May 16, 2016, © Leeham Co.: As improbable as it sounds, a short-term surplus of Boeing 787s has developed, say several market officials. Lease rates in some cases on 787-8s and 787-9s have dropped below $900,000/mo for 787-8s and somewhat above this figure for 787-9s as lessors compete with Boeing to place airplanes.
Analysts covering leasing companies, both publicly traded and privately owned, have also heard about falling lease rates for 787s.
“However, this all hinges on the cost and learning curve assumptions, which are difficult to get confident with considering we hear 787 lease rates are under pressure, and there are slots opening up, which can impact timing of future deliveries,” Canaccord wrote in a research note last week after the Boeing Investors Day in which officials outlined the plans to recover $29bn in deferred production costs. Other analysts also report hearing of lease pricing pressure on the 787s.
The most commonly quote sales prices are about $115m and $125m for the two airplanes, with the latter also said to go for $138m. Lease rates to mediocre credits are typically 1%, or $1.15m and $1.25m. Good-to-excellent credits typically see lease rates of 0.75% to 0.82%.
It’s the discount to the 1% rate that have been under pressure, according to lessors and advisors.
How has a surplus of this high-demand airplane occurred?
Boeing created some 787 surplus
Some of the surplus was created by Boeing as sales scurried to get orders for the 777 Classic to bridge the production gap to the 777X.
Boeing struck a deal with United Airlines last year to swap 10 787-9s on order for 10 777-300ERs. Sources say the 777s were heavily discounted as part of Boeing’s effort to fill the production gap between the Classic and the new 777X. This freed up near-in delivery positions. Boeing had to scramble to find homes for the 787s, a lessor says. The United airplanes were re-placed by Boeing, even as lessors tried to place 787s with the same customers.
This year, Boeing and United swapped another four 787-9s for four more -300ERs, freeing up the former’s slots.
Aeroflot cancelled 24 787s as part of its down-sizing. This brought the total of suddenly available 787s to 38. A few more 787s were cancelled here and there, as well.
Several lessors that ordered 787s on a speculative basis now found themselves competing with Boeing to place airplanes. Boeing, of course, knows what the lessors’ contract prices are for the airplanes and for Boeing, its first priority is its own production airplanes, say market sources. Knowing the contract prices for the lessor airplanes gives Boeing an advantage in pricing. In addition, Boeing has different profit margins than lessors and different financial and production pressures than lessors. Most tend to work in Boeing’s favor when it comes to competing for business.
Boeing did not respond to a request for comment.
As noted in our post of reactions to the investors day, analysts remained skeptical of Boeing’s ability to recapture $29bn in deferred production costs. Margins outlined by Boeing are aggressive.
Other 787 challenges
There are other challenges coming up on the 787 as well. Greg Smith, the CFO, told the analysts on investors day that integrating the 787-10 into the production line will cause flat deliveries in 2017, not growth, but there will be a surge in deliveries in 2018 when the 787-10 is scheduled to enter service.
“There will be some headwinds in 2017, despite the growth that is taken into account. Obviously, we’ll have lower 777 production rate, getting down to the seven per month. And at the same time, we’ll begin the transition to 787-10. And again, in order to have smooth transitions at 787-10 in the production system, think of that implementation very similar to how we introduced the 787-9 or the 737 MAX. Longer initial flow times on those airplanes, building test airplanes in 2017, delivering those in 2018, and as a result our delivery expectations for 787 in 2017 will be about similar to 2016. And with all that said, again we continue to expect cash flow to increase in 2017.”
Going to production rate 14/mo for the 787, as it turns out, is contingent on Boeing selling another 161 aircraft in the 1,300 accounting block.
“As we look forward over the remainder of the decade, wide-body sales campaigns will be the focus, again selling 777s and maintaining the seven per rate production, selling the remaining 36 unsold 747s in the accounting block and recovering the $880 million of deferred production and then lastly selling the additional 787s which will solidify the 14 per month production rate,” Smith said.