Boeing stock sell-off on United news appears misplaced

Nov. 16, 2016, © Leeham Co.: The market sell off yesterday of Boeing stock appeared on the surface to be a reaction to the news that United Airlines is deferring 61 737-700s and switching these to four larger 737-800s and the balance to either the 737-8 or 737-9.

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Figure 1. Boeing stock traded down on news that United Airlines is deferring 65 737s. The price stayed flat through early today. But stock for Spirit Aerosystems, which makes the 737 fuselages, recovered after a short dip (Figure 2). This suggests the Boeing sell-off was for other reasons. Click on image to enlarge.

Boeing’s stock today remains flat-to-down slightly.

An odd thing happened concurrent to Boeing’s stock decline.

After a short dip, stock of Spirit Aerosystems recovered to the level before the UAL news and remained there through the time of this writing. Spirit makes the 737 fuselages. If Boeing’s stock was hit by the United decision, then logic suggests Spirit’s stock should have been, too.

This suggests the Boeing’s sell off has other reasons.

Analyzing United’s move

United’s move struck many as odd because the orders for these 65 737-700s were placed early this year.

But new executives have joined UAL since then, including Scott Kirby as president and COO and Andrew Levy as CFO.

Kirby came from American Airlines, where cost-cutting was his hallmark, and Levy, after a hiatus, from Ultra Low Cost Carrier Allegiant Air.

Concurrent with the deferral and up-gauging, UAL announced plans for a new class of service, Basic Economy, that is straight out of the ULCC handbook. Smaller airplanes don’t typically fit into ULCC business models.

Officials also announced re-streaming the capital expenditures with the deferral. United adjusted $1.6bn in cap-ex as a result.

United’s own words

Let’s take a look at exactly what United said in deferring the 737s. This is from the transcript from the investors’ day yesterday when the moves were announced.

First is on the 737-700 order that was placed with Boeing earlier this year for 65 units. We’ve made a couple big changes there.

The first four aircraft are going to deliver next year in the back half and they’re going to come as -800s. We like that airplane a lot better because of the favorable unit cost or the seat cost that you can drive from that airplane due to its larger gauge. The balance of the order, 61 aircraft are going to be deferred. We do not know when they are going to come, but they are going to come as MAX airplanes, 737-MAX, most likely MAX eights or nines, but at this point in time, all we can tell you is that, we are going to defer that out and once we have firm delivery dates for the balance of the order because it’s not a cancellation, it’s a deferral.

United continued later:

We’ve already been adding some used top quality A319 aircraft coming in from China, and if we can find other transactions like that, we’re going to take advantage of that. Used aircraft is a little bit a tougher game to play. You have to find the right opportunity, you’ve got to make sure, you have enough units as well. But that’s an area that we’re going to focus on trying to, when we do need aircraft, whether for replacement or growth, to try to look into top alternatives that might exist in the used market.

We’re also looking at other opportunities perhaps to identify the airplanes. So we’re taking a look at all of the airplanes and how we fly and we want to convince ourselves that the configuration we have today is the optimal one to optimize the profitability of the business. So there are some things here that we’re looking at and I will say that because the 737-700 order was going to start to come pretty quick, that was where we started our focus on looking at the fleet plan and it was on the narrow body side.

Thus, it appears there was more to deferring the 737-700s than initially met the eye.

Effect on Boeing

What is the effect on Boeing?

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Figure 2. Spirit Aerosystems stock quickly recovered after a dip on the news United was deferring 737 orders, indicating no long-term concern by investors over the move. Click on image to enlarge.

Initial reaction was this was a real negative. Stock traded off. But stock for Spirit, while it dipped, recovered. Boeing’s did not.

“This is not an issue for us,” said Boeing spokesman Doug Alder, noting that the 737 line is oversold. With only four of the 737-700s scheduled for delivery at the back end of next year, switching these to 737-800s fills these slots: no holes there.

With the balance of the airplanes scheduled for delivery after 2017, there is plenty of time for Boeing to adjust for these deferrals, either by reselling the slots or playing musical chairs with other customers.

Moving up to more profitable models

One blog headline asserted, “Boeing loses in United deferral” and the analysis that followed bordered on the ridiculous. It is a complete misreading of the situation.

Boeing gains because the up-gauging to the larger 737-800 and the newer, and larger 737-8/9 means more profits than come with the small 737-700.

Any assumption that the prospect of swapping to larger aircraft wasn’t anticipated in the sales contract would be in error. These are routinely included contract provisions.

Deferring airplanes also can be viewed positively for Boeing if it faced an oversold situation in the timeframe associated with the UAL aircraft. Deferrals relieve the pressure.

Conclusion

It’s still not clear to LNC why Boeing stock traded off and stayed at the sell-off level when Spirit did not, but it doesn’t seem to us that the UAL deal is to blame.

27 Comments on “Boeing stock sell-off on United news appears misplaced

  1. These were the aircraft Boeing sold really cheaply to ward off the Bombardier C-series. I wonder how much more Boeing will be charging to move to the Max. Might also be an opening for Bombardier to re-pitch the C-Series to UA

  2. Financial markets are manic-depressive. Nearly half of transactions are done by computer-based orders. One can therefore think that the fluctuation of the title of Boeing has nothing to do with the industrial realities of the manufacturer of aircraft! Indeed, we can believe that the people of Bombardier will seize this opportunity. Undoubtedly, Delta’s business model with its CSeries (and those that are likely to come, such as a CS500), will make the competition consider the new possibilities of airplane travel, cost models, etc.

  3. Hmm Boeing sold those really cheap to fill the production gap, I cannot see them keeping the discount the same to defer and switch to Max. If they sell these planes at the same discount as the 737-7 deal they are idiots. But I think the real message is, even with that HUGE discount the 737-700 NG DOES NOT CUT THE MUSTARD.

  4. Maybe United wondered why their US competitors aren’t ordering 737-700s and 737-9’s

    • Perfectly! A cost cutter like Scott Kirby thinks in cash flow and is never impressed by the dollar earned on purchase. What will be the net residual value of a 737-700NG in 2026 with a price per barrel of oil at $ 183?

      • Not really a vote of confidence in Boeings current output- when they can be replaced by used A319s from China! (as the passengers wont notice of course)
        When the entire fleet of existing and used A319s are replaced in 2026, what will it cost then with oil at $183 ? The earnings wont as good as now, so wont be as much cash to pay for them, interest rates wont be so good either. Its will be a basket of deplorables.
        A relatively small advantage now is kicked down the road to make a bigger problem later ?

  5. Lets hope that this does result in a UA order for C series aircraft. If and when enough of these are flying U.S. routes the relative discomfort of the 737 and even the 320 to a lesser degree will become widely known. Loyal as they are to Boeing maybe even SWA would consider a mixed fleet of Max 8 and CS-300.

    More reason for B to launch a new (wider!) single aisle aircraft with two wing sizes to cover the market from max 7.5 to 757 and thereby also cover much of the MOM market. As someone who actually looks out the window (bigger on C series) and hates being squeezed between two big people, the C series (and the E2) will be a pleasure to fly on.

    • It’s a good idea to get to the MOM model. To make it happen more quickly, Bombardier will have to create a new partnership, for example, with the aircraft component division of Pratt & Whitney. The latter pays for the development of the engine and other components that it can produce and the first pays the wings and plans of engineer while remaining the prime contractor. A 50/50 joint venture and a new business model that would change the situation in the single-aisle sector. Naturally, the price to be paid by P & W would be high. But in this case, why not make more room for GE and its Leap?

      • And then, think of it: Alain Bellemare is a child of P & W, is not it?

        • The jet engine business is high risk and with high capital requirements as it is, combining it with the airframe business which matches those business risks is a no goer for the stock market or any competent executive. United Technologies just offloaded Sikorsky to avoid just these sort of issues.

      • Qatar said they are open to NGs as well. As there was no talk of the NG/MAX mix or anything solid I am not sure how serious they are.

  6. United’s competitors Delta, American, Jetblue, Spirit, Frontier and Hawaiian are switching to A321 for most of their networks.

    I think the chances Leahy didn’t place a solid A321NEO proposal on Kirby’s desk a while ago are pretty slim. Switch the 737-9 to -8s and they’re all set.

    • United will eventually need to replace its transatlantic 757s. While those are mainly the youngest 757s in the fleet, they will reach maximum life by the mid-late 2020s. Right now, the A321LR seems like the only potentially viable replacement. If Boeing doesn’t respond with some kind of MOM aircraft, then United will presumably go with the A321LR.

      On the other hand, if Boeing goes ahead with a MOM aircraft program, United is likely to be a launch customer. And in that case, there’s a good chance that it will go all-Boeing on the narrowbody side by the late 2020s. United now has ~160 737 MAXs on order vs. no A320neos, and its A319/320 average fleet age is already about 17 years. The writing is already on the wall.

      Both Andrew Levy and Scott Kirby came from airlines that showed a preference for simple fleet plans. (Allegiant with the MD-80, America West/US Airways with the A320.) They’re not going to retire the A320s until they are thoroughly worn out, but that doesn’t mean they disagree with the premise of simplifying the fleet.

      I think the CSeries or E2 have a better chance of finding a long-term role in United’s fleet plan. They provide a lot more differentiation from the 737 MAX in terms of role/capability than the A320neo family.

      • I see the chances of United starting a substantial transcon / Caribean A321 operation, like the rest of the pack, in the next 2 years as more than 50%.

        TATL is a niche, UA switched to 767s. Scaling back seems unlikely.

        The latest adjustments confirm many orders are much softer than the OEM’s want everyone to believe.

  7. Could it be by the fact that the employee trading window for Company stock closes tomorrow night?

  8. The problem I see with this deferral is that only four of the original 737-700 will be converted to the 737-800. The other 61 aircraft will be of the MAX variety. In the end nothing will be lost for Boeing, but the 737NG line should be impacted somewhat. Because it is my understanding that the 65 737-700 that were initially ordered were heavily discounted not only to block the C Series, but also to fill some postions in the transition from NG to MAX.

    LNC: “Smaller airplanes don’t typically fit into ULCC business models.

    Perhaps, but today they acquired the 24 Embraer E-175 that Republic had initially purchased. They might not be operated directly by them but they are certainly part of their strategy. Like other observers, I see a second chance for Bombardier to sell the C Series to United. But I am not sure Bombardier would be willing to sell the C Series at the same price as the 737-700 were. If BBD were no willing the first time they might be even be less willing now that they have secured large orders with Delta and Air Canada. The latter is, like United, a member of Star Alliance. This means they could pool C Series parts together. So there might be tough negotiations ahead. If any.

    Normally this deferral should be nothing but a small blip on Boeing’s radar. But what I find disturbing is that it comes at a time when the market environment is perceptibly changing. The aerospace sector as a whole, and more specifically commercial aviation, looks like a big balloon that has been flying high for a long period of time and now starts to deflate a bit and is consequently losing some altitude. For now the rate of decent is not very dramatic because there is still plenty of air inside the balloon. Unless in the meantime something hits the ship we should be heading for a smooth landing.

    Bloomberg: “United joins a spate of carriers deferring aircraft deliveries, stoking concerns of a cool-down in the global aerospace market. American Airlines, Southwest Airlines Co., International Consolidated Airlines Group SA and Turkish Airlines have also tapped the brakes on some deliveries in recent months.”

  9. Its interesting to see United complain bitterly on how the Middle East airlines are hurting them despite Emirates showing conclusively that they have benefitted every time a new route was opened, then, rub their hands with glee about the prospect of picking up cheap second hand aircraft overseas meanwhile not giving a stuff to Boeing and American jobs.

    Perhaps for boeing in the short term the route to greater profitability is reducing their costs sustainably. Unfortuately this is hard for potential investors to guage if they have been succesful unlike anouncing orders.

    • “Unfortuately this is hard for potential investors to guage if they have been succesful unlike anouncing orders.”

      There is a trend to again go for forcing the territory to match the map ingoring realities and the true interdependencies.

      The last time this happened ( not in the bible, can’t be real ) the result was the “dark ages”.

  10. Hey guys,

    I’m not so sure if that other blog has totally misread it.

    Its well known that the discounts on the -700 for UA were extremely keen.

    Would Boeing have entertained the same discounts for the -800? I wouldn’t think so.

    Would Boeing have entertained the same discounts for the -7max? I very much wouldn’t think so.

    The -8max? No chance in hell – its their prime narrowbody earner in the future – no way are they going to firesale it before its even off a runway.

    The big question is; will the contract provision *fully* rectify this discount difference from -700 to -8max as well as the airframe difference?

    I would suspect it won’t.

    Spirit will still be getting paid the stock rate by Boeing for an 8max fuselage. Therefore, the impact is in Boeing’s margin and not on Spirit.

    Spirit may suffer from production rate issues if Boeing cannot fill the slot hole this opens, but that’ll be a story for another day.

    • I think Boeing would go pretty far at this stage to prevent United ordering a bunch of CS300 and/ or A321’s. As such they can move, convert and change their mind a lot and Boeing won’t get “angry”.

  11. My question, will both the 737 and A320 be able to deliver,
    2017 at least 550 units, 2018 at least 600 units.
    All systems go?

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