June 24, 2016: Brexit continues to creep into US analyst reports for the potential impact of companies doing business in the United Kingdom.
But there are other issues as well. Highlights this week:
Spirit Aerosystem (Neutral)
June 23, 2016
|SPR noted that recently, BA is stepping up its efforts to finalize a new pricing agreement. However, in our view, SPR does not appear to be in any rush to come to a new pricing agreement with BA. We think SPR appears content with the terms in the current interim agreement and we think it’s possible the negotiations could extend beyond the end of the current 787 contract accounting block in September. There has been considerable speculation that Lawson’s departure is related to a lack of progress on a pricing agreement with BA. If so, we saw no evidence of that. CFO Sanjay Kapoor has been leading the discussions with BA and although we expect Tom Gentile to be involved, we’re not expecting the CEO transition to have much of an impact on the discussions.
SPR notes no changes to the A350 delivery schedule despite Airbus’s lingering issues with the program. Despite SPR’s assurances, our concern is that the build up of traveled work could cause Airbus to ramp up the A350 slower than expected. We also continue to see risk to expectations for 50 A350 deliveries this year. SPR didn’t provide incremental color on A350 cost improvement and we’re still expecting a near $500M charge on the program
June 25, 2016
CS: The move resulted from an April decision to accelerate retirements of the 737 Classic fleet, which was originally scheduled to occur between 2019-2022 but has now been pulled forward to Sep. 2017. LUV did not want to subset its pilot groups to accommodate flying all three derivatives, and also cited maintenance, efficiency and product benefits. In order to backfill the lift, LUV has pulled forward 737-800 deliveries and is adding 41 used 737-700s between 2016-2018. The MAX deliveries, which were deferred to 2023-2025, will eventually replace these used -700s, though LUV retains some flexibility to take the MAX earlier if desired. This allows LUV to stick to its plan of no more than 2% growth in its fleet count thru 2018, and we see this as evidence of capacity and capital discipline. (Credit Suisse US Airlines Analyst Julie Yates Stewart)
Boeing (Sell), June 25, 2016
Boeing has reportedly reached a deal to sell 80 aircraft to Iran. However, (1) there are many hurdles to this actually turning into deliveries, including sanctions and financing; and (2) if it does occur, the unit numbers are all small relative to the current status of each corresponding aircraft program. A firm order has not been placed as it requires U.S. government approval due to sanctions. The Wall Street Journal reports (6/23) the order would consist of 4 747, 6 737NG, 40 737MAX, 15 777, and 15 777X for delivery through 2025.
There are currently 168 delivery positions open in the 777 skyline for 2016- 2020, relative to delivering at 7/month (according to Ascend data). There are 5 and 4 777-300ER positions sold in 2019 and 2020, respectively (according to Ascend). 15 unit deliveries to Iran, were they to occur, would be less than 10% of that bridge to 777X. Once to the 777X, the 777 volume challenge is not solved, because not nearly enough 777Xs have sold to support a 7/month production rate on that aircraft, even if Iran were to take 15 of them as well. There is an average of 37 777X positions sold per year 2020-2025. We also remain concerned with 787 demand relative to high production, and [there are] no 787 orders in the Iran MoU. There are also significant risks (as noted above) that this order does not actually occur, and that financing will be difficult to obtain if it does. Lawmakers have voiced opposition to a deal and put forth bills that if passed could complicate any transaction.
June 25, 2016
It is not yet clear how Brexit will ultimately impact US aerospace and defense stocks but preliminary thoughts are below.
The chief risk is slower global growth. Commercial aircraft demand is largely a function of global growth and so the key Brexit risk is that financial contagion from the vote slows growth in the real economy. We are not experts on this topic but clearly, there is now more reason for concern. Business jets are vulnerable too, though bizjet OEMs with the most US exposure (i.e. Textron) may be relatively insulated. The aftermarket impact will depend largely on traffic growth, which had been especially robust (~7%) but is settling in at a more normal level (~5%). Europe accounts for ~25% of global traffic and is expected to grow 5% this year.
B/E Aerospace may benefit. Facilities in the UK generated ~$750 mn of sales for BEAV last year but these are mainly denominated in dollars and so the weaker pound benefits earnings, all else equal, because a portion of the cost base—mainly labor—is denominated in local currency. BEAV does, however, have a small amount of euro-denominated sales and so a weaker euro could offset a portion of the benefit of the weaker pound.
Spirit Aerosystems faces modest translation risk. For Spirit, 9% of 2015 sales were in the UK and a portion of these, principally for A320, are denominated in pounds along with their associated costs. This exposes Spirit to some translation risk as a result of the weaker pound, though we would note that Spirit’s A350 contract is denominated in dollars.
Reaction to Brexit, June 27, 2016
US Airlines: A dim international outlook, particularly on the Transatlantic, weighs on the Legacies (AAL / DAL / UAL – all OW), but the domestically focused, higher quality carriers should demonstrate relative demand resilience. We view ALK (OW) and LUV (EW) as fitting these characteristics.
Aerospace: Significant Europe exposure negatively impacts several in the group (such as a BEAV – EW) as well as those levered to broader economic growth (TXT – UW). We believe the resilient Defense exposure at COL (EW) and proprietary, non-discretionary Aftermarket business at TDG (EW) create buffers in a downside scenario.
Aircraft Lessors: Outsized European exposures at 30-45% (and international more broadly) leave this group vulnerable to regional concerns. While this risk is indirect as aircraft trading and lease payments are USD-denominated, the magnitude of the exposures create a potentially tough risk-reward going forward, in our view.