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May 26, 2024
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Our colleague Scott Hamilton scooped the industry on Boeing’s plan to re-engine the 737 for 2017 as well as move forward with an all new airplane for 2021-22.  While it is admirable for Boeing to attempt to stem the tide of Airbus’ incredibly successful neo, with more than 1,000 orders in the few months it has been offered, does offering a re-engined aircraft that will be economically obsoleted a mere four to five years later by a new model make sense from any perspective?  We suspect Boeing’s all new aircraft will be pushed to the right, giving Bombardier, COMAC and Irkut an opportunity to compete with 21st century aircraft with 21st century engines, with the CSeries being the most advanced.

Boeing’s two pronged strategy appears foolhardy for several reasons, but necessary given continuing issues with the 787.

  1. According to reports from Seattle, the re-engined model will be economically obsoleted by an all new model 5 years after introduction.  Can Boeing possibly recover the development costs for a re-engining program in only 5 short years?  We know several Boeing customers are demanding better fuel economy in today’s high cost environment, and Boeing would likely lose several customers without a RE offering, as evidenced by the surprise launch at the 11th hour to save the smaller portion of the American Airlines order.  Given the success of the neo, were this a little league game, it would have already been called using the “mercy rule” given the disproportionate order volumes in 2011.  Boeing had to take action, and it will be interesting to watch DL and WN.
  2. When Boeing is ready to deliver its new aircraft in 2022, Airbus will announce its all new aircraft, for introduction around 2027, that will likely be even more efficient as the game of leap-frog continues between the manufacturers.   Thus, Airbus would re-gain the advantage shortly after Boeing introduces the new airplane, and have ten years of production to recover the costs of neo before a new model is introduced rather than the five years at Boeing.
  3. Producing both airplanes together makes no sense, unless Boeing is planning to bifurcate the market between old and new technology aircraft at different price points.  The problem is regardless of the attractiveness of each, Airbus will be able to price its aircraft to the point of economic indifference, and reduce the price of neo to match the economics of the all-new aircraft.  An all new technology aircraft should have at least a 15% reduction in total operating costs (like the CSeries) over today’s models, while neo and 737RE are about 8% better.  Boeing will end up with an expensive airplane it will need to discount somewhat to compete with neo, and Airbus will certainly match any low price point for the 737RE.  The profitability of the current cash cow will disappear with dual price points and an increasingly competitive marketplace with 5 rather than 2 players.  This industry does know how to prepare financial models, and price to the point of economic indifference.
  4. Boeing needs cash to cover continuing difficulties with the 787 program, for which additional delays will soon be announced. Production difficulties continue with rework and “traveled” work due to continuing supply chain problems, and Boeing has a long way to go to stabilize and increase production rates to meet its backlog.  While the first 787 will be delivered this year, we understand through confidential sources that only 3-5 aircraft will be delivered this year, and with more than 20 aircraft subject to significant rework, cash flow will remain negative for this program well into 2012.  With a slower production ramp-up and further payments to customers for delays likely, positive cash flow for 787 may have to wait until 2013.
  5. The 737RE, for a five year time period, is a stop-gap measure to keep cash flow coming, as the existing 737NG is proving to be simply not competitive with the A320neo family.  Since the 737NG is the most profitable program at Boeing, with development costs long written off and amortized over a large volume, it is even more significant to cash flow.  The handwriting one the wall indicates that with Airbus taking most of the market, Boeing’s backlog could have quickly dried up without a competitive offering, and it would have continued to lose key customers.  Without the RE, Boeing may have lost the entire AA order, which would have been a disaster for a customer with a “preferred pricing” agreement in place that ensures they pay no more than anyone else.  The other preferred US customers, through merger, are now significant Airbus customers, making those campaigns even more difficult because of fleet commonality benefits.  Airbus has captured market leadership, and Boeing is now reacting to Airbus rather than innovating to maintain its market position.
  6. Buckingham Research indicates that the 737RE could offer both the LEAP and GTF engines.  For a five year period, that would entail a significant investment, and given the exclusive contract with CFM, we believe only LEAP will be offered on a 737RE.  Boeing would need to extend the landing gear by at least 4 inches to accommodate the GTF, which would be a more expensive modification than LEAP.  We see the GTF as unlikely, despite its superior growth potential and economic advantages over LEAP, due to the larger fan size that would be difficult to accommodate.
  7. Both Airbus and Boeing are targeting the Bombardier CSeries.  Bombardier is a master at stretching airplanes, as evidenced by the 3 stretched models of the CRJ that doubled its original capacity.  The fact that it has reserved trademarks for CS500 and CS900 has not been lost on Airbus and Boeing, who recognize that the CSeries offers a 15% reduction in total operating economics, not simply fuel burn.  As the first true 21st century airframe with 21st century engines in the narrow-body class, Boeing and Airbus are forced to compete on price – and the best way to lower prices is to increase volume to amortize fixed costs over a more units.  Plans appear to be in place at Both Boeing and Airbus to increase capacity to 60 aircraft per month.  The goal – price the Bombardier CSeries out of the market and not allow a foothold in the traditional duopoly turf.  The key question is will it work, or will the mild mannered Canadians up the ante with more aggressive campaigns of their own.
  8. High production rates in fragile economic times present a potential problem — a supply bubble that will eventually burst.  While many carriers, US operators in particular, need fleet replacement, financing those aircraft is another question entirely.  With Airbus offering lease financing with its AA contract, will Airbus and Boeing become lessors, and end up with the residual risk on interim airplanes?  I wouldn’t want to finance either an A320neo or 737RE knowing that economic obsolescence is planned within a decade – but that’s what manufacturers will be asking the financial community to do.  It almost like “Psst — want to lease our new Edsel?”

What happens when the last of the carriers order, and new technologies become available?  Residuals plummet, and somebody holding EETC paper will get burned badly.  My advice to financial institutions is to carefully balance portfolios and NOT overload with neos and REs, which will have a limited life before economic obsolescence.

Our judgment:  Boeing is between a rock and a hard place.  While it would love nothing better than to launch an all-new airplane, the experience with 787 indicates that the company is simply not ready for another new technology development.  The answer is to drop back into punt formation and run a fake punt through a re-engining program. But unless Boeing plans to push the all new aircraft significant to the right to allow the 737RE to have a ten year role in the marketplace, we believe the investment will not generate an adequate return. While a re-engining program could potentially stem the tsunami of the Airbus neo, it is clearly a stop-gap measure that shouldn’t further exacerbating Boeing’s cash flow issues with 787, 747-8, and the need to do update 777.  Is this another strategic error by Boeing, or is there a message implied that an all new airplane may be a lot further off than 2022.  2027-2030 would make a lot more sense, and enable the company to evaluate non-traditional designs.

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