Image Source: Boeing
By Brian Nelson, CFA
Nearly a decade ago, Boeing (BA) and Airbus (EADSY) made some big bets on the future. On one hand, Boeing envisioned a world of increasing point-to-point travel requiring wide-body aircraft with ultra-fuel efficient economics, laying the groundwork for the blueprint of the 787 Dreamliner, a mostly-composite aircraft. Airbus, on the other hand, had a different view of the future. The European plane maker believed that air travel would be dominated by the hub-and-spoke system where massive planes would be needed to transport passengers between global hubs. It decided to build the massive A380 superjumbo.
If Boeing had not already declared victory, it can probably do so now. In mid-July, Airbus announced that it would cut its production of its once-prided superjumbo to just one plane per month by 2018. Airbus had once believed that airlines and lessors would scoop up as many as 1,200 of this giant plane in the next 10 years after first delivery, but it has so far only delivered ~190 A380s with just ~125 more on its order books. The company spent a whopping 25 billion euros developing this massive plane, and it looks like it’s going to be a bust. Many are calling for the death of the double-decker A380, and it looks to be headed that way. Without sufficient production to scale costs, the economics just doesn’t work. Boeing also implied that it is considering ending production of its iconic 747 jumbo, perhaps best recognized as Air Force One. The age of the mega-sized commercial aircraft may be over.
Airbus has hedged its bet, of course, and the rest of its family of planes continue to catch the favor of airlines and lessors across the globe. At arguably one of the most watched industry events, the Farnborough International Airshow, Airbus landed a total of ~280 orders and commitments worth ~$35 billion, while Boeing pulled in ~180 aircraft orders and commitments worth a total of ~$27 billion. The narrowbody workhorses continue to be in high demand, with Airbus’ A320 family accounting for the vast majority of business, including its larger A321neo model, which took the “lion’s share of single-aisle announcements” at the show. The workhorse Boeing 737, perhaps made popular by Southwest’s (LUV) low-cost ambitions, received the most customer interest, including next generation 737-800s and various versions of the 737 MAX (200, 7, 8). The US plane-maker also landed the largest commercial services order in its history and orders from the UK Ministry of Defence at the show.
The real story for investors in the commercial aircraft-making supply chain from giants such as General Electric (GE), United Technologies (UTX), and Honeywell (HON) to smaller players including Hexcel (HXL) and Astronics (ATRO) to lessors such as Air Lease (AL) and AerCap Holdings (AER), the latter having gobbled up AIG’s (AIG) aircraft leasing operations, is the commercial aerospace backlogs at these two large plane makers. Commercial aerospace backlog at Boeing alone stands at ~$417 billion, and while this is down from $430+ billion at the end of 2015, it still accounts for a whopping ~6.5 years of its expected 2016 ‘Commercial Airplanes’ segment revenue. The 5,700 commercial-airplane unfulfilled orders it holds on its books is an even-more amazing ~7.7 times the number of deliveries Boeing expects to hand over to customers this year (740-745). Airbus’ backlog of unfulfilled deliveries is similarly robust at more than 6,000, and production decisions should continue to drive combined deliveries higher for the next few years, according to most estimates. A transition to the new Boeing 777X may cause some choppiness after the turn of the decade, however.
Image Source: Astronics
There are few industries with greater visibility than the commercial aerospace business, and the recovery from terrorist activity from 9/11 to more recent events speaks to sustainability. Cancellations and deferrals were relatively minor as a result of passenger-demand shocks as travel for business and leisure are a core part of the world’s everyday life. Passenger demand is expected to ramp at a 6% compound annual growth rate for many years to come, according to United Technologies, and while other industry participants such as Boeing forecast passenger traffic growth at ~4.8% per year over the next two decades, the consensus is still an above-inflation pace of expansion. Boeing will tell you that commercial aerospace is a growth industry. We expect such robust demand to continue to fuel Best Ideas Newsletter holding Priceline’s (PCLN) growth. Expedia (EXPE), Travelzoo (TZOO) and TripAdvisor (TRIP) are also key beneficiaries.
Image Source: United Technologies
On the first day of the 2016 Farnborough International Airshow, Boeing released its widely-followed Current Market Outlook (CMO), calling for as many as ~39,600 new airplanes needed over the next 20 years, valued at ~$5.9 trillion. Airbus expects demand for ~33,000 new aircraft at a price tag of ~$5.2 trillion. The single-aisle market will account for the vast majority of those expected deliveries, namely the 737 and A320 family of aircraft, but also Bombardier’s (BDRAF, BDRBF) C Series (the first delivered June/July), Embraer’s (ERJ) E-Jet family and China’s Comac C919, which is targeting first flight by early 2017.
Bombardier has encountered a swath of issues entering the single-aisle market, with its C-Series development running more than two years behind schedule and coming in significantly over budget, but it’s in–a recent large deal with Delta (DAL) has validated is presence in the single-aisle market, in our view. Many are writing off the C919 as “behind-the-technology-curve,” despite its brand-name supply chain that includes Rockwell Collins (COL) and Parker-Hannifin (PH) and others, but we think China will be a legitimate player in the single-aisle market, if not this iteration the next. Embraer’s re-engined, narrowbody E-190-E2, which is targeted to enter into service in 2018, is ahead of schedule.
Image Source: Rockwell Collins
The long-term picture of the commercial-aircraft making business remains a robust one, but we’d be “somewhat one-sided” if we didn’t outline some of the near-term risks. First, equities tied to the commercial aerospace cycle have shown a tendency to trade more in tandem with the pace of new orders than the strength of deliveries or earnings. Given the size of the commercial aerospace backlogs at giants Boeing and Airbus, flush with more than a half-dozen years’ worth of production, airlines and lessors have some option value to wait before placing new orders as near-term delivery slots are already full. This could weigh on the pace of new order growth in the next few years, even if the overall market is a healthy one. Airbus, for example, has warned that its order target for 650 during 2016 may be a “stretch,” and it’s worth noting that its performance at Farnborough was better than Boeing’s. Orders through July 26, 2016, at Boeing totaled 333, an annual pace implying a book-to-bill ratio below 1 for the year.
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