Aug. 31, 2016: The dog days of August continue, with limited news and research notes from the Wall Street aerospace analysts.
A few items of note from the past week:
Aug. 30, 2016
We retain our NEUTRAL rating and $103 price target, implying ~21% downside, and remain generally negative on the stock after Boeing’s (BA’s) announcement that it will not increase commercial aircraft prices. Specifically, press reports state that BA announced that it will continue to quote July 15th base prices in 2016. We have three observations. First, it’s common knowledge that BA’s ‘list prices’ have little applicability since ‘true prices’ charged to customers come at significant discounts to ‘list prices’. Second, it’s been well known by investors for some time that both Boeing and Airbus have been under meaningful pricing pressure. Third, we don’t expect any near-term impact to BCA margins. We think BA’s announcement is more confirmation of what many already knew, and in addition, may set the stage or be a possible prelude to further production rate cuts. In our view, the logic is straightforward, weak pricing is an indicator of weak demand which implies further production cuts. While we’re neutral, our negative thesis is that street estimates remain too optimistic and are not taking into account the impact of a cyclical downturn.
Aug. 30, 2016: Boeing (Sell)
Bloomberg reported that Boeing will not increase airplane list prices this year, which also occurred in 2009 and 2001. Boeing typically raises list prices annually based on an internal escalator that roughly tracks inflation. Boeing raised list prices 2.9% in 2015 and 3.1% in 2014.
Escalators are a critical component of Boeing Commercial Aircraft margins, because they are almost 100% pass-through and are applied to aircraft in backlog as well as new orders. This is a large component of Boeing’s ability to compete, as aircraft transact at discounts to list. We think a lack of pricing increases in 2016 reflects a challenging competitive environment, what we continue to believe is a supply/demand mismatch in the marketplace, and overall slow new order activity. Large commercial orders were down 35% yoy in 2015 and are down another 30% YTD.
This is also specifically a particularly large challenge for the 787 program deferred production math. Boeing expects 70% of the unwind to come from aircraft mix and escalators. With no escalator, we estimate that mix drives 7% higher pricing in 2020 vs 2016, far lower than the 21% increase when including a 3% escalator. We address this risk in our June 14, 2016 note The 787: A deferred-production-dreamliner-dream, deferred in which we used a 3% price escalator. If Boeing is unable to get annual pricing increases, we believe the amount of deferred that can be unwound could be even lower than our already well below consensus estimates.
This also creates margin risk on the 737 and 777, each of which Boeing has reportedly sold recently at significant discounts.
Aug. 29, 2016: Aerospace Pictures
Large commercial order update
Boeing YTD net new aircraft unit book-to-bill is 0.72X (narrow-body 0.96X; wide-body 0.24X). Airbus YTD is 1.21X (narrow-body 1.24X; wide-body 1.05X). Therefore, total Boeing and Airbus is 0.94X. Total Boeing and Airbus orders are down (29)% YTD with Boeing down (12)% and Airbus down (38)%.
August 26, 2016: Monthly Dispatch
We estimate traffic growth was ~4%+ in July, bringing it to 5.9% YTD. Traffic growth has slowed to ~5% y/y since March, in line with the long term trend, and we could see a downward revision to IATA’s 2016 forecast for 6.2%, which is already down from 6.9% to start the year. While reacceleration is possible, 2H16 comps are tougher (6.9% in 2H15 vs 6.1% in 1H15) and airlines have been vocal about their intention to dial back capacity growth. Recent deceleration has been most prominent in Europe with 1-2% for Q2, and we estimate July was similar. We expect 1-2% for North America in July too, though it probably won’t remain so low. China decelerated to 13-14% in July vs 15% YTD.
BA book-to-bill looking like 0.7x this year. Aviation Week published an internal memo from Boeing this week stating their target of 535 orders for 2016 (0.7x book-to-bill vs guidance of ~1.0x). Boeing has secured 335 net orders through Aug 23, and while we believe that they can exceed their target for 737s (297 net orders vs target of 324), wide-bodies may fall short. YTD, Boeing has combined net orders for 27 current gen 777s and 787s vs. a target of 88 each. There are potential wide-body orders from carriers like Emirates, Oman, and Saudia, though ME carriers face declining load factors and yield pressure. Chinese carriers can always order additional aircraft too, including wide-bodies. Ascend shows ~1,030 LOIs for Boeing aircraft, including ~430 wide-bodies.
Retirements and parked aircraft trends exemplify wide-body/narrow-body disparity. The parked fleet of narrow-bodies (737s, A320s, 757s and MD-80s) has declined to 5.2% of the overall fleet, according to Ascend data, down more than 200bp from January and nearly 300 jets in absolute terms. Meanwhile, the number of 777s in storage is up ~150% y/y, though likely overstates the weakness off a small base, and parked A330s have also increased. We see a similar contrast in retirements as legacy and wide-body aircraft retirements have increased vs 2015 while 737s and A320s are flat to down so far this year.
What would the effect be on Boeings financial engineering if they reset the list price at the highest price anyone has ever paid?
This would not be possible because “it’s been well known by investors for some time that both Boeing and Airbus have been under meaningful pricing pressure” (Buckingham).
– Buckingham: “In our view, the logic is straightforward, weak pricing is an indicator of weak demand which implies further production cuts. While we’re neutral, our negative thesis is that street estimates remain too optimistic and are not taking into account the impact of a cyclical downturn.”
– Goldman: “We think a lack of pricing increases in 2016 reflects a challenging competitive environment, what we continue to believe is a supply/demand mismatch in the marketplace, and overall slow new order activity.”
– Morgan Stanley: “Airlines have been vocal about their intention to dial back capacity growth.”
Do we see a pattern here? Is this a new trend or just a cyclical fluctuation? Are we going through a small recession or are we heading towards a Global Recession? We have to keep in mind that this is unfolding at a time when fuel prices are still quite low and while airlines are generating substantial profits. So it is possible that airlines are just being cautious. But the numbers don’t lie and they clearly indicate that traffic growth is slowing down. And this is happening at a time when the world economy is itself slowing down. In my opinion the situation will likely deteriorate further. But I have no idea how long this downturn will last.
It seems to me that the airline industry is showing a bit more discipline than it has in the past, which hopefully portends well for overall airline profitability.
In the current fuel price environment, they probably feel it is better to be a bit cautious about capacity growth because there are plenty of serviceable aircraft that are currently parked that could get pressed into service in the event that growth exceeds current projections.
The wildcard for the industry will be if the global economy accelerates, thereby stimulating demand for air travel and for oil resulting in the industry having to press into service old gas guzzlers in a $100/barrel fuel environment. I suspect they view that scenario as unlikely and are willing to take the risk.
“The wildcard for the industry will be if the global economy accelerates.”
There is a lot of uncertainty in the air at the moment:
1. Uncertainty about the upcoming US election.
2. Uncertainty about the consequences of Brexit.
3. Uncertainty about China’s economic transition.
There is also a lack of vigour in the world economy despite ideal conditions:
1. Low interest rates, and in some cases negative rates.
2. Low fuel prices for an extended period of time.
3. Low market volatility, with no meaningful fluctuation since June.
I still believe that there is a lot of growth potential remaining in air transport. But perhaps we were due for a pause. The irony here is that Boeing’s output is likely to break a new record this year.
what major economy is growing anywhere near double digits globally? I can’t think of one, but I don’t follow India/SE Asia much (though massive LCC growth/Indigo etc. seem to indicate whatever is there might already be “planned for” in existing orders).
I think I read that halfway through the year Boeing was at like 5 percent of goal for sales. This action then is pretty much easy to see coming.
There’s a glut of orders and a shortage of growth. Outside of the 757 replacement cycle there aren’t many carriers that haven’t basically chosen fleet replacement plans already. Then there’s the SWA labor news and, frankly, their obvious need for a larger type. QR and EK are prepped for some large-ish orders (would a lower list price, and thus lower discount from list, impact BA offerings there relative to escalation revenues in other orders had there been a list increase??)
India has double digit growth and China air traffic growth is said to be 10% due to consumerism push by Chinese Government. EU and US are pretty stagnant, which would seem to be more a problem for Boeing as they have more at stake with the long thin point to point model (I’m sceptical of this description, but anyway) than Airbus as they need it to succeed to cover the 787 deferred.
I’ve previously written that the problem with mega orders is that the airlines which place them are ensuing they will get great discounts on all the aircraft of a specific model that they will ever buy, so if price escalation is also out it is serious as it cuts into what might already be negligible margins.
It will be interesting to see if Airbus follow suite.
A test to see if I can get photos to show!
I’ll try again…