Boeing And Airbus: The Bubble Burst
Summary
- Jet maker shares have significantly increased in value as COVID-19 measures are easing.
- This marks the first step in the recovery trajectory.
- Production cuts are steeper due to the nature and size of the disruptor and the delivery mix.
- Despite the bubble bursting, I believe the commercial airplane industry remains investable though Boeing faces a more complex road to recovery.
- Looking for a helping hand in the market? Members of The Aerospace Forum get exclusive ideas and guidance to navigate any climate. Get started today »
Following the COVID-19 crisis, Boeing (NYSE:BA) but also Airbus (OTCPK:EADSF) decided to dial down production on commercial aircraft programs. Over the past trading sessions Boeing shares, but also shares of Airbus, have significantly gained, consistent with my view shared in early March. In this analysis, we look at why steep changes to production were introduced and why they could remain for the foreseeable future.
Source: Aerocontact
The only programs on Boeing’s side that are not seeing reductions in production are the Boeing 767 and Boeing 747, since these programs depend on freighter sales. You could say the Boeing 737 MAX dodges the bullet, since production was halted prior to COVID-19 becoming problematic, but we are seeing that the production ramp up will be slower than initially anticipated. Airbus aimed to keep production steady for the Airbus A380, which is not a sign of strength as the program is in its final days, but we also are seeing Emirates and All Nippon Airways push back the final deliveries. On the Airbus A220 program, planned production rate increases have been postponed while the A320, A330 and A350 outputs have all been reduced.
Commercial aircraft deliveries: Near record highs
Figure 1: Commercial aircraft deliveries Airbus and Boeing (Source: AeroAnalysis)
There are a couple of reasons why very steep reductions in production were needed. Figure 1 shows that Boeing and Airbus were producing aircraft at record levels before the Boeing 737 MAX and COVID-19 crisis hit. Putting it simple, if you are cycling and someone puts a branch in your wheel while you are at full speed, you will fall harder than when you don’t cycle as fast. With production and the global economy at record highs and high demand, COVID-19 has disturbed demand quite significantly. COVID-19 was the branch that has been put between the wheels (aircraft production). The momentum loss was so sudden and global that there was no time to adapt the production plans without having to lower production.
On top of that, aircraft production remains a cyclical business. It’s obvious from the diagram. What's also rather obvious is that since 2003, instead of starting the leg down around 2013 completing the cycle, aircraft production kept growing. So, the downturn has been significantly delayed and if the hit is as instantaneous as it is now with COVID-19, that provides a solid damper on aircraft production. That also brings us to the next factor and that's the COVID-19 impact was quite instantaneous. In an environment where companies fuel their growth with debt, that provides a solid base for a crash landing and dries demand for aircraft rapidly. Whereas economic impacts such as a banking crisis ease into the economy, lockdowns directly hit the economy.
So far, we have a delayed cycle and record production that explains the drop in aircraft production, but what also plays a role is the nature of the disruptor. The combined delivery numbers of Airbus and Boeing don’t show a lot of deviation during previous downturns because Airbus has spent much of the previous decades penetrating the market while Boeing was making the bigger cuts to production to reflect reduced demand during the downturns. Boeing’s numbers showed a 15% decline in deliveries due to the 2007-2008 financial crisis and 16% in the aftermath of the dotcom bubble. With COVID-19, we have seen cuts around 30 percent being announced and that fetches quite well with the declines we saw after 9/11 and the Gulf War. War obviously has an economic impact and so does a pandemic, but it does seem like matters that induce fear such as pandemics and war hit the aircraft industry harder than actual economic downturns. So, COVID-19 being a pandemic in its nature would invoke a bigger reaction resulting in reduced demand for aircraft.
Positioned for growth
Figure 1: Share of airplane deliveries for growth
What's often overlooked is the fact that the air travel and commercial aircraft market went from a clear growth position to a (temporary) shrink. So, growth is being delayed, and while installed bases of thousands of aircraft are usually touted to propel the investment case for aircraft manufacturers, in recent years deliveries were driven by growth. That growth is gone for the time being and so is the immediate need for new aircraft. Over the long term 56% of commercial aircraft deliveries is supported by growth. From aircraft type to aircraft type, from region to region and from airline to airline, this will of course differ, but the overall figure gives a pretty good indication on how much the commercial aircraft industry leans on continued growth. In recent years despite some fluctuation in the shares of growth and replacement in the delivery mix we see that growth supported the delivery increases.
Figure 1: Airplane deliveries for growth
Looking at the deliveries supporting growth, we see that in any given year that has been between 535 and 1,240 units assuming among Boeing and Airbus the same percentages for supporting growth hold. Currently we are seeing cuts to production in the range of a third of the full production, and depending on aircraft program that can even be as high as 50%. There's a couple of ways to view this. The first one is that not all production to support growth is being eliminated. This makes sense because every airline fleet looks different and so every airline has different requirements and growth trajectories. While growth has been dented, it's not the case that all airlines around the world will be flat or trending down on their fleet sizes.
The other way to view it is that previously airlines have kept older aircraft in the fleet because Boeing and Airbus couldn’t build jets fast enough. With demand for air travel drying up, the older aircraft were the first ones to be phased out. Airlines have been shrinking their fleets via attrition, which means that some 20 to 40 percent of the production capacity that was reserved for replacement of older aircraft is no longer needed. Regardless of the way you view it, the near-term mix of replacement and growth supporting deliveries has changed. It's no coincidence that the current production rate reductions are matching the share of deliveries previously reserved to replace aging fleet members. In other words: The replacement cycle has now become part of the growth and recovery story.
Conclusion
In this analysis, I had a look at why the cuts in aircraft production have been so steep. There are several reasons for that. What we observed is that events such as wars and pandemic lead to a more rapid cooling than economic downturns. The fact that production wasn’t really following a cyclical path anymore and seemed to be in a super cycle supporting growth amplified the need for steeper reductions in aircraft production. For Boeing and Airbus, the current downturn provides an opportunity to recalibrate rates on all its key programs and while earnings will be pressured for the coming 2-3 years and possibly even longer, I don’t believe the (very) long-term prospect makes the aerospace industry uninvestable. During the lockdowns, the sentiment was as if nobody will want to fly anymore. With lockdowns easing and looking at capacity recovery and passenger numbers that, as expected, we see that's simply not the case and that has set share prices of the jet makers significantly higher, though the risks are still present.
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This article was written by
Dhierin-Perkash Bechai is an aerospace, defense and airline analyst.
Dhierin runs the investing group The Aerospace Forum, whose goal is to discover investment opportunities in the aerospace, defense and airline industry. With a background in aerospace engineering, he provides analysis of a complex industry with significant growth prospects, and offers context to developments as they occur, describing how they might affect investment theses. His investing ideas are driven by data informed analysis. The investing group also provides direct access to data analytics monitors. Learn more.Analyst’s Disclosure: I am/we are long BA, EADSF. 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (57)
The bubble already burst in 2019, 23% overall decline in deliveries, just happens it was ALL on the Boeing side.
The mostly US-centric readers for whom you write are mainly focused on Boeing, I understand that.
But even for the sake of proper investment insight, this crisis may firm Airbus leadership position for a long time.
The dividend rate on BA is 0% and it is not going to go up in the near future. This makes it unattractive to those who do interest arbitrage (get loans at 0% and invest in companies like AAPL which are all going to moon). So, it looks like only folks investing (or shorting) are the speculators, buy the dip mentality and quant traders. Do you have any thoughts along these lines? TIA
ThE 777x gained 4 inches in cabin width,
As Dhierin said, the 777X increase is mostly optical, due to sidewall sculpturing
Once set, it is impossible to increase fuselage cross section without a completely new fuselage.
That would be achievable if they had a good management.
to see how all of this shakes out!!!!!! moblackty