Boeing’s Ray Conner speaks to JP Morgan conference

Ray Conner, CEO of Boeing Commercial Airplanes, appeared today at the JP Morgan aerospace conference.

Here is a running synopsis:

Ray Conner (RC)

Joe Nadol (JN) of JP Morgan:

RC: It’s important to recognize that batteries are not used in flight. They are back-up to start the APU and for the systems. After events, put together 200 engineers. Have done 200,000 hours of analysis. Have come up with comprehensive solution and presented to FAA on Feb. 22 and last week to Japan.

  • This is not just a Boeing-type of solution. We’ve worked with a number of people outside Boeing to ID causal factors and run by them and did the same with potential solutions.
  • That’s what we presented to FAA.
  • We’ve provided different layers of protection for fixes.
  • Hope to see approval of certification plans and then move into certification testing.
  • We would not go forward unless we thought we had it nailed.

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Embraer facing slack years: JP Morgan

Update: Even as we posted this, Jon Ostrower Tweeted PW has been selected to re-engine the E-Jet. We’re trying to confirm.

Embraer faces declining deliveries this year and next due to declining orders and a declining backlog, reports JP Morgan in a research note issued January 8.

JP Morgan writes:

We are downgrading Embraer…because we believe the stock does not fully account for a decline in commercial deliveries. We are lowering our 2014 E-Jet delivery estimate to 60 from 80, and we see potential for both upside and downside to this estimate.

  • We forecast 85 E-Jet deliveries in 2013 and 60 in 2014, down from 105 in 2012. Our 2013 outlook is based on our view that the company has filled ~75 slots this year, reinforced by indications from management, and the trickle of orders since then. Visibility into 2014 volume is much lower. We estimate that only 21 slots are filled (using data from Ascend), and even if we allow for some reshuffling from other years, Embraer still has a decent number of orders to gather just to reach our estimate. Embraer has taken ~306 E-Jet orders the past five years, or 61/year on average, and our delivery estimates for 2014 and beyond are in line with this.
  • E-Jet backlog was likely down to ~162 aircraft at year end. This represents only 1.5x 2012 deliveries vs an average of 3.2x historically. The backlog is only 1.9x our 2013 delivery estimate of 85 E-Jets, indicating that without an order pickup, the lower rates we are assuming will not be sustainable. The estimated E-Jet backlog in units is down ~65% from its 1Q08 peak of 466 and has declined in 15 of the 19 subsequent quarters.
  • Opportunities still lie in the US. Embraer does have opportunities to rebuild the backlog, the most prominent of which are in the US. Last year, management indicated it would compete for 300-500 US replacement orders in the coming years. Embraer failed to capture the first of these as Delta ordered from Bombardier, but there are other opportunities, such as a potential order from American for up to 200 76-seaters. This order could take place in the coming months if American exits bankruptcy independently, but a merger with US Airways (as our airline analyst Jamie Baker believes is likely) could push this out to 2014. We expect a resolution on the merger question in the coming weeks. Either way, Bombardier will surely provide stiff competition, and we see it as at least a mild favorite. Embraer has also pegged a ~150 aircraft opportunity from United. Large US orders would clearly benefit Embraer but even with 20-30 deliveries into the US annually, production should remain below last year’s 100+.

Our take:

We think EMB has seen a drop in orders because, at the end of 2011, officials announced they will re-engine the E-Jet. But throughout 2012, the market has waited for information about what the E-Jet RE will look like. The engine hasn’t been selected yet, as far as we know. A new wing is assumed, as are upgrades to the systems–which we hear will be borrowed from the KC-390 military aircraft.

As a result of the ambiguity, we think customers have been holding off ordering aircraft.

Furthermore, Bombardier has won some key competitions: Garuda and Delta Air Lines, where the CRJ proved to have lower operating costs and pricing considerations also favored BBD. The E-Jet is superior in passenger comfort to the CRJ, but for cost-driven airlines who don’t really care about passenger comfort, the lower operating costs of the CRJ may prove the winning combination with a more aggressive pricing and deal from BBD.

Embraer needs to make its RE decisions soon to regain momentum.

Boeing’s 3Q strong; initial analyst takes; transcript link

Boeing announced strong results for 3Q2012. The press release may be found here.The transcript from the earnings call is here.

The initial analyst take is below. Note the pension comments in JP Morgan; this helps explain why Boeing wants to shift new hires to a 401(k) program from a Defined Pension Plan.

Bernstein Research

Boeing reported a very strong Q3, particularly related to its outlook for the year. For the year, the company has raised guidance for defense revenues, defense margins, and operating cash flow. We see cash generation as a particularly important area of focus for Boeing. Although Boeing Commercial Airplanes guidance was unchanged, we will be looking for more insight on progress on the 787 during the earnings call – we see the 787 as central to the long term performance story. High margins in defense are consistent with our view of strong margins across the defense sector as companies (including Boeing) focus on cost reduction.

Boeing reported Q3:2012 EPS of $1.35, above consensus of $1.13 and our expectations of $1.03. Boeing attributed the EPS beat to “strong core operating performance”. Boeing raised 2012 EPS guidance by $0.35-$0.40; to $4.80-4.95, up from $4.40-$4.60. The size of the EPS guidance increase is encouraging because it suggests even better performance in Q4.

Sales for the quarter were $20.0bn, in line with consensus of $20.0bn and our expectations of $20.1bn. Boeing raised sales guidance for the year up $500M-$1bn, to $80.5-$82bn from $79.5-$81.5bn on expectations of higher Boeing defense sales.

Goldman Sachs

Boeing reported 3Q12 EPS ahead of its consensus, raised its 2012 EPS guidance to a range above consensus, and generated strong orders and cash flow in the quarter.

3Q12 reported EPS of $1.35 compares to consensus of $1.12 and GS at $1.15. The tax rate was 550 bps below our estimate, which added roughly $0.10. Boeing’s reported segment operating profit is 8% above our estimate which was above consensus.

Total revenue of $20.0bn was 1% below our $20.2bn estimate, as Boeing Commercial grew 28% and Boeing Defense declined 4%. But total EBIT margin of 7.8% was 70 bps ahead, with Commercial 20 bps better and Defense 150 bps better.

Free cash flow in the quarter was $1.18bn, implying FCF/NI of 1.14X. It is up from $564mn qop and $104mn yoy.

Total company backlog increased sequentially to $377.6bn from $373.8bn. BCA book-to-bill was 1.41X, while BDS was 0.76X.

Boeing raised its full-year 2012 EPS guidance to $4.80-4.95 (ahead of consensus of $4.72) from $4.40-4.60. Even when adding the $0.10 tax benefit in the quarter to consensus, the mid-point of the new range is still above the Street’s prior expectations. Boeing raised its revenue guidance to $80.5-82.0bn from $79.5-81.5bn. It reiterated its BCA margin guidance, but raised its BDS margin guidance by 25 bps. Operating cash flow guidance was raised to >$5.5bn from >$5.0bn. The 2012 787 + 747-8 unit forecast of 70-85 was reiterated.

JP Morgan

Boeing put up a solid quarter with a big headline beat and higher guidance, but the pension expense outlook is even worse than we had expected. Defense margin drove the operational beat and a lower than expected tax rate contributed as well. Boeing delivered the preliminary 2012 pension guidance we had expected, and it is a whopper. Pension expense is expected to be up by $1 bn, about half of which is driven by previously inventoried expense. We had anticipated that the inventoried pension could provide incremental headwind, but not by nearly this much. The difference between this and our current 2013 estimate could be worth another 55 cents of EPS. We anticipate that management will offset some of this with some combination of share buybacks and pension contributions, but we believe that full capital deployment plans will not be discussed until at least December; so, GAAP EPS estimates for 2013 are likely to drop in the coming days.

EPS of $1.35 exceeded our estimate by 24 cents and consensus by 23 cents Relative to our estimate, EBIT accounted for 14 cents of upside, with defense margins comprising nearly all of it. Tax contributed another 9 cents. Management raised 2012 EPS guidance from $4.40-4.60 to $4.80-4.95

BCA EBIT of $1,153 mn was 4% ahead of our estimate on margin strength. We estimate the core operating margin (ex R&D and the low margin 787 and 747-8 programs) was 17.3%, in line with our 17.2% estimate. We had had some concern that a 737 block extension during the quarter could provide some pressure, but this did not materialize. R&D was also modestly lower than expected, contributing to the overall 30 bps margin beat. BCA margin guidance remained ~9.0% despite the 9.9% YTD level. Q4 period costs could provide some headwind, but we believe there is plenty of conservatism in this guidance.


Q3 at $1.35 included $0.10 from lower tax rate: Q3 EPS at $1.35 including $0.10 benefit from lower 29% tax rate. Upside relative to our model came from BDSS (Defense) as BCAG (Commercial Airplanes) came through overall in line with our expectations. BCA margins at 9.5% with pre R&D at 13.8% diluted by higher 747-8/787 deliveries. We estimate pre R&D margins ex 747-8/787 at 17%, in line with Q2. BDSS revenues down 4% vs our -8% while 10.5% margins were 100bps better than our model. FCF at $1.2B or 113% of net income dragged down on $1.8B inventory build and $750M pension contribution.

787 cash costs improved by ~$15M per unit: 787 deferred production grew by $1.1B, slightly below prior quarter on similar production. While we need further details for precise calculation, we estimate deferred production per unit improved by $15M relative to Q2. BCAG reported a $1B unit accounting loss reflective of 747-8 and 787 losses, much higher than $144M in Q2 on seven additional 747-8 and 787 deliveries.

Boeing 787s require 13 months of rework, concludes UBS

UBS Securities, in a research note issued today, estimates that the Boeing 787s delivered so far spent an average of 13 months getting rework done, with three delivered in April reduced to 9-12 months. Writes UBS:

On average, we estimate that the 11 787s delivered thus far spent 13 months in change-incorporation. While it appears Boeing did not deliver any 787s in May, we estimate that the three delivered in April (LU 37/38/42) spent between 9-12 months in change-incorporation.

Change-incorporation key component of 787 unit costs: Change-incorporation work is a key component of 787 unit costs. We estimate Boeing’s 787 unit production cost at ~$240M in Q1, more than double its assumed average cost at ~$109M over the first 1,100 units. We expect 787 unit costs to trend lower as mix of change-incorporation deliveries lessens.

JP Morgan, also in a note issued today, had this to say:

787 still on the right track, but it’s never easy. Boeing delivered no 787s in May, a step backward following three deliveries in each of March and April. This does not appear to be due to execution issues, but rather to a pilot strike at Air India and the carrier’s efforts to extract more compensation for delays. We anticipate that there could be at least four deliveries in June, which would bring Q2 deliveries to seven, above Q1’s five. Boeing will need a significant ramp in 2H to reach its guidance for 35-43 deliveries this year, but the ability to deliver aircraft directly off the assembly line rather than sending them through change incorporation should improve the flow, and more aircraft should be delivered from change incorporation as well. Management has indicated in the past that aircraft #66 would be the first to go from the assembly line to the flight line without passing through change incorporation, and this aircraft is now in the last position on the Everett final assembly line, although it is unlikely formal delivery will take place until July. While there will be ups and downs, such as May’s lack of deliveries, we continue to expect 787 execution and financial metrics to improve through the year.

Odds and Ends: More from the Airbus Innovation Days

We have some follow-up to our trip last week to the Airbus Innovation Days:

A350 Program: Aviation Week has this article about the A350 program, noting that the A350-800 seems to be suffering from from benign neglect.

A350 Engineers: There is a lot of buzz “out there” that the A350-900 program is sucking up engineers from the A350-1000. We asked Airbus about this at the Innovation Days. There is no question that the -900 timeline is challenging (see chart) but Didier Evard, EVP of the program, says engineers will be released soon for the 1000.

“This year we have to ramp up the 1000 team,” Evard said. “We have internal plan and to increase the workforce from the outside to start the detail design this year.”

We asked what was the level of engineers assigned to the 900, using the example that if 100% were the norm, was the program at 100% or 125%, for example. Evard didn’t directly address that but said:

“The 900 this year will go down from 100% to around 60% or 70% and be stable.”

A380 Wing Rib Fix: Airbus showed this illustration:

Although the slide shows 60 ribs per wing, in practice, Airbus says only 20 have needed repair.

A320neo affecting A320ceo demand: JP Morgan issued this observation following the Innovation Days:

A320neo EIS is affecting demand for the current version. The imminent introduction of the a more efficient version of the A320, the neo is scheduled to enter service in 4Q2015, should make it more difficult to drum up demand for current generation A320s in 2014/2015. The years immediately preceding the changeover have always seemed like a potential rough patch, both for the A320 and the 737, which will transition from the NG to the MAX, in 2017. According to Ascend, A320 slots are filled for 2014 with 484 aircraft scheduled for delivery, 42/month implies ~480 deliveries, but 2015 is not yet full at 362 A320s. As some customers could walk away ahead of the neo introduction or for other reasons and new orders should be hard to come by, holding the rate at 42/month looks reasonable. Lease rates on current generation A320 family aircraft have been the weakest among major Airbus and Boeing platforms, an indication that the market is not as hungry for more of them as it is for other models.

We heard long ago that Airbus was worried about demand for the ceo, but we also heard the same is quite true for Boeing on the 737NG with respect to MAX sales. This is why we are seeing many Airbus and Boeing deals include the current generation of airplanes with the re-engined models. It’s also why, we believe, we’re seeing pricing on the current generation of airplanes dropping precipitously, which will of course affect residual values and lease rates.

Boeing comments on 787 delamination, delivery expectations

Jim Albaugh, CEO of Boeing Commercial Airplanes, today commented on the delamination issues on the 787 and the effect on deliveries and production going forward. He spoke at a JP Morgan conference. there are several stories that can be found on Google News, but here’s a link to a Reuters piece that neatly sums things up. Here is a link to Aspire Aviation’s synopsis.

Among other things, Albaugh said Boeing should deliver 70-85 787s and 747-8s, roughly evenly split between the two, or about 35-42 of each airplane. Jon Ostrower also Tweeted that the plan is to deliver the last re-worked 787 in 2014. Some may recall that Boeing’s Scott Fancher, at the time the head of the 787 program (now heading up 777), once said it would take “years” to complete the rework on the plethora of 787s lined up at Everett’s Paine Field. Ostrower also Tweeted, quoting Albaugh, as saying the first “clean” 787 will be line #66 (it had been forecast to be #63).

The other key point is about the delamination. While this has gotten a lot of high-profile attention, particularly in the context of the overall 787 program difficulties, independent sources we checked with tell us that while this is another annoying and embarrassing event for Boeing, the fix in relatively simple and the problem not particularly consequential. Boeing, of course, has said as much but skeptics continue to question Boeing’s credibility due to the history of the program often turning out to be worse than Boeing’s statements. Case-in-point is Boeing’s continued insistence that it will meet the goal of producing 10 787s per month by the end of next year and the disbelief expressed by every aerospace analyst and consultant we’ve seen. (Granted, there may be some who accept the goal as doable, but we’ve not seen them.)

Separately, an interesting public dispute between Air India, a 787 customer, and Boeing emerged. Air India says Boeing agreed to pay $500m for delays of 27 787s. Albaugh says that’s news to him. We ask, what precisely did Air India say? The news reports are too ambiguous. Did Air India say cash compensation or that Boeing is paying $500m in compensation, which, of course, could take many forms such as discounts, services, parts, etc? This would make Albaugh’s statement that no check is being written correct. So it goes….

Boeing comments on the 737RE

As the aviation world waits for Boeing to define the 737RE, it might be worth taking a close look at the July 27 earnings call discussion relating to the airplane, apart from the topic of where the aircraft will be built—we covered that thoroughly last week.

Our resource is the earnings call transcript as published by Seeking Alpha. As we go through the transcript, we will highlight certain statements and then offer some commentary at the end of the section.

Here is what CEO Jim McNerney said in his prepared remarks.

Also in recent months, a broader customer view has emerged in support of the greater certainty of gaining significant incremental improvement in a re-engined 737 in the near to midterm over the more perfect solution which may be available further down the road. It has always been our view that if it looked like we are putting meaningful market share at risk by waiting to do a new airplane, we would re-engine instead. That combined with our new engine technical production assessment against lead time for new engine decision led us to the judgment that we have made.

We are confident that our re-engined 737 will maintain the value proposition we have in the marketplace today and we expect to see strong demand for this product. It will be the most fuel-efficient airplane in its segment and have the lowest operating cost, while also meeting customer needs for range, payload, standardization, reliability and fleet compatibility.

Over the next several weeks, we will continue our work to finalize the configuration and other details in anticipation of a launch this fall pending board approval.

Comment: As we have talked with our various market sources, one believed Boeing would suffer a market-share drop of at least 20% if it elected to proceed with a new airplane instead of a re-engine. This drop would come because customers would pull back on orders for the 737NG while waiting for the new airplane. Whether this is a valid number might be debatable, but the theory is consistent with McNerney’s comments. Earlier this year, Boeing Capital Corp. held an investor’s meeting in New York and remarks indicated that Boeing was prepared to take a 10% 737 market share drop in favor of a new airplane, figuring it would regain it with an aircraft superior to the A320neo family. Then there is the question of whether Boeing could actually afford a new airplane program, a topic McNerney did not address, in light of the losses on the 787 and 747-8 programs and the billions in cost overruns and delayed cash flow. Finally, there was strong undercurrent that the Board of Directors was not prepared to approve another new airplane program with the 787 and 747 programs in the condition they are in.

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Analysts opine on Embraer, Bombardier

Goldman Sachs and JP Morgan issued notes this week that give some opinions on rivals Embraer and Bombardier:

Goldman Sachs: Embraer

July 31: We believe Embraer remains the best, yet most ignored, story in our commercial aerospace coverage. We highlight the following key incremental takeaways from the EPS report and conference call: (1) 2H regional jet new orders could equal or surpass 1H (even though 1H was a record) which would mean full-year 2011 book-to- bill would surpass 2.0X. We think demand for the E-190 right now is stronger relative to current supply than any aircraft in the world. (2) Tone on business jet was noticeably more positive for the first time in a while, with particular strength noted on the Phenom 300. We think ERJ can close to triple its business jet revenue between now and 2015. (3) Defense opportunities are occurring faster than expected. We continue to see very large upside potential in ERJ’s Defense segment given initiatives around the World Cup and Olympics and how large the KC-390 program will be. (4) Management sounds confident it can continue to expand margins despite the Real, and possibly meaningfully if the Real were to reverse. (5) Next-gen product   strategy decisions are likely made by year-end, and it sounds like one of either a clean sheet or E-195 stretch / re-engine will occur (we believe the case for the latter increasingly makes sense).

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Odds and Ends: $19bn cash turnaround for Boeing

We’re catching up from a week out of the office and one thing that especially caught our eye is this comment in a research note late last week from JP Morgan:

Potential cash turnaround on 787 is enormous. By the end of this year, Boeing plans to have amassed $19 bil in 787 inventory, most of which will consist of so called deferred production costs, or the extra cost above the long-term average to build the first few dozen aircraft. We expect the initial 787 block to be 1,000 aircraft, which should take ~8 years to deliver. Even if the program never contributes a penny of earnings and ends after that initial block, it should therefore generate ~$19 bil of operating cash flow over that delivery period, or an average of ~$3/share annually. While from an accounting standpoint this would be a reduction of inventory, it is best thought of as underlying cash profitability on the aircraft (say 20% margin on 120 units/year times $100+ million each) that is offset perhaps entirely by the amortization of the sunk cost from the delays. The potential $3/share of positive 787 FCF compares to an expected cash outflow of $8/share from 787 inventory build this year, plus another $3/share of R&D and capex, making the total 787 outflow ~$11/share. Overall, the vast majority of the cash flow improvement opportunity results from elimination of the cash outflow, so while the difference between a 20% margin and a 10% margin might be significant, it pales in importance next to simply getting the program ramped up and into the black.

Other items of note:

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787 Update, Week of May 26

Testing continues on the 787 as it prepares for first flight in June.

Speculation is rampant over whether the airplane will be ready to fly before, during or after the Paris Air Show (but for clarity, “during” does not mean “at” the air show).

We believe Boeing would dearly love to be able to talk about first flight at the air show. Tests appear to be moving more quickly than anticipated, as reported by Flightblogger in its running countdown to first flight.

We are hearing widely divergent opinions about whether first flight will happen in time for Boeing to discuss it at the air show or not.

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