Boeing stock sell-off on 777-200ER deal over-blown

  • Stock sell off on Boeing 777-200ER purchase price overblown.
  • Wells Fargo stock downgrade the next day spurs larger sell-off.
  • Credit Suisse takes a deep dive into Boeing cash flow.
  • Accelerating PDPs, purchase payments continues to support cash flow.
  • HOLIDAY SCHEDULE: Unless there is major, breaking news, Leeham News and Comment is taking the Christmas-New Year’s holidays off. We resume our normal publishing scheduled Jan. 4, 2016.

Dec. 22, 2105, © Leeham Co.: The sell-off in Boeing stock last week tied to the Delta Air Lines purchase (Letter of Intent) of a 777-200ER for $7.7m was overblown.

The stock was off 2.6% Thursday after Delta CEO Richard Anderson Tweeted an LOI had just been signed to buy a 777-200ER. This sell-off, and an earlier one when Anderson said the -200ER could be acquired for $10m, prompted hand-wringing over 777 values and the potential impact on new 777 Classic sales needed to build the bridge to the production of the 777X.

If these same people had been paying attention, the concern over 777 Classic sales have been brewing all year. LNC and several aerospace analysts have noted that sales of the 777-300ER have slowed and those that have been made have come at a substantial price discount to the historic levels Boeing wants to maintain.

Most of the Classic sales this year have been freighters, and this market is sliding backwards, according to IATA data, not forward. The smaller Boeing 767-300ERF is in more demand, driven by the express carriers, than is the larger, long-haul 777F.

Delta acquiring some tired, old 777-200ERs that require major MRO has no effect on the potential sales of 777-300ERs. These aircraft have very different passenger and cargo capacities and serve different markets and missions.

The -200ERs coming out of the Malaysia Airlines fleet, as this carrier restructures, and the -200ERs coming out of the Singapore Airlines fleet as part of its renewal program, aren’t the worry.

The greater worry is and should be the plethora of 777-300ERs coming on the market. These are the airplanes that can depress new Classic sales. Transaero and Kenya Airways -300ERs, many of them only a few years old, are coming on the market. Emirates Airline has a number of -300s/ERs nearing the end of their lease terms. (Emirates also has 12 Airbus A330-300s coming off lease next year.)

There is a narrow customer base for new (or used) -300ERs, and Boeing has run through them all in attempting to generate sales. A new customer was obtained this year, United Airlines, which has a large fleet of -200s/ERs from legacy United and the former Continental Airlines. It ordered 10 -300ERs in a swap for Boeing 787s. Boeing hopes to obtain a follow-on -300ER order from UAL before the end of this year.

Wells Fargo downgrade

The aerospace analyst at Wells Fargo downgraded Boeing last week from Outperform (Buy) to Market Perform (Hold).

“We are downgrading BA shares to Market Perform from Outperform as we believe the risks/reward heading into 2016 are less favorable,” Wells Fargo wrote in a Dec. 18 note. “This includes the likelihood of below-consensus initial guidance (January 27), offsetting the favorable cash-generation story. We highlight lower price escalation for commercial aircraft as a potentially under-appreciated headwind. While the free cash flow return to shareholders remains attractive, we think the concerns about economic growth and the general aerospace cycle will make it difficult for BA to Outperform.”

Wells Fargo also wrote:

Some of the concerns we think are already well appreciated by investors include: (1) the likelihood of a 777 rate cut from 8.3/mo to 7/mo; (2) very weak 747 demand; (3) lower oil + higher interest rates = lower demand for new planes (i.e., book/bill <1x); and (4) lower medium-term defense revenue growth relative to peers following the competitive LRS-B (bomber) loss.

…Under-Appreciated [concerns]: We believe other potential risks are perhaps less recognized, including: (1) the impact of lower price escalation, which could affect Commercial Airplanes (BCA) sales, EBIT, cash flow, and backlog; (2) the likelihood that the 757 replacement will be a clean-sheet (not derivative) aircraft, which could raise R&D by 2018 and crowd out some share buybacks; and (3) a further 777 rate cut below 7/mo.

Lowest Escalation Since 2009. Commercial aircraft pricing is adjusted by inflation, and we believe escalation factors are at their lowest levels in six years. In early 2009 Boeing cut EPS guidance by 7%, mostly for these lower-escalation effects; we believe the 2016 effect would be less severe but still non-trivial (perhaps 2-3% of EPS).

Credit Suisse cash flow analysis

Credit Suisse (Neutral [Hold]) last week issued a lengthy analysis of Boeing’s cash flow, which has been the focus of aerospace analysts for more than a year. Boeing is returning billions of dollars to shareholders through stock buybacks and increased dividends. Boeing has been boosting cash flow by agreeing with some customers to advance pre-delivery payments—in some cases, by several hundred million dollars—and in some cases through up-front cash purchases of airplanes to be delivered in the future, as opposed to on-delivery.

These cash advances are helping fund the return to shareholders, but mean lower cash receipts at some point in the future. As an inducement to customers to participate in the cash advance program, Market Intelligence indicates discounts over and above the usual negotiated purchase price discounts are being offered. These are described as being in the low single-digit percentages.

Credit Suisse writes:

[Free Cash Flow] harvest remains the driver: Boeing’s valuation centers on peak FCF. If all goes well this could be both powerful and tangible, given the ongoing capital allocation program. Book:bill remains important to many, but appears to be a more directional valuation factor at present.

Peak FCF of >$20/share could drive ≥$210 valuation: With five remaining planned rate hikes (2x 737, 1x 767, 2x 787), BA should be able to largely weather a decline in 777 rate and defense mix (as mature products roll off) and still deliver $20 of FCF/share in 2020, or higher given the major profit initiatives underway (not in our model). If BA can hold mature rates beyond 2020, a valuation on peak (at 10.5x) could instead become a valuation on plateau, warranting a higher multiple of 12-13x for a valuation of $242-262. Within this, 787 cash profitability remains the biggest lever, potentially worth ≥$5.00/share from 2014’s ~$4.24 headwind. To better illustrate the pieces, we deconstruct BA’s FCF by program in our new FCF bridge (Exhibit 10).

But, Macro sets up poorly for now: Broader macro concerns (weakening Asia/EM, low oil, strong US$, potential for further interest rate hikes) could compromise the market’s ability/willingness to discount peak (2020) in the short-term, which drives our Neutral rating. In addition, other nearer-term friction items such as 787 curve progression, 777 bridge, MAX ramp, and a soft patch in bookings, could continue to hold back valuation. Thus, shares look range-bound until the malaise passes, basing our TP of $158 and Neutral rating on a mid-cycle multiple of 14.6x on ’16 FCF of $10.84. We see ample time to recalibrate on potential peak of >$20/share in 2020 once prevailing macro worries abate.



19 Comments on “Boeing stock sell-off on 777-200ER deal over-blown

  1. I think we’ll see significant dynamics in the 777-200ER fleet in the next few years. 800 A350-900 and -1000s in the pipeline. Looking art the larger A350 customers, most are 777-200ER operators. I do not think they are for growth.

    Sixty A350s will enter into service in 2016, eighty in 2017 and one hundred in 2018. Nine A350-900s and four A350-1000s a month after 2018.

    Boeing 777-200ER deliveries peeked 1998-2002, the oldest 777-300ER’s are just 10 yrs old.

    So there will be lots of young capable 777-200ER’s on the market in the next few years. I think we will see a significant 772 converted freighter fleet later this decade.

    • The dynamic is that the 772ER is going through its replacement phase. Nothing new. 772ER freighter? I doubt it since you can buy a 763F right now. There’s not even a BCF program. Again, the 772ER replacement cycle is not stamped with an A359. Speculative “thinking” is the same as guessing the time the sun will rise. You’ll know 100% if you’re there.

      Back to the original post. This is a classic example of where gossip travels faster than good news. Since most investors don’t take their stocks personally, if the news of the days dampens their position in anyway, they’re selling. It’s a shame that most aren’t as knowledgeable about aerospace like LNC and other aerospace news agencies. If you’re smart, you’re long the stock.

      Thank you for another great year. I look forward to the next with you two at the helm. Happy holidays.

      • “Again, the 772ER replacement cycle is not stamped with an A359”

        Well, yes it is. The slots are booked & Boeing has no suitable replacement (Range 787-10/ OEW 777-8).

        Where do you think the 25 772s of SQ are in 3 years? Or those of UA, AA, JAL, CX, BA, AF around 2020?

        It just that a good part of the public doesn’t know or is in a denial at this stage.

        • Well not it isn’t. Perhaps you should call Scoot and tell them they are my in line with your “777 replacement is stamped with A350”

      • Rotate:

        767 and 777 F have little in common, not even the bin sizes!

        And yes there is a program ready to0 go, FedEx, Boeing and Singapore were working on it until Singapore decided to give their retired 777s to Scoot (which is no changing to 787s)_

        So its in the drawer just ready to be pulled out, an MD11 class freighter (range and payload) that’s a lot less maint.

        I expect to see it launch in the next few years as feedstock becomes assured.

        • The article makes it clear the freight market is going backwards. Just because feedstock becomes available, the money to buy AND do the heavy maintenance and convert isnt around for a declining market. Any market is being eaten up by hold space in scheduled widebodys.

          Remember its disruption thats the key to understanding many existing industries, and its not just ride sharing. Having plans in the drawers to carry on as before doesnt work anymore.

          • There is still a lot of demand for large airlift in quantities, not all of it is satisfied by belly, a lot more is. Also the routing may not work.

            UPS would be a candidate, DHL (or one of their leased operation) FedEx has to either buy brand new 777s or have conversions to replace the MD11.

            777F dedicated has a single shot flight to mainland US, but there is not as much demand to cut a few hours off. Ergo, if you look at the numbers the 777 conversion are literally an identical replacement to the MD11 (but they can carry more bulk as the cans are taller (or can be pun intended) than MD11 accommodates.

            And its an efficient payload carrier. You can replace older 747s including a 400BCF if you don’t need the front load capability (UPS went with front load on their 747-400s as they got those new, but they did get 2 or 3 of the BCF as well.

    • I wonder what the rest/replacement value of a 16yr old well used 777-200ER is, compared to these repair costs, while the airline is introducing 787-9’s and has replacing A350s from 2018..

      Total costs could be easily be $20-25mln in my opinion. It seems wing spars/ribs, fuselage ribs, stringers maybe central wingbox, floorbeams, keel beam, wing fittings got an unsolicited, material properties changing heat treatment.

      Boeing / GE apparently don’t want a 777 write off caused by a GE90 explosion in the 777 track record. The FAA issued an AD on the 777 / GE90-85 in 2011, fought by GE and Boeing, but upheld. They want this aircraft back in the air, even if retired in a few yrs. It seems GE picks up the ticket.

  2. Job well done in 2015, looking forward to more great reporting in 2016.

    Merry Christmas and a Happy New year

  3. Reading LNC (without paying for the subscription!) means we already know most of this. Perhaps all the analysts read LNC and all the dire predictions in the comments section and we caused the stock to fall.

  4. My best holiday wishes to Bjorn, Scott and Leeham!

    Merry Christmas and Happy Holidays!

    Looking forward to continued great coverage in the New Year, which is likely to be replete with landmark events!

  5. Nice way to end the year with both the GTF-powered A320neo and C-series achieving certification as well as the successful return last night of the SpaceX Falcon 9 first stage landing.

    Merry Christmas and a Happy New Year.

    This one is for Björn (e.g. IMO the best version of possibly the top Christmas song of all time): 🙂

  6. I would add that the Falcon X both delivered its payload to orbing AND returned the 1st stage.

    The first is expected but you never know, the second is Pretty stunning

    • Probably increases the risk 10 fold. Interesting if they can maintain a good return rate.

  7. Thanks for all the insight in ’15 Scott and Bjorn. Looking forward to more in ’16. Merry Christmas and a Happy New Year.

  8. Frank reporting, ineteresting insight and compelling opinion, thank you and enjoy the christmas/ new year break

  9. God Jul til dere begge, Scott & Bjørn ! Her hos Leeham er det Jul hver dag, alle de gavene vi har fått i post-form !! Takk for alle hyggelige debatter dere har gitt oss anledning for her !

    • Thanks FT,

      appreciate your Norwegian!

      God Jul och Gott Nytt år till alla läsare av vår Blogg./Björn

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