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*BREVAN HOWARD ASSETS SAID TO BE $24.8 BILLION AT END OF SEPT.

*BREVAN HOWARD ASSETS SAID TO DROP ON REDEMPTIONS AND CURRENCY

But like Canada and Russia, it is discovering how hard this is

SINCE the 1990s the global market for full-sized commercial airliners has been a duopoly. The market, which by some estimates will be worth $4.6 trillion over the next 20 years, is dominated by Airbus, a European firm, and Boeing, its American competitor.

In theory, at least, airlines will soon have a wider choice of planes. On November 2nd COMAC, a Chinese state-owned aircraft manufacturer, revealed its C919 plane (pictured), a competitor to Airbus’s A320 and Boeing’s 737, the two most popular planes in the skies. COMAC says the C919 will have its maiden flight next year—two years later than first scheduled—and will enter service around 2019. The Chinese are not the only ones who think they can break the duopoly. After several delays, Irkut, part of Russia’s state-owned United Aircraft Corporation (UAC), hopes to launch its MC-21 aircraft, another potential rival to the 737 and A320, into service in 2017.

Many aviation analysts remain sceptical about whether these rivals, even with generous state backing, will ever put a significant dent in the bulging order books of Airbus and Boeing. Although the Russians and the Chinese may well be good at designing aircraft, they have little experience in creating the hugely complex production systems and supply chains needed to build them to the extremely high standards of reliability and safety that airlines expect. The need to improve their safety record will ensure that they are “not a near-term risk” for the likes of Boeing, according to Jason Gurksy, an aerospace-industry analyst at Citigroup.

Even Canada’s Bombardier, which has a good record of safety and quality for the smaller aircraft that it makes, has struggled to break into this lucrative market. Fewer than 250 of its much-delayed CSeries planes have been ordered. By contrast, Boeing has already delivered almost 5,600 of the 737 and has orders for a further 4,200. It emerged recently that Bombardier had tried unsuccessfully to sell a stake in the project to Airbus. On October 29th Bombardier announced that the provincial government of Quebec, where the firm is based, would pay $1 billion for a stake of 49.5% in the CSeries, whose development has so far cost Bombardier $5.4 billion.

Incumbents are just as hard to dislodge in the market for smaller “regional” jets (ones with up to around 100 seats), which is dominated by Bombardier and Embraer of Brazil, but which COMAC, UAC’s Sukhoi subsidiary and Mitsubishi of Japan are all trying to break into. COMAC’s regional jet, the ARJ21, had its first test flight in 2008, but because of concerns about cracks in its wings and dodgy wiring it has still not been certified for commercial flights in America. Mitsubishi’s MRJ and Sukhoi’s Superjet were also delayed by technical problems. The Superjet is now in service with a handful of airlines, though orders have been sparse; and the MRJ is expected to make its maiden flight shortly, possibly this month.

Even the giants of the industry find that it is not easy to get an entirely new aircraft design off the ground. The research-and-development costs for Boeing’s newest aircraft project, the 787 Dreamliner, grew to $28 billion as a result of problems with its supply chain and its electronics. And revenues from Airbus’s newest aircraft, the giant A380, hardly cover its production costs, never mind the capital sunk into its development. If even the industry’s two dominant firms find it a long, expensive struggle to get a new aircraft design in the sky, no wonder their would-be rivals are having such a hard time.

Moving more price targets to Dec-16 basis; upgrade

Zodiac to Neutral from Underweight

We recently moved our price targets on Airbus, Meggitt and Senior to a Dec-

16 basis from Dec-15 basis. We now do the same for Safran (OW), MTU

(UW), and Zodiac (which we upgrade to Neutral from Underweight).

* Zodiac (upgrade to Neutral; raise PT to €27 from €23): ZOD reports its

FY15 results on November 24, having pre-announced a profit warning on

September 15. Ahead of the FY15 release we leave our estimates

unchanged. However, rolling our multiples-based price target forward to

Dec-16 from Dec-15 increases our price target by 17% to €27. We believe

that there is still a wide range of outcomes for ZOD’s earnings YE Aug 16-

18E, as the key unknown is the rate of improved execution after five profit

warnings since September 2014. We thus believe that the appropriate rating

is Neutral.

* Safran (remain Overweight; raise PT to €82.5 from €75.5): We now

value Safran on a Dec-16 basis, from Dec-15 previously, increasing our

multiples-based PT by 9%. We are not changing our EPS estimates with this

note. In our results note of October 22 we outlined two major investment

positives for Safran (best-in-class aftermarket growth; a very big FX

tailwind from 2018) and two emerging concerns (execution problems on two

new engines; the potential for a full EU investigation into the civil aero

aftermarket.

* MTU Aero Engines (remain Underweight; raise PT to €85.5 from

€78.5): We now value MTU on a Dec-16 basis, from Dec-15 previously,

increasing our multiples-based PT by 9%. We increase our MTU defined

EPS for 2015-18E by 2% pa, following the Q3 15 results last week. MTU is

going through a major transition period whereby a lot of its older engines are

being retired from service, and are being replaced by new engines which are

sold at a loss in the expectation of future high margin spares sales. This

transition is challenging but will leave MTU well positioned for the future; it

is not the reason for our UW rating. Our main concerns (flagged in several

previous notes) are MTU’s accounting practices whereby it is boosting

2015-17E EPS by c20-30% pa from capitalising R&D and the interest

payments on new investments, and significantly boosting reported FCF by

omitting entry fees paid to join new programmes and also omitting vendor

financing commitments on those programmes. As a result of these issues,

MTU is the most expensive civil aero stock in our coverage on a 2016E

clean EV/EBITA of 16.1x, a 24% premium to the European Civil Aero

average.

VW has made a new admission of ‘irregularities’ on c.800k vehicles that give misleading CO2 results under test conditions. VW has put the cost at EUR2bn, but notes this is an ‘initial’ estimate. This comes on top of the existing EUR6.7bn provision for the 11m vehicles with NOx defeat devices, and is separate to the new EPA violation notice on 10k diesel vehicles issued on Monday (which VW denies). VW has given little detail on the incremental 800k CO2 affected cars, but we believe most (but not all) to be diesels in Europe.

Assessing the impact of this latest shock is not straight forward. We have added a further EUR4bn in recall / customer compensation cost to the EUR12bn we had already modelled on the NOx issue. Versus VW’s own EUR2bn and EUR6.7bn estimates, this allows material leeway to cater for compensating customers for ‘lost’ fuel economy and/or residual value impact. We note that the 800k number could yet go higher. We also model an increased commercial impact in 2016, with customer behaviour more likely to be affected in our view over uncertainty on fuel economy than it has been on NOx. The net result is a 10% downgrade to ’16 EPS, with our TP falling to EUR116.

VW’s latest admission on CO2 will have ramifications across the sector. As with NOx, attention will likely quickly focus on the incremental compliance costs of a shift to a ‘real world’ test cycle – which we put at c.€3bn. We caution against knee-jerk over reactions, but have previously noted greatest ‘real-world’ CO2 risk at Daimler (=) & VW, and least at Renault (+). Tyre makers may be the safest place in the sector short term given their insulation from OE market disruption.