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.
Robert Spingarn – Crédit Suisse AG
I’d like to ask a comprehensive question on the 737 re-engine, and so it is a multiple part but I think it’s important. Knowing that you haven’t launched the aircraft yet, I suspect there’s still some detail framework around it in order to — since it was the key, I think, to the American win. So could you add some more color on the following items. First, the configuration, is this an engines-only exercise to mitigate cost? And how should we think about the R&D profile and CFM’s share of that profile? And then what are your market expectations for this model, in particular for the near-term domestic competitions? And then finally, if you could clarify American’s comment that it doesn’t expect to receive delivery of this model until 2018, suggesting that it is not the launch operator while it may be the launch customer.
Well, let’s see. I’ll start at the beginning. As I may — as I said in my comments, because I anticipate that there may be more than one question on this, so I’ll try to sweep a number of these in. As most of you know, as I said in my remarks, we spent the better part of the last year or 18 months pushing hard on both options. And as the new small airplane largely a technical and production question, re-engine, largely a marketplace acceptance question because the do-ability of it technically is less costly and has less risk. I think what we’ve seen over the last, I would say over the last 2 to 3 months, we’ve seen the marketplace assessment pushing more for the re-engined option. We’ve also been somewhat more mindful of the risks associated with getting a massive new production system up on an all-new airplane by 2019, which doesn’t suggest we couldn’t do it but there is more risk as you get deeper into it than perhaps we appreciated at the beginning of the assessment. You combine these two things and you get to a re-engine decision. And just to bear on one part of your question, it is largely about the engine. The configuration that we’re looking at is that there will be some systemic impact on parts of the airframe. But I think I would characterize our strategy as to minimize those while still achieving the kinds of operating efficiency, cash-on-cash and performance goals that I mentioned in my talk. I think that’s one advantage of this option quite frankly is that we do have confidence that CFM can produce the engine. And we see very manageable risk on incorporating it into, and integrating it, into the airframe. So again, and we’ve been studying this for awhile, so this didn’t occur to us a week before the American Airline competition. This is something — and I would characterize the American Airlines’ deal as part of a much broader voice of the marketplace that it is very highly valuing efficiency today versus more efficiency tomorrow. And you know the environment they’re operating in and perhaps — and we’ve always said that the last thing we would do is do an all-new airplane if it put a lot of market share at risk in the short and medium term. And that which gets to the question of would the marketplace wait for the perfect solution further down the road or not? And so mix that all together and that’s where we ended up. You had one specific American Airline campaign question and I’ve lost it.
Comment: Boeing has been looking at several configurations of the airplane and market estimates of the R&D cost have ranged from $1bn to $4bn, depending on the extent Boeing has to go to revamp the 737 and whether the FAA is going to require re-certification of the airplane. It’s commonly accepted that, like Airbus, some strengthening of the wing and wingbox will be required to accommodate the heavier LEAP engine. Whether the nose gear has to be raised depends entirely on the fan size and as of today, this has not been determined. There is a question of how much of the systems may change. Boeing is considering putting a 787-style cockpit in the airplane but it is unknown outside the company if the decision to do so has been made. A new wing or new wing configuration has also been looked at.
Buckingham Research, in its post-earnings note, estimated the following costs:
We think the new wing/center wing box design could cost ~$1bn. BA has already unveiled a new interior for the 737 and will very likely incorporate planned avionics improvements into the 737RE. We think Boeing may consider including a 787 cockpit as that would add a competitive advantage to customers looking for a common cockpit with both widebody and narrowbody aircraft. Integration work and avionics engineering could cost as much as $500mn-$750mn. New avionics will almost certainly require recertification of the 737RE at a cost of roughly $750mn to $1bn.
What’s worth noting is that the analyst, Richard Safran, is a former aerospace engineer with Northrop and has some real basis to make these cost estimates.
But note that McNerney talks about “minimizing” changes and below, CFO James Bell gives an R&D estimate. And remember that back in March we interview Mike Bair, the VP for Future 737 programs, who told us the R&D on re-engining was closer to $2bn than the market-reported $4bn.
Thus, we conclude that Boeing is going to try and keep the changes to the airframe to a minimum rather than go with things like a new wing.
McNerney did not answer the question of what is the share of CFM for the R&D.
Robert Spingarn – Crédit Suisse AG
That, Jim, and the R&D profile perhaps from James.
Yes, okay. Yes, James, you can talk to the R&D profile which is very manageable, okay. The 2018 is less a function of when we can get the airplane done. And more a function of when American Airlines needed the plane.
Comment: This is contrary to what American told us. American said flatly it does not want to be the first customer to operate a new airplane. Nothing was said about 2018 being a “function of when American Airlines needed the plane.”
On R&D, Rob, obviously, a derivative airplane is a lot less expensive, a lot less risk associated with than an all-new airplane. So we will see that the R&D impact to this will be a lot less. R&D will go down in ’12 as we’ve told you. I think it was going down at any scenario but obviously, we will have a better opportunity to do a little better in ’12 than we probably previously thought if we were doing a totally new airplane.
Robert Spingarn – Crédit Suisse AG
James, you said before that R&D on something like this is something like 10% to 15% of a new aircraft, is that fair?
That’s probably about right. Yes, about right.
Comment: This suggests Boeing’s share of the R&D is $1bn-$1.5bn if a new airplane would cost $10bn. Unclear, as noted above, is what the CFM cost is over and above Boeing’s share.
Joseph Nadol – JP Morgan Chase & Co
I’d like to dig into pricing a little bit on the RE to the degree you’re willing to share anything. Airbus has said in the past that they are going to get and are getting a multimillion dollar premium for the NEO than they were for the A320 classic. And I’m wondering if you can say, stand today and say that a part of your business model and you will demand a premium for your aircraft? And then the second part of this is with that in mind, as we look out beyond the next few years in the 737 but really into the middle part of the decade, how sustainable do you think those fantastic margins are just as you put together the business case?
Well, I think there’s no question that we will be delivering significant productivity to the airlines with the re-engined product. I think the fuel efficiency is, and this is fairly conservative isn’t it, in the 10% to 12% range, operating cost improvements are also significant. So an airline in a perfect world would be willing to pay for that. And we expect to capture a large part of the value in the pricing. Obviously–and that’s our plan– obviously, the competitive element, campaign to campaign, can get in the way of that. And that’s reality, but that’s another reason I think to take–to find a sweet spot of a lot of value but with manageable financial and technical risk. And that’s the approach we’ve taken. But we expect–we plan on it and we expect to get value. You’re right, Joe, that we are at a, I don’t want to say high watermark but I want to say pretty robust level now that we’ve been producing this plane for a long time. And I think those margins are sustainable.
Comment: We talked with the fleet planner of a major airline who has seen data that Boeing has to offer up to this point. His department concluded that all-in, the 737RE will be 10% more efficient than today’s 737-800. We note, however, that the situation is still fluid and the configuration is not yet firm.
Ronald Epstein – BofA Merrill Lynch
Sorry to keep beating on the 737 horse, but kind of back to that. I think I understand why the 737 re-engining decision was made, but I guess it’s not clear to me how it was in that time frame. I mean, can you speak to what is the broader strategy for Boeing in the narrowbody market? By doing the re-engining, you presumably aren’t going to do the new airplane, which was presumably going to be bigger. So how do you solve the — when you had a bigger narrowbody problem with this and it just seems like it was done kind of last minute under duress in a campaign. Can you speak to that?
Yes. I mean, I do understand where that question comes from, I think. But I do want to emphasize again that we have been studying the re-engine option to the same degree that we’ve been studying a new airplane option for the last year or more. So this was not something that we sidled up to at the last minute. Admittedly though, Ron, and our view of the marketplace changed over the last 3 months, I would say. And as I said in my — in answer to the last question, I think the significant economics that we can deliver with re-engine are more highly valued over the next 5 to 7 years than even better economics after that point. And this is in-depth discussion with customers and one of which was American Airlines. But believe me, that was not the only customer we talked to. And that we also validated that the re-engine could deliver the kind of numbers I alluded to earlier. You wrapped that all — that combined with the not having all the answers we wanted on the production system to support an all-new airplane in hand, I think that — so the technical risk kind of moved to the right and the marketplace moved to the left, if I can phrase it that way. And that’s why we made the call we did.
David Strauss – UBS Investment Bank
Jim, following on that question, you talked about the re-engined airplane, some of the operating economics kind of in absolute terms. Can you talk about what kind of operating economics you think this airplane will have relative to the NEO? I think you’ve spoken in the past that you actually think that on a cash operating cost per seat basis that the NG actually has, still has better economics than the NEO. And as a follow-up question, can you give us a time frame when you would expect to make a decision on the exact fan size that’s going to go on, that you put under the wing of re-engined airplane?
Yes. I think, as to the first part of your question, let me just get into the end zone quickly. Based on the data we’ve got and the customer data we’ve got, we believe our re-engined airplane will be — have roughly the same margin of capability over the NEO as our current airplane has over the current A320, which is sort of a 2%, 3%, 4% depending on the mission, depending on the model cash-on-cash gap. And so we plan on based on what we know now of retaining that gap is one way to think about it. The fan size, we have studied a number of options on the fan size very thoroughly. We’ve also studied some elements of core configuration, too. So trust me when I tell you that this has not gone unstudied. We are centering now the two teams on a favored configuration that we’ve been working on. And it would be premature to mention right now what it is until we get — until have we got the approval, and customers know specifically about it. But I think we’re in pretty good shape, that we have centered on an option that makes sense to us.
Comment: McNerney largely contradicts the Boeing pre-Paris Air Show press briefings in which the media was told the 737NG has an 8% margin over the A320 (a figure which Airbus has always disputed). Two percent is more in line with what an operator of A320s and 737NGs tells us. This same operator concludes that the 737RE will “restore the status quo,” giving the 737-800RE a 2% advantage over the A320neo.
As for fan size, we understand the consensus seems to be narrowing in on the 66” fan. This means no nose gear changes with the cascading effect of minimizing changes to the airframe, wing and wingbox, thus reducing R&D costs.