Jan. 23, 2017, © Leeham Co.: The global economy is softening and airlines are deferring airplanes, but we don’t see Airbus or Boeing trimming aircraft production for their single-aisle airplanes.
Over-sales and rising fuel prices support today’s A320 and 737 production rates and the increased rates previously announced by Airbus and Boeing.
While oil prices are low compared with the pre-Great Recession levels, Embraer’s John Slattery noted that fuel costs went up more than 48% last year alone. Fuel now costs more than $50/bbl. West Texas Intermediate Crude was selling at $51.08 Thursday, off $1.40. There will be ups and downs, but the trend is up.
Slattery, the president of Embraer Commercial airplanes, believes “fuel efficient fleets will become more critical in the coming years,” he wrote in a Tweet Jan. 7.
Airbus and Boeing previously announced rate increases to 60/mo for the A320 and 57/mo for the 737, both by the end of the decade. The backlogs support these numbers despite some shifting around through deferrals.
Over-sales (meaning double booking delivery slots) by both companies are done with the expectation that some airlines will defer or even cancel airplanes.
Airbus’ John Leahy, the chief operating officer-customers, nevertheless complains he doesn’t have any delivery positions available until 2021. He wants to push production beyond 60/mo.
Boeing, which market intelligence tells LNC has pretty much used up its over-sales margin, is in a battle to retain market share. This is why it’s likely to proceed with the 737-10 MAX to answer the shellacking it’s getting from the Airbus A321neo vs. the MAX 9. Airbus sold about 1,200 A321neos. Boeing sold about 290 MAX 9s that have been identified. LNC believes this number is somewhat more than 400 after allocating the Lion Air order along the lines of its 737-800/900 fleet.
We don’t believe Boeing will cancel plans to boost production rates.
Orders peaked two years ago, but with low fuel prices and backlogs extending to 2020 and beyond, this is a normal part of the cycle. The order dip will get worse before it gets better.
With fuel prices coming back up, and as Airbus and Boeing burn off the backlog, we see an upswing in orders next year or in 2019, barring some extraordinary global event.
For Boeing, the bigger threat is President Trump enacting some policy that will prompt the Chinese to retaliate against Boeing. About one-quarter of Boeing’s 737 backlog goes to China. Trump’s rhetoric to date already casts a cloud over these.
Low oil prices prompted some airlines to shop for used aircraft, notably Southwest and United. In fact, UAL’s CFO Andrew Levy noted on the earnings call last week that this shopping spree continues. United is leasing more than 20 Airbus A319ceos from the used airplane market.
Levy didn’t specify what airplanes UAL is looking for.
“We will now retire all 20 remaining 747s by year end, but there is no change to capacity or CapEx as a result to the earlier retirement timeline,” Levy said. “Our 14 new 777 300ERs, two of which we accepted in December of 2016, and the remaining, which will become in the first half of 2017, will essentially backfill the 747 capacity interrupts.
“As we retire in our fleet needs and explore how best to achieve them, we were actively seeking opportunities in the used aircraft market,” he said. “Our fleet review is work in progress and we will update you later this year when we have some of them in this year.”
Another reason LNC sees Boeing sticking to its 737 production rate increases (again, barring some global or Trump catastrophe), is the need for cash flow to support the stock price and meet commitments to shareholders to buybacks and healthy dividends.
Those who predict Boeing will not implement the higher rates completely miss this priority set by CEO Dennis Muilenburg and the Board of Directors.
Declining production rates on the 777 Classic will bite into the cash flow. The 737 rates must rise to offset this.
Bernstein Research noted this requirement in its earnings preview note issued last week.
“We see Boeing as a strong investment opportunity for 2017, with rising free cash flow through 2020, driven mostly by the 787 program and the 737 production ramp, which more than offset 777 declines. Free cash flow has historically driven Boeing’s share price,” Bernstein’s Doug Harned wrote.
“Demand for commercial airplanes remains strong for narrow-bodies (737) and new technology widebodies (787), from continued traffic growth and replacement,” Harned wrote. “At current backlog levels, we see the drop in 2016 book-to-bill to 0.9 as immaterial.”