Boeing: Take Profits Now

| About: The Boeing (BA)

Boeing (NYSE:BA) announced record deliveries of 648 commercial aircraft and net firm orders of 1,355. Airbus (OTCPK:OTCPK:EADSF) deliveries were lower, 626, and orders higher, 1,503 net. So in 2013, Airbus received 52.6% of the net orders and has a backlog of 8 years production at current delivery levels.

Boeing has had a strong run over the past 12 months and the latest dividend and buyback news is looking to reinforce that. The hoped for increased defense export orders though, with the loss of potential orders in South Korea and Brazil, does not seem to be happening. So going forward, much of the value depends on delivering the strong order book for commercial aircraft. Boeing successfully launched the 777X in Dubai, with commitments for 225 from three Gulf State airlines and a previously announced 34 from Lufthansa. The problem is getting from the here and now to 2020, by which time the 777X should be flying.

If we look at the orders from the Dubai Airshow


Quantity / Model

Value at List Prices


Etihad Airways

(30) 787-10

(17) 777-9X

(8) 777-8X

(1) 777 Freighter

$18.2 billion



(115) 777-9X

(35) 777-8X

$55.6 billion



(75) 737 MAX

(11) 737

$8.8 billion


Qatar Airways

(50) 777-9X

$18.9 billion


Total Orders and Commitments

342 airplanes

$101.5 billion

For these, the designs for the 777X and 787-10 have yet to be finalized and the 737 MAX has testing and certification to go through, so only 12 are firm orders for current aircraft. While this is partly due to where Boeing is in the new aircraft cycle, Airbus is still picking up orders for the A330 and A320 ceo, both soon to be superseded.

The total order backlog is now well over $400B but firm orders are only truly firm when they are delivered and paid for - Lufthansa, when ordering the A350 (and 777X), cancelled a firm order for 3 of the A380 because its traffic forecasts changed, and Emirates was the launch customer for a version of the A340 before the firm order was postponed and then cancelled. These kind of cancellations and delays, because of the financial weakness of the ordering airline, have to be accommodated by Boeing and Airbus, which is why they look for a book/bill ratio greater than 1.

The real problem though is Boeing's commercial aircraft offerings are looking weak compared to Airbus, at least until the 777X is available and the 787 issues are sorted. According to Marty Bentrott of Boeing, "they think the 787 will be reliable in another 6 months or so." That timing will bring us up to Farnborough, the major European air show in 2014, when the A350 should be entering the final stages of certification. So even if Boeing is able to keep to that schedule, the 787 has lost its 5-plus year lead.

This weakness is showing up in customer defections and the failure of Boeing to win orders it really should be getting. Over the past 12 months American, Lion Air and Norwegian, having been 737 only, have split orders between the 737 MAX and the A320 neo, VivaAerobus, a 737-300 customer, has chosen to go all Airbus by 2016, IAG (British Airways, Iberia, Vueling) and the Lufthansa Group have decided to standardize on A320 for single aisle aircraft. Delta decided to add to the Airbus A320 fleet that came with the merger to Northwest, despite having ordered 100 737NGs in 2011. Japan Airlines has for the first time ordered planes from Airbus, the A350, British Airways ordered A350s despite receiving 787s this fall and Lufthansa bypassed the 787 for a mix of A350s and 777X. Since its launch in 2006, the A350 has outsold the 787 and now has firm orders for over 800 compared to 1,000-plus for the 787.

Until the battery problems are solved and the glitches substantially reduced, the 787 won't be the reliable backbone of an airline, so a major risk going forward is that customers see the 777X as a better buy, leading to orders for the 787 drying up, and possibly cancellations, resulting in a write off on the 787. Boeing's program accounting quantity is 1,300, basically the number of planes over which they estimate revenue and cost and calculate margins. This accounting quantity affects current profitability as Boeing doesn't wait, until an airplane program reaches breakeven, before taking profits. As the A330, with an order from AirAsia X, has just passed and the current 777 has comfortably exceeded 1,300, under normal conditions the 787 should reach that total. The A330 and 777 though were competing against each other and not, as the 787 is, against two good alternatives while handicapped by reliability issues.

While the market for large commercial aircraft remains strong amid a Boeing/Airbus duopoly, Boeing should be comfortably profitable even if it ends up in second place in each of the major categories. Second place companies, which have lost market leadership, rarely have inspiring share prices.


Despite the three-year delay before deliveries started, the 787 is looking as though it was rushed out before it was ready to keep the late delivery penalties as low as possible, and airlines are suffering from poor design or poor quality control or both. The 777X will have composite wings but doesn't have a composite fuselage or lithium-ion batteries. "We took on too much risk" with the 787, says John C. Wojick of Boeing. As Boeing is not sufficiently confident to standardize on composite fuselages and lithium-ion batteries, why should its customers accept those on the 787?

Outside of the substantial order from American early in the year and the launch of the -10 at the Paris Air Show, there was little enthusiasm for the 787 in 2013. Uncommitted airlines have a wait-and-see attitude and Boeing has had to watch Airbus improve the A350 backlog. Now the 787/A350 (1030/814) firm order ratio is not much different to that of the 777/A330 (1478/1305) despite the 5-plus year Boeing advantage between their schedules for starting service.

The 787 has suffered from several serious fires. The JAL/ ANA battery fires leading to the 3 month grounding and the Ethiopian Airways fire at London Heathrow from the battery in the emergency location unit. That 787 needed a substantial rebuild and finally started commercial flights again on December 23, nearly 6 months after the incident. There was also an electrical fire during testing, leading to a 6 week grounding. The final report on the JAL battery fire is due in the fall but the redesign and airline monitoring and appropriate replacement of the batteries and controller has avoided new major problems although JAL has now found another fault during maintenance when smoke was noticed in the cockpit.

Other glitches include: ANA, 5 Dreamliners with engine defects; JAL 3 Dreamliners with fuel leaks; ANA and United also reported finding wiring problems with the emergency location unit; in August, ANA found 3 Dreamliners with a fire extinguisher fault; in September, LOT found low pressure oil filters missing from 3 engines; Air India had an overheating oven which prompted an investigation, as did another of their 787s losing an 8ft x 4ft panel in flight in October.

JAL reported, in June and October, that anti-icing systems on an engine failed. Now the airlines, like JAL, that are flying with GEnx engines, have been warned against flying within 50 nautical miles of high-level thunderstorms because of the risk of ice crystal build up. So JAL feels unable to use the 787 on certain international routes until GE offers a fix, expected in the spring.

Glitches need to be cleared up over a reasonable time for dispatch reliability to improve, but ANA reported problems with windscreen cracks before the battery grounding, yet Air India had to fly a replacement unit to Sydney in November. For Norwegian, Boeing had a team go over their first 2 Dreamliners because of 6 breakdowns in September. A third new Dreamliner was then stranded in Florida on December 21 and had to wait for spares until after Christmas, despite having a Boeing GoldCare agreement.

Delays and breakdowns can get expensive. For Norwegian, payments to passengers for delays and inconveniences can be €250,000 ($338,970) per 787. In September, it had to lease an A340 on short notice or cancel flights. After the Florida breakdown, Norwegian had to lease a 777 with crew. As neither of the leased aircraft is as fuel efficient as the 787, Norwegian also lost money there.

ANA, the 787 launch customer, has been used to a technical dispatch rate of 98.9% and Boeing claims over 99% for ranges other than the 787. After 2 years of deliveries and with over 100 Dreamliners flying, 787 dispatch reliability is still only 97%. LOT, for example, postponed 50 Dreamliner flights out of 1,300 between June and October. So 3 flights in every 100 are delayed or cancelled for technical reasons. The first delivery for the Airbus A380 was delayed for over 3 years too, but dispatch reliability was over 97% within 12 months of the first commercial flights and Boeing claims 99.5% for the 777.

Better fuel economy is one area where the 787 has delivered but, according to Air India officials, it is overweight when compared to the original design. This lessens the potential gain when fuel economy is a moving target - Boeing and Airbus improve performance whenever they sensibly can. Emirates expects the 777X to be 16-17% better than the 777-300ER and both the 747-8 and the A380 offer more than 20% better fuel economy than the original 747s.

The 3 year delay and 2-plus years of uncertain reliability can shift the business case. Two thirds of ANA's passenger revenue comes from domestic flights in Japan. This revenue is vulnerable as the high speed train network is extended with more comfortable and faster trains. Passengers are switching when the train journey is 3 hours or less and ANA has a further 43 787s on order.

If the leasing companies can't place the 787s on order, they will cancel, as ILFC did with 10 A380. Over 150 of the 1,030 firm orders are from Leasing Companies, only 6 of the deliveries.

Compensation to airlines - LOT is receiving around $30 million in cash from Boeing in settlement. LOT had 2 Dreamliners grounded but that sum probably settles costs of the glitches on all five 787s and any outstanding payments for late delivery too. Obviously much of this was for the battery grounding but with ANA and JAL yet to settle and claiming revenue hits of up to $200M, some sizable sums will need to be paid, even if all the late delivery payments have been sorted out.

ETOPS governs the maximum flying time a twin engine plane can be from an appropriate diversionary airport. The 787 was designed for 330 minutes but is currently certified for 180 minutes. Until the 787 has flown for 12 months without major issues, and certainly not before the ice crystal accumulation problem in GE engines in high altitude thunderstorms has been solved, will it be significantly increased. In many cases this requires both the FAA to sign off on the increase and the local regulatory authority to authorize the airline to fly the 787 on a given route. As is, because it can't fly direct, the 787 has little or no economic advantage over 777s and A330s on Europe/Africa to South America and many trans Pacific routes. It could therefore be undeliverable to certain airlines until it has a higher ETOPS rating.

The 787 glitch saga came at the wrong time. No new aircraft is trouble free but had Boeing used the 3.5 year delivery delay to continuously improve the 787, it would still be the dominant widebody of this generation - a worthy successor to the 777. It became clear however from the evidence which came out during the battery problem that Boeing persuaded the FAA the Lithium-Ion problems found in laptops and cellphones didn't apply. So it chose to freeze the 787 design where possible, probably to save money.

With the 777X family now launched and commercial deliveries of the Airbus A350 looking to start this year, Boeing's time to get this right is limited. It is getting closer to the point where transferring 787 orders to the new 777X or to the A350 looks like a safer bet for airlines, especially if they don't have early delivery dates.


The current generation of 737 has been outsold by the A320 for years and outdelivered since 2002 and only its 20 year start has allowed the 737 to stay in front in overall order numbers. Boeing hoped that Airbus would have to redesign but a 15% fuel saving was enough for airlines to want to buy the A320neo. Boeing was then forced to react with the 737 MAX or lose major single aisle customers like American and Southwest.

The recent order from Air Canada for 61 of the 737 MAX to replace old A320s goes against this trend but they are also phasing out A330s and A340s for 777s and 787s, so it seems to have already made the decision to go all-Boeing. The only region where the 737 MAX is ahead in firm orders is North America, but the total market split is 60:40 in favor of Airbus.

So why is Airbus winning so strongly when Boeing is claiming 4% better fuel consumption with the 737 MAX design?

Airlines always look at how an aircraft is likely to perform on their route network. Quantas, which operates both the 737NG and the current A320 finds them indistinguishable. Lufthansa considered the 737 MAX would have a 2% fuel advantage, even though many of its flights are between European cities less than 800 nautical miles apart where the 737 has always shown gains. That Lufthansa has decided to standardize on the A320 ceo/neo for its single aisle fleet, when the 737 has a lower list price too, shows the Airbus family must have other advantages.

In China, $100B a year is spent on improving rail, mostly on the high speed networks. Tickets there are half the price of flights and avoid the delays at airports. Airlines no longer schedule flights under 300 miles and have reduced flights up to 470 miles. In Japan and Europe the high speed rail networks are being extended too. In these markets, the 500 nautical miles routes where Boeing demonstrates its 4% fuel gain will be dominated by rail.

The 737 also loses out to the A320 ceo when hot/high airports are significant in the airline's network. It seems unlikely the 737 MAX is much closer to the A320 neo, given the 37% size difference in air intake between the CFM Leap engines for the two aircraft. So it will be less attractive, for example, for Chinese airlines flying to Tibet, Indian airlines flying to Kashmir, South American airlines flying to Bolivian airports, Mexico City etc.

The 737 started off the Low Cost Carrier market with Southwest in the US, Ryanair in Europe, etc. While Boeing has successfully held on to these, others like EasyJet have changed to the A320 and many of the newer airlines in the East, like ANA's subsidiary Vanilla Air, have chosen to start with 320s.There is little incentive for A320 users to change as the A320 neo is basically the current A320 with more efficient engines. This means that pilot training is expected to take 0.5 days, so crew can easily move between the two types of aircraft. The Airbus target of 95% airframe compatability will also it easier for maintenance and to stock spares.

Boeing is looking for 90% commonality with the 737NG and so has more to change. This, as well as starting service earlier, makes the A320 neo a safer choice. So, if Boeing wants to increase its market share and convert some of these customers, it will have to offer lower prices and accept lower profits.

At the lower end of the 737 market, offerings from Bombadier and Embrauer are looking to gain traction. While the Comac 919 does not yet appear to be a threat, it will pick up orders in its home market - China. The only question is whether those orders would have gone to Airbus or Boeing.


As the 747-8 Intercontinental can't fly many more passengers than the 777X or the A350-1000 and will be more expensive to run with 4 engines and has less capacity than the A380, it's unlikely to attract many more orders although Korean Air is acquiring another five. The freighter version though should continue to be a workhorse and its competition comes, not from the A380, but from freighter versions of the 777 and A330. Look for Boeing to continue to scale down production from the current 18 per year.

The CEO of Airbus, Fabrice Berger, is looking for Airbus to overtake Boeing in aircraft deliveries in the next four to five years by increasing future production of the A320 neo and A350. As Airbus has a larger backlog, this should be sustainable in the long term unless Boeing comes out with a new breakthrough aircraft or the 777X is seen as a much better choice than the A350 and the 737 MAX reaches closer to 50% market share from the current below 40%.

Boeing needs to regain credibility for its engineering capabilities and improved quality control is essential, if it is to keep its current customers and grow market share. The 737 MAX, with the targeted 90% compatibility with the 737NG, should be a step on the way and making the 777X in Washington State is likely to reassure customers too. However any significant issues going forward means more airlines looking on Airbus as a safer partner.

A further risk for Boeing is fall out from World Trade Organization decisions. Now that Boeing has bid on and won the US tanker contract, it would probably be happy for the decisions to be ignored as the WTO found it should repay $5.3B in illegal cash subsidies and $2B in state and local subsidies. Once the Final Assembly Line in Mobile, Alabama, is running, Airbus will be a lot less vulnerable in the US market. It could therefore ask the EU to apply penalties to imports of Boeing aircraft only to avoid a trade war while hurting Boeing in Europe.

Boeing has too many issues in monetizing the strong commercial order book for last year's run up in share price to be repeated. There is a large downside risk especially if the problems with the 787 continue and the 737 MAX program is not substantially trouble free. Take your profits now.

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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