Premium #147 – A closer look at the impact of last week’s aircraft orders

There were two large aircraft orders last week, one for 50 aircraft at Delta and another for 10 aircraft at Kuwait Airlines. Their economics, implications, and contribution to the bottom line of the aircraft OEM, however, appear to be quite different. Airbus won a hard fought order with Delta, but at a deep discount likely to result in low margins. Boeing won a smaller battle, but with a lower discount, and will likely earn a substantially higher margin per aircraft from its order. The Delta Order The long awaited wide-body order from Delta selected Airbus as the big winner. The order for 25 Airbus A350-900s and 25 Airbus A330-900neos is worth $14.2bn at list prices. According to Avitas, however, the size of the deal is closer to $6.2bn. Delta may have secured a 57% discount, on average, from list prices. That is excellent news for Delta shareholders, but not as good news to Airbus shareholders and their bottom line. If Avitas is correct accurate, there has been a big transfer of value from Airbus shareholders to Delta shareholders. The industry rumor mill indicates that Boeing lost the Delta order because of its inability to offer a 787 delivery slot that suited Delta. The implication is that Boeing’s 787 sales are doing rather well with a backlog that hasn’t much flexibility. If Boeing could have, they certainly would have shuffled deliveries to be able to slot in aircraft for Delta. No OEM would want to say no to the second biggest airline in the world. Clearly, both companies wanted this order. Airbus, with the introduction of the A330neo, created a pricing weapon to be used against the 787-8 and -9. Because their aircraft is a low-cost derivative of an existing aircraft, they have much lower development costs to amortize per aircraft, and can offer these aircraft at much lower prices than Boeing could offer a 787, particularly after the extended development program dramatically increased program costs. Our analysis of “pricing to economic equivalency” indicates that Airbus would need to price the A330neo about $25 million lower than the 787 with fuel prices at $100 to make up for the higher fuel burn. However, at $80 fuel, that differential shrinks to between $15 and $20 million. Of course, the OEMs quote list prices, which in recent years have deviated significantly from actual prices than in the past, with discounts of 55% plus for key orders now seen often. Almost any airline is able to achieve 30% off. While not quite in the day after Thanksgiving “Black Friday” retail sales territory, the OEMs today are close. List prices appear meaningless guidelines. If we look at historical list prices, they have risen much faster than inflation, reflecting the desire of aircraft OEMs to better obfuscate their economic realities when they report transactions. Hence list prices for aircraft involved in transactions this week that seem astronomical when compared with the reality of what airlines pay. It is likely that Boeing would have offered Delta a typical 45-50% discount on the 787-9 for this order, pricing aircraft at around $140 million. Based on the Avitas deal estimate, Airbus sold their planes at an average of about $124 million. We would expect that the A350 would be priced higher than the A330 neo – with the A350 in the $140 million range and the A330-900 around or just under $100 million. The Delta order has been characterized as having been won through the availability of earlier delivery slots. Airbus and Boeing are pretty well sold out until 2020 for their new technology 787 and A350 models. Could it have been the low pricing on the A330neo that made the difference? Airbus' strategic pricing weapon against the 787 – the A330neo – has won its first competitive battle. But does this mean Boeing is in trouble? Of course it doesn’t, despite what one reads in the media. Boeing is well positioned, particularly in the large twin segment with 777 and 777-X, and has the fully amortized and highly profitable 777-300ERs that are still selling. The Kuwait Airways Order The second major deal this week was the announcement that Kuwait Airways intends to purchase ten 777-300ERs. This order has a list price of $3.3bn, which pales in comparison to the $14.2bn Airbus/Delta deal. Boeing may at some point be forced to offer deeper discounts the 777-300ER to ensure that it’s production line stays busy until the new 777X enters service. However, we do not believe that Boeing provided discounts anywhere near the level of 57%. And even if Boeing did discount that heavily, it might still end up with a more profitable deal than Airbus, as the Boeing 777 program, unlike A350 and A330neo, requires no further development, is way down the cost curve, and remains highly profitable. After the Delta order, the Airbus A350 program is still 25 orders behind from where it was in January (after the Emirates cancellation of an order for 70 A350s). Boeing on the other hand is sitting on 53 additional 777 orders year-to-date and a backlog about 270 aircraft through October. While this backlog won’t last through the 777X EIS, Boeing is under less pressure than Airbus. The Bottom Line: A win at Delta would have been good for Boeing. But a loss is not as painful as it appears. Airbus needed this order more than Boeing did, and priced accordingly. It may turn out that after all the discounts and accounting clouds are cleared, that Boeing could have made more profit on the ten 777s sold to Kuwait than Airbus will make on its 50 aircraft sold to Delta. Volume is only one factor in the equation – margin is another. Selling airplanes is one thing – cash flow and profitability is another. As an example of what the deal might look like we collaborated with Collateral Verifications (CV) in creating the following table. CV has conservative valuations on discounts; they believe Airbus does not need to discount the A330 too much given its popularity - they mention recent sales at $130m, then throw in escalations for the next four years and even with big a "Delta discount", the A330-900neo is around $130m. Using our own estimates on amortization and production costs we estimate the assumed profit. In summary, Airbus may have had a big win, but they may be averaging a profit of $24m per aircraft sold compared to nearly $40m in profit per Boeing aircraft sold. It is clear that Airbus regards the Delta deal as strategic; with hopes of influencing American next. Which is perhaps why Avitas has a much lower (13%) valuation on the Delta sale than CV. Indeed Avitas may have factored more items and reduced its estimate of the real price for the Delta deal.

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