Production assessment, Round 3

Some interesting items came out of the Boeings 1Q09 earnings call yesterday (April 22) with regard to production and deferrals.

Oversales of the 737 have been a key element in Boeing being able to maintain current production levels of 31/mo, despite the global recession. As was previously acknowledged by Boeing, 2009 737 oversales were about 100. On the year-end 2008 earnings call in January, CEO Jim McNerney acknowledged that oversales for 2009 had been reduced to about 15% over the production (which mathematically equated to about 55-56 737s).

On the 1Q09 earnings call, McNerney said there were only about 1-2 deferrals of 2009 deliveries. In the context of the exchange below, the 60 deferrals refers to slightly more than half being 737s and slightly less than half being wide-body airplanes.

Susanna Ray – Bloomberg News

You mentioned that there were 60 deliveries scheduled for 2010 and 2011 that were deferred in the first quarter. I am wondering if any were deferred in 2009 and how many. Then I am also wondering how long the delay or the deferral is for those on average.

Jim McNerney

There were no deferrals in 2009, excuse me, maybe one or two, but nothing significant in 2009. The deferral timing varies. It is hard to generalize, but it is generally one to two years.

This raised an interesting question: what happened to the 55-56 737 oversales acknowledged in January if they were not deferred?

We’ve asked Boeing for clarity and will update this post if we receive it.

2010 Oversales

Boeing CFO James Bell acknowledged that the 2010 737 sales book is “balanced.” In other words, there are no oversales remaining. We previously reported that there were 100 oversales in 2009 and something less than this in 2010 and 2011 but more than 30. (We never did find out a more precise number, but we believed 2010 to be closer to 100 than to 30.)

The 2010 “balance” in the 737 order book now means that if there are any new deferrals, Boeing will be faced with cutting into production, building white tails, or finding new buyers. As we know, Boeing is loath to build white tails so cutting production or finding new buyers are the two alternatives.

Bell said on the 1Q call that it must provide 10-12 months notice to suppliers of the 737 for production cuts. This being the case, decision timeline on production cuts in 2010 would line up like this, assuming a first-of-the-month effective date:

1Q10: A decision in May would be required to effect cuts in March with a 10 month notice.

2Q10: A decision in June for April (10 months).

3Q10: A Decision in August for July (10 months).

4Q10: A decision in December for October (10 months)

If Boeing can’t sell positions in 2010 that are opened by deferrals and is faced with cutting production, how deep will cuts be? This is a matter of intense debate within Boeing and great speculation outside the company. In January, Steve Udvar-Hazy, the CEO of mesa-lessor ILFC, suggested Boeing ought to cut rates by 30%-35%. He subsequently has been supported by other lessors and many aerospace analysts. We predicted in February that the 737 rate could come down to around 26-27/mo, roughly a 15% cut. We understand that the worst case discussed in Boeing is 24, which is still well above the Hazy suggestion and well above UBS Securities, which has floated the idea of an even deeper cut.

CFO Bell indicated on yesterday’s earnings call that as of today, Boeing believes it can maintain current 737 rates next year and in 2011. But we think 2010 is going to be a close call.

2011 and Beyond

Bell said there are oversales in 2011. We know from our discussions that 2011 started with an oversale situation (less than 100, more than 30 and we believe it was somewhere in the mid-range). As airplanes were deferred from 2009 and 2010 into 2011 and beyond, this added to the baseline oversales, minus any  2011 deferrals.

McNerney acknowledged on the earnings call that there are 60 deferrals now in 2010/11 (more than half 737s, the rest wide-bodies) and discussions have been held with customers on deferrals for more than 100 aircraft.

Boeing announced that entry-into-service for the 747-8 Intercontinental has been rescheduled from 2Q11 to 4Q11. It’s unclear whether this is at the behest of Lufthansa, the only airline customer for this model, or because of continuing program difficulties with the 747 development, on which more than $1bn has now been written off.

We met last month with a key Lufthansa officer with direct knowledge of the 747-8I program. He confirmed there are development issues with the GEnx engine (both he and GE told us these issues are not particularly unexpected for a new engine program), as well as other development problems largely and previously disclosed by Boeing. More interesting was insight to Lufthansa’s planning strategy for integration with new airplanes.

The German airline is a customer for the Airbus A380, which continues to delivery slip (even exclusive of global economic issues). Some of Lufthansa’s A380 deliveries have slipped as a result. The airline has a fleet integration plan that called for deliveries of the A380 and slightly smaller 747-8 on more or less a concurrent timetable. As the delivery schedule for one plane or the other slipped, this affected the concurrent integration planning.

Thus, although Lufthansa isn’t happy with either Airbus or Boeing on the delivery schedules, it turns out to be a convenient happenstance that the two programs are slipping essentially in tandem, if for entirely different reasons.

But in the end, it’s still unclear who was the driving force in the latest 747-8I EIS slip, Boeing’s own production issues or Lufthansa’s desires, or both.

On the Airbus side

The 737 deferrals and production discussion above naturally begs the question about A320 family deferrals and production plans in 2009/10/11.

Airbus previously announced plans to reduce production beginning in October from 36 to 34 a month. As we’ve previously reported, Airbus suppliers are already planning on a 2010 production rate of 24-26/mo (the same is true for 737 suppliers we’ve talked to). Like Boeing, Airbus had oversold 2009 by about 100 airplanes and by declining numbers in 2010 and 2011. Like Boeing, as carriers deferred deliveries into 2010 and 2011 and from 2010 and 2011 to future years, the number of oversales became a moving number up and down.

Like Boeing, Airbus has said that rates for the A320 will remain constant this year (taking into account the October adjustment) and it expects rates next year will remain comparable to this year. Both companies are hoping the economy recovers next year in order to sustain rates.

Unlike Boeing, Airbus A320 customers historically tend to have a higher risk profile, with large sales to start-up airlines and weaker carriers, thus leading to greater risk of deferrals or cancellations.

1 Comments on “Production assessment, Round 3

  1. EADS and Boeing are both hostage to the larger macro economy. If one would believe some market analysts, prosperity is right around the corner; if one pays attention to the likes of Nouriel Rabbini and Paul Krugman, a different picture emerges. Personally, I tend to believe the latter, not because I’m a pessimist or a cynic, but I just don’t see credit loosening and consumer spending returning to previous levels for years to come. An “L-shaped” recovery would be very painful even to the most profitable airlines.

    Throw in swine flu and other unforeseen events, then air travel could tank even further. I would love to see the current production levels for the 737 and A320 maintained, but I am not optimistic.

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