Oct. 20, 2016: This week’s analyst summaries focus on continuing delivery shortfalls at Airbus because of delays in receiving Pratt & Whitney GTF engines; continued expectations Boeing will reduce again the projected production rate of the 777 Classic; and a comment on Alcoa, a major supplier in metals to the commercial aerospace industry.
The Alcoa note, from Goldman Sachs, is of particular interest in that it looks ahead to 2017. Reading between the lines (which isn’t very hard in this case), Alcoa seems to be saying 2017 is going to see a further softening of demand for airliners.
Coupled with some yield concerns expressed by some airlines (not included in the notes below), it looks like 2017 may shape up to be an even softer year for orders than 2016.
Airbus (Outperform), Oct. 18, 2016
We update our model to include reported Q3 deliveries and the perimeter change in Defence & Space. We remain positive on Airbus, with expectations for strong cash flow improvement in 2018 after near term program hurdles are overcome. In Airbus Commercial, we updated our assumptions to include lower A320neo deliveries this year and a slower ramp for neos next year, all due to GTF challenges. We have assumed a substitution of A320ceos for A320neos. …Our target price [is] €77.
A320neo and A350 deliveries were still slow in Q3. Engine delivery issues continued to impact A320neo deliveries in the period. Interior issues are still challenging for the A350, but management is now more confident in getting to 50 deliveries for 2016.
We see negative sentiment for commercial aircraft demand and specific Airbus issues (A350, A320neo, A400M) as placing pressure on the share price. Our greatest Airbus concern is the timing of deliveries for GTF engine on the A320neo. We see commercial aircraft demand as solid through 2020 for narrow-bodies, with weakness in mature wide-bodies (A380, A330). We may still see another charge on the A400M during 2017, but smaller than the charge in Q2.
Market Perform, Oct. 17, 2016
Based on customer discussions and UTX statements, our understanding is initial problems related to long cooling times and faulty FADEC error messages have been resolved. Issues appear to remain with high combustor temperatures that require frequent inspections. Customers report that fuel burn and noise performance are at least as good as planned targets. None of the issues appear to have any connection with the geared architecture.
The largest challenge today for the GTF is the production process, with UTX management saying there is difficulty in ramping up production of five parts. The immediate challenge is the bonding of a titanium sheath to an aluminum fan blade, which is taking twice as long as planned with low yields. The blade problem has led Pratt to cut 2016 GTF deliveries from 200 to 150 engines. The bonding process today is largely manual, with Pratt intending to automate in order to get rate and yield up. We expect this to mean that 2017 deliveries are back end loaded, given likely time necessary to automate the process.
For Airbus, the implication of delays will be 20 fewer NEO deliveries in 2016 than planned, but these should all be replaced by A320ceos. Most important for Airbus will be 2017, when the production ramp needs to take off. Pratt said it will deliver 350-400 GTFs in 2017, most of which we assume go to Airbus, as the most critical program. We model GTF production at 350 engines for 2017, but we believe there is risk, particularly for the next three quarters. Bombardier said it will only deliver 7 C-Series this year, rather than the planned 14.
We see the challenge for Pratt as significant. Unlike GE, Pratt has not had recent new commercial engine experience. The last new engine Pratt developed was the PW6000, which first flew in 2000 and was unsuccessful. There is less institutional knowledge on how to ramp up a new program – and this engine design is set to go onto five new platforms.
Our understanding is that CFM’s (GE, Safran) LEAP engine is proceeding well in terms of both performance and production. But, it is still early, so it remains to be seen if the supply chain can successfully perform on the steep production ramp ahead.
Boeing, Neutral, Oct. 14, 2016
De-risking of 777 would be a positive catalyst: The market does not believe Boeing can continue to produce 777 at a rate of 7 per month though EIS for 777X, even with some blanks for 777X beginning in 2018. And while BA has acknowledged that more orders are needed to hold to the above, a formal rate cut would remove a key overhang. We see our target price of $148 once the overhang is lifted, and assuming a dividend increase (mid-December) of at least 10%, and preferably closer to 15%.
Embraer (Buy), Oct. 14, 2016
Embraer reported that in 3Q16 it delivered 29 Commercial jets and 25 Executive jets, for a total of 54 aircraft. Our estimate was 27 Commercial / 26 Executive, and 53 total. So total units are slightly better than our forecast and likely better than consensus; while total mix is better, and mix within business jet is better, mix in regional is in-line. Total company backlog at 3Q16-end was $21.4bn, down 2% sequentially. The change in backlog implies 3Q16 total company new orders of $1.01bn for book-to-bill of 0.67X (0.77X on a TTM basis), using our revenue estimate in the quarter. This was likely roughly expected given intra-quarter order activity. ERJ now has 479 firm regional jet orders in backlog (4.4X our 2016E delivery projection). That compares to 500 firm last quarter (4.6X), and 530 firm in the year-ago period (4.9X).
Alcoa, (Neutral) Oct. 12, 2016
Alcoa again reduced its 2016 Commercial Aerospace forecast, to the low end of its prior 0-3% expected growth range. Initial guidance for the year was 8-9%. Management also backed away from prior guidance for 2017 of Aerospace up >10%, describing the environment as “more dynamic than what we had expected” and citing market participants with an “absolutely huge” range of forecasts. The company now points to softening demand for wide-bodies and solid growth of narrow-bodies. Alcoa sees de-stocking from part standardization and supply chain optimization absorbing demand and continuing into 2017. Although engine ramp-ups at OEMs are a positive, Alcoa noted they are somewhat offset by ramp-up challenges. Legacy spares demand remains strong.