Gulfstream, the jet manufacturing arm of General Dynamics (GD -3.97%), has always pinned high hopes on China turning into a big market for its multi-million dollar business jets. Gulfstream's conviction may seem strange to some as the country's share in the global business jet fleet is a minuscule 2%. So, why is Gulfstream so upbeat on China? And why should General Dynamics' investors worry about a country that so far accounts for just 3% of the conglomerate's overall sales?
"The gap between supply and demand has appealed to international players hoping to enter the Chinese market." -- South China Morning Post
China is becoming a breeding ground for the planet's new billionaires because of increasing urbanization. According to Hurun Report, the country is home to 358 billionaires, second only to the U.S., which has 481. With growing appetite for luxury, Chinese tycoons are buying private jets more than ever, evidenced by the rising business jet deliveries in the Greater China region (China, Hong Kong, Taiwan, and Macao) over the last few years.
Source: The Greater China Business Jet Fleet Report 2013. Chart by author.
The delivery numbers would have been much higher had it not been for the restrictions imposed by the military on China's airspace for security reasons. In April 2014, Forbes reported that only 20% of the country's airspace was available for non-military planes. There are also other challenges like fewer airports, lack of trained pilots, lengthy flight permission process, and so on. And, finally, there's the recent anti-corruption campaign by the government that could be deterring the rich from buying personal jets.
The result is that China accounts for just 2% of the world's fleet of business jets. But there's so much pent-up demand that if China's skies open up, it "may herald the greatest expansion of business and private aviation in the last 30 years," according to a Reuter's report. This has attracted plane makers like Gulfstream, Bombardier, Embraer, and Dassault to name a few.
"OEM market share lead by Gulfstream (38%) ..." -- The Greater China Business Jet Fleet Report 2013
Gulfstream delivered its first jet to China in 2003, and has the largest market share in the country's business jet market. Bombardier and Dassault trail at number two and three with 30% and 9% market share, respectively.
Gulfstream has more than 130 business jets in operation in the country, up from just 30 planes in 2008. The company's portfolio of larger jets in the mid-size, super mid-size, large, and ultra-large categories is a big advantage as the Chinese prefer big jets. In April last year, China gave Gulfstream one of its biggest single orders of 60 jets. In 2015, the jet maker sees China driving demand for its business jets as America and Europe remain sluggish.
Gulfstream's long-range G650ER business jet. Source: Gulfstream.
A big reason behind Gulfstream's success in China is that it tapped into the market early on. The company's regional senior vice-president Roger Sperry told Flightglobal, "We set up a sales office in China before there was even a market there. We have continued to invest heavily ever since." The company opened a factory-owned service center at the Beijing Capital International Airport two years ago -- something no other business jet maker has done yet. It has been able to wade through the strict norms and regulations with the right partners.
"Revenues for the Aerospace group were 19 percent of our consolidated revenues in 2011, 22 percent in 2012 and 26 percent in 2013." -- 2013 General Dynamics Annual Report to shareholders
The chart below shows why the aerospace segment is becoming more important for General Dynamics. Sales and profitability of the segment have consistently increased over the past few years. Currently, aerospace forms the lion's share of General Dynamics' profits, and China has become Gulfstream's second largest market after the U.S.
Source: General Dynamics, chart by author.
Gulfstream's China market could grow significantly over the years. In its latest business outlook, Bombardier has predicted that business jet deliveries in China could reach 2,225 by 2033, which translates into 10% of global demand.
Assuming Gulfstream maintains its existing market share of 38%, the company could deliver approximately 845 jets by 2033. According to the Greater China Business Jet Fleet Report 2013, 77% of the Chinese fleet is made up of large and ultra large jets. So, if preference patterns remain similar, nearly 650 of Gulfstream's potential future deliveries could be large jets that fetch around $50 million per plane. Thus, the company is looking at possible revenues of $32.5 billion from China in the next 20 years. Plus, if the business maintains 18% operating margin, operating earnings could be $5.8 billion.
This is a conservative estimate as it excludes deliveries of medium size jets and growth in market share. Gulfstream's chances of increasing market share in China are quite likely as it has unveiled two new jets in the long-range, large-cabin category -- G500 and G600 -- scheduled to enter service in 2018 and 2019.
A dream come true?
China is a case of abundant opportunity coupled with difficult roadblocks. Gulfstream has positioned itself nicely in the market and could earn billions if demand forecasts come true. Since aerospace is General Dynamics' most profitable business, success in China can create greater value for its investors.
