Can Boeing's Epic Backlog Drive Future Growth?

Jun. 8.14 | About: The Boeing (BA)

Summary

Boeing's backlog continues to grow as airlines are placing massive orders.

The current backlog reflects more than eight years of production at full capacity, but there are doubts regarding the sustainability of backlog as some call it a bubble.

Boeing is confident about the stability of the market, and believes the backlog to be rational.

To make the most of the rising demand for fuel efficient jets, Boeing has adopted the smarter method of re-engineering current aircraft models, particularly after draining cash in the 787.

The American aircraft major Boeing (NYSE:BA) is on a growth path and has been portraying impressive development in the past few years. The jet maker is on a roll and is expected to thrive given the rising demand for fuel efficient aircraft. The increasing demand and requirement for jets is showing in the epic backlog that the Chicago-based aircraft major has registered. As air traffic is rising, the plane maker is logging massive orders. But Boeing's not alone, European peer Airbus (OTCPK:EADSY) stands in the same place.

Strong numbers in the order book augurs well for jet makers, but only if they can clear the backlog at a faster rate and convert them into sales. This means boosting the production rate, but that isn't as simple. In addition, airlines are demanding more fuel efficient planes. Let's dig deeper to ascertain how Boeing's taking stock of the entire matter.

Orders Mounting Like Never Before
The maker of the Dreamliner boasts of a commercial backlog close to 5,200 aircraft, recorded by the end of May. The company's website, which was last updated on June 3, shows that the jet maker has net orders for 394 aircraft in 2014. During this period, Boeing's received gross orders for 439 737s - its best selling plane. The 737 is Boeing's most popular and widely sold jet that aids in cash generation. Japan TansOcean Air placed orders for 6 737s, and another seven came from unidentified customers. In May, the company won a $3.8 billion contract (at list price) to sell 50 737s to China-based Juneyao Airlines. Part of the order placed by the low-cost carrier is also for the next generation 737 Max.

The 777 recorded orders for seven units, while the 747 and the 787 each got orders for a unit only. Meanwhile, there were 54 737 cancellations that pulled down the net order. In comparison, Airbus' net orders, adjusted for cancellation, totaled 203 planes for the first five months of the year.

Presently Boeing is in talks with Emirates with regards to a potential order for its 747-8 aircraft. The 747-8 jets haven't received a good reception lately, and the jet maker is working to boost its sales. Emirates, which operates the highest number Airbus A380 superjumbo jets, is looking for large planes with improved fuel burn. This brings a fantastic opportunity for Boeing to present its iconic 747.

The current backlog represents more than eight years of production for both Boeing and Airbus. And this comes as warm news for investors. But the question that worries many is, if the backlog is sustainable, or is it a bubble?

Is The Backlog A 'Bubble'?
Boeing's order book has seen a sharp rise in the past two years that has propelled the company to push its production rate, which has had a positive impact on the deliveries. The company has delivered 271 jets in the first five months of the year. The current order trend indicates that the orders will continue to surpass deliveries in the future too, making the backlog grow.

But how secure are the backlogs of the two jet makers? Senior VP of Avitas Adam Pilarski is skeptical about the order size and raises a very relevant question - "are the existing orders and deliveries rational?" He says that the backlog is vulnerable and believes that several uncontrollable factors external to the companies would have to fall in place to sustain the backlog. The first threat is the breakneck demand coming from the Asia-Pacific region. Several low-cost carriers are placing orders in expectation of rising passenger traffic, which exposes jet makers to the risk of emerging market trends. Another essential factor pointed out by Pilarski is that orders are coming in for fuel efficient aircraft as fuel prices have increased considerably. Since more than a third of the operating expense is on account of aviation fuel, fuel saving jets are bagging order. However, if fuel prices go down, the backlog could get affected.

While Pilarski is apprehensive about the order size, both Airbus and Boeing have shown great confidence on the backlog and believe that the overall market is much more stable than what it used to be. Andrew Shankland, Airbus Senior VP is "reasonably optimistic." He indicates that the global gross domestic product (GDP) is seeing steady growth. While it was 2.3% in 2013, it's 3.2% in the current year. Among other encouraging signs are the improving freight traffic and better revenue passenger kilometers. Higher fuel prices have also triggered airlines to order fuel efficient aircraft.

However, it should be noted that airlines are placing orders, but are demanding lower prices. Airlines are demanding "more for less", says Boeing CEO Jim McNerney. While they want competitive rates, they need advanced engines that consume less fuel as well. To satisfy both needs, Boeing is re-engineering its existing aircraft.

Remodeling Planes
The plane manufacturer is upgrading its current family of 737 aircraft. The re-engineered version, the 737Max, would sport new engines. In July 2011, Airbus announced that it is re-engineering the A320, the upgraded version to be called A320neo. Following suit, Boeing immediately took action and announced its plan to bring the 737 Max, which is scheduled to enter service in 2016. The jet maker says that the 737 Max would offer 14% better fuel efficiency, while making lower carbon emission at the same time. The plane has already crossed a big milestone - registering record orders for more than 2,000 in such a short span of time.

Also, after investing massively in the 787 program and witnessing several complications and technical problems, McNerney has decided to take the smarter route of revamping current models instead of making new jets. The advantage of working on an existing platform is enormous, be it from the point of view of the development cost, or technical hurdles and other similar engagements that keep adding to the total investment. Boeing's intentions have been good - to introduce a revolutionary jet. But the amount of cash drained into the project lead the company to adopt the cost effective alternative. As such, it's re-engineering the 777. The upgraded version, called the 777X, would feature new engines with fresh composite wings. Airbus is also on a similar track and plans to launch A330neo by adding new engines to A330 and making other minor changes.

Conclusion
Boeing has the best of engineers. Its strategy to reuse existing proven platforms to form an improvised version looks quite reasonable. This could help the company to gain more orders, stay competitive and offer aircraft at better rates than its European foe. With its backlog growing from strength to strength and the company striving to boost its production rate, Boeing looks set to deliver.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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