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.