expenses, so they're not included here.

Boeing and Airbus make the bulk of the passenger airplanes flying the commercial routes of the world's airlines. And they also report much lower warranty expense rates than the other manufacturers, who make smaller aircraft.

Bombardier's Aerospace Division owns Canadair and Learjet, and competes with the smaller "regional jet" end of the Boeing and Airbus product lines. So does Embraer, which also makes business jets. Dassault owns Falcon Jet. And then the king of the business jet market is Gulfstream Aerospace, owned by General Dynamics. Finally, Textron owns the Cessna Aircraft, Bell Helicopter, Hawker, and Beechcraft brands.

Industry Warranty Expenses

In calendar 2016, these seven manufacturers reported paying the equivalent of $921 million in warranty claims, down about 8.3% from just over $1.0 billion in 2015. Five of the manufacturers report their revenue and warranty expenses in U.S. dollars, and two report in euro, but the average foreign exchange rates did not change much from 2015 to 2016. Warranty accruals, meanwhile, fell by 14% to $1.08 billion last year.

For the three American manufacturers, we also now have first quarter 2017 data, and by August we'll have first half data. For the other four, however, since they report only their yearly warranty expenses in their annual reports, our charts cut off with the fourth quarter of 2016. And we won't have any additional data until next May or June at the earliest.

Keep in mind that Textron and Bombardier also have significant operations in land-based vehicles as well, and they both report only their company-wide warranty expenses without breaking down the spending by division or product line. Textron also now owns Arctic Cat, which is now a subsidiary of Textron Specialized Vehicles Inc. So it is not possible to correlate warranty expenses to aircraft market shares, because we'd have to also count Bombardier's trains and Textron's golf carts and snowmobiles along with all the aircraft they make.

Also, Boeing, Dassault, General Dynamics, and Airbus also have significant military manufacturing operations. Fortunately, the military is not insistent on receiving free warranties from their largest suppliers, so they don't contribute to the claims or accrual totals. And most of these manufacturers clearly separate their commercial and military revenues, so we can compare civilian revenue to civilian expenses.

Something else to consider is the way in which warranties are delivered in the aviation industry. As with trucks and recreational vehicles, most of the suppliers of engines and other major components supply their warranties separately to the customer, rather than the single comprehensive warranty supplied with most other goods such as passenger cars, appliances, and computers.

In the aviation industry, this may be working to the advantage of the large airliner manufacturers, since it spreads the total warranty cost among more manufacturers. Small planes don't have as many suppliers, so therefore their nameplate manufacturers end up footing a higher share of the total warranty cost.

Claims and Accrual Rates

What we're going to do is take the claims paid and accruals made by each of the seven manufacturers, and divide each by the corresponding revenue figure. This will give us a pair of percentages representing their claims and accrual rates. Since some of the data is annual-only, each group of four consecutive quarterly pairs will have to be identical.

Let's start with the Airbus Group, formerly known as the European Aeronautic Defence and Space Company. Airbus reported 48.6 billion euro in commercial revenue last year, up about eight percent from 2015 levels. Its claims fell by almost one-fourth, but its accruals rose slightly faster than commercial revenue did. So its claims rate fell slightly from 0.21% to 0.15%, while its accrual rate rose slightly from 0.17% to 0.18%.

Figure 1
Airbus Group
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2016)

Figure 1

When you have to go to hundredths of a percentage point to show changes, you know those changes were minor. Indeed, except for 2013 and 2014, Airbus has maintained a claims rate that's remained extremely close to its 0.2% long-term average. Except for 2011 and 2012, the company's accrual rate remained extremely close to 0.4%, before finding a new low of 0.17% in 2015.

Notice that the company's accrual rate spiked first, and then its claims rate followed two years later. The company never said much about what caused the sudden increases, but it looks like whatever it was is now safely behind them.

If one were to guess what the warranty cost of a typical Airbus jet might be, the fastest way to make an estimate would be to multiply the list price by the expense rates above. Therefore, the popular A320 family, selling for roughly US$98 million each, might be expected to generate claims of $150,000 and require accruals of $175,000, based upon the above expense rates.

It doesn't mean these are the exact warranty expenses. Every product has a different expense rate, which most companies keep confidential. All an external observer can calculate is the average rate over the entire product line.

Brazilian Jets

Next, we'll head to Brazil, where Embraer is based. It's name, short for Empresa Brasileira de Aeronautica, basically means "Brazilian Aeronautics Company." Once government-owned and once manufacturing aircraft primarily for the military, it launched an initial public offering of stock in 2000, and diversified soon thereafter into business jets and regional airliners.

In Figure 2, we can see that the company's warranty expense rates have remained relatively stable over the past 14 years, except for that very noticeable spike in warranty accruals in 2011. In 2016, thanks to large and noticeable declines in claims and accruals, the company's warranty expense rates both fell, despite a small decline in sales revenue.

Figure 2
Embraer S.A.
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2016)

Figure 2

Last year, in fact, was the first and only time Embraer's accrual rate fell below one percent, and was only the fourth time its claims rate did so (but the claims rate in 2007 was slightly higher than 2016's 0.6%). But although its warranty expense rates are declining, they're still not as low as Airbus.

Here's where the question of size comes into play. Airbus makes one of the world's largest commercial jets, the double-decker A380. List price is US$433 million.

Meanwhile, one of the bestselling Embraer models is the E190, which is currently flown by American Airlines, JetBlue, and Air Canada, among others. List price is currently around US $32 million.

Given each company's average claims and accrual rates last year, one would expect the warranty cost of an A380 to be about two or three times as high as that of an E190. However, the list price is almost 14 times higher. In other words, while the expenses of the larger jet might be higher, proportionately to price, they're lower.

Canadian Jets

This pattern continues with Bombardier, whose CRJ900 is slightly smaller but slightly more expensive than the E190. Last year, the entire company reported a claims rate of 1.5% and an accrual rate of 2.0%, among their best expense rates ever.

However, those expense rates are far above the percentages reported by either Airbus or Embraer. We suspect that has more to do with the company's trains than its aircraft, but we have no way to measure that. Last year, Bombardier reported $8.3 billion in revenue from external sales of business jets and commercial airliners, and $7.6 billion in revenue from trains and ground transportation equipment. We doubt the warranty expense split was anywhere close to 50/50. It's probably less than 30% aviation and more than 70% train. But that's just a guess.

Figure 3
Bombardier Inc.
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2016)

Figure 3

Using that guess, we're going to suggest that Bombardier Aviation's average claims and accrual rates are closer to 0.8% and 1.2%, respectively -- a bit higher than Embraer's but a bit lower than General Dynamics' average rates. However, this is only a guess. Company-wide, the average rates last year were 1.5% and 2.0%, respectively.

French Jets

And now we get to a bit of a puzzle. Last year, Dassault Aviation reported paying 104 million euro in claims and making 50.6 million euro in accruals. Sales of Dassault Falcon business jets were reported at 1.95 billion euro for 48 units. So that suggests a claims rate of 5.3% and an accrual rate of 2.6%. Both are unusually high, especially in this peer group.

Dassault also manufactures the Rafale and Mirage fighter aircraft for the French, Egyptian, Qatari, and Indian militaries, among others. But even if we include all of that military revenue in our expense rate calculations (which we did not), the claims rate would drop only to 3.3% while the accrual rate would fall only to 1.6%. With Bombardier, we can blame the high expense rates on the trains. But with Dassault, what can we blame them on?

Figure 4
Dassault Aviation
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2007-2016)

Figure 4

Dassault didn't begin reporting its warranty expenses until 2007, so we have only 10 years of warranty expense data, compared to at least 14 years for all the others. However, during each year in that decade, either one or both of the company's expense rates have been above four percent. In the peak year of 2013, Dassault's claims rate hit 6.9% while its accrual rate hit 9.3%. Those rates are far above its competition's.

Removing Extended Warranty Expenses

Next we have three American companies to examine. We begin with Textron Inc., which as we noted in the April 13, 2017 newsletter, made an accounting change that caused its warranty expense rates to plummet. Turns out the company simply decided to discontinue reporting its product warranty and extended warranty expenses together.

In Figure 5, we're retroactively removing the extended warranty expenses from the totals originally reported for the years 2013 to 2015, and we're including only the product warranty expenses as reported for 2016 and 2017. That drops the company's warranty expense rates from the 1.5%-to-2.5% range all the way down to 0.5%. In other words, extended warranty expenses were probably somewhere between one and two percent of product revenue all those years ago.

Figure 5
Textron Inc.
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2017)

Figure 5

Textron Aviation owns the Cessna, Beechcraft, and Hawker brands, so it is a market leader in both small propeller-driven planes used in general aviation as well as light business jets.

However, as we already mentioned, it now owns Arctic Cat, and also makes Bell helicopters, E-Z-Go golf carts, Cushman hauling vehicles, lawn care equipment, unmanned drone aircraft, and even amphibious military landing craft. It's also trying to enter the low end of the military jet industry through a new joint venture. In other words, it's much more than just an aircraft company.

What we don't see is the pattern of Bombardier, where non-aircraft product lines generate much higher warranty expense rates than do the aircraft product lines. And we don't see the pattern of Dassault, where a mix of military and civilian sales complicates the analysis. Instead, what we see are low expense rates for a diverse product line, aircraft and non, civilian and military.

We should note that from 2003 to 2005, Textron reported its warranty expense data only once a year, which is why the data points in the chart are the same for each four consecutive quarters. In 2013 and 2014, the company originally reported its warranty data quarterly, but in the 2015 revision it retroactively provided only annual data for those years.

General Dynamics and Gulfstream

In Figure 6, the data looks more volatile than did some of the others, but this is heavily influenced by the availability of 57 quarterly measurements as opposed to only 14 annual measurements, each one averaged over four quarters. In reality, most of the data fits between the one percent and two percent marks, while the seasonal variation within each year is usually less than half a percent.

Figure 6
General Dynamics Corp.
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2017)

Figure 6

General Dynamics is primarily a defense and government contractor, with the U.S. government accounting for some 60% of its 2016 total revenue. It made the F-111 and the F-16 fighter jets for the Pentagon, not to mention most of the submarines operated by the U.S. Navy. However, there are more than 2,500 of its Gulfstream business jets in current operation, and its commercial aerospace group accounted for most of the non-government revenue last year.

With $91 million in claims and $140 million in accruals against $8.36 billion in aerospace revenue, the company's claims rate came in at 1.1% and its accrual rate came in at 1.7% last year. Its claims rate fell a bit in the first quarter of 2017, while its accrual rate remained about the same.

Given that G650 business jets typically sell for $67 million, and given these expense rates, it's likely that the warranty cost per unit will be higher than all but perhaps a Falcon jet. But Gulfstream operates 11 company-owned service centers worldwide and has factory-authorized warranty facilities on six continents. And a G650 can fly up to 18 passengers at just under the speed of sound for up to 8,100 miles (nearly 13,000 km). So this is the price of luxury in the civilian aviation industry.

Boeing Keeps Its Rates Steady

Finally, let's take a look at Boeing. Last year, the company spent $309 million in claims and made $356 million in accruals, making it one of the top warranty providers in any industry, let alone aerospace. But it's also a huge defense contractor, with civilian aircraft accounting for only 68% of total revenue.

Even after making those adjustments, however, the company has still managed to keep its warranty expense rates around 0.5% to 0.6% for most of the past two years. And those rates are significantly lower than they were from 2012 to 2014, when accruals climbed as high as 1.4% of commercial airplane revenue totals.

Figure 7
Boeing Co.
Average Warranty Claims & Accrual Rates
(as a % of product sales, 2003-2017)

Figure 7

With average warranty expense rates around 0.5%, and with average list prices for the 747, 777 and 787 families running well over $200 million and sometimes up to $400 million per unit, it's likely than all of these wide-body aircraft will generate upwards of $1 million in warranty costs per unit. With the third-generation 747-8 priced at $387 million, it's likely that Boeing is accruing upwards of $1.9 million per unit sold.

However, while that's by far the most accrued per plane, it's far from the most accrued as a percentage of revenue. That title would go to Dassault. Last year, Dassault sold 48 Falcon Jets for roughly US$45 million each. For its accrual rate to be 2.6%, that would imply average accruals of $1.17 million per unit. So while accruals might be lower per unit compared to a jumbo jet, accruals as a percentage of product price would be much higher.

Can't Compare Companies?

We can't really compare one company to another, however, because as we've seen, no two companies are alike. Some such as Dassault, General Dynamics, and Boeing have significant military businesses in addition to their civilian aviation operations. Some such as Bombardier and Textron have significant non-aviation lines of business in addition to their aviation operations. And some have significant service or finance operations in addition to product sales. Even with Embraer and Airbus, between 15% and 25% of total revenue comes from non-warranted sources.

In addition, some of these companies are positioned as luxury providers, featuring the white glove style of warranty service. But in general, what we see in terms of expense rates is the larger the aircraft, the lower the warranty expense rates. Airbus and Boeing are lowest. Dassault is the highest. And the others line up more or less in size order between those extremes.

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