Premium #195 - Wide-Body Production Trends and Demand

Delta Air Lines sent analysts into a tizzy a couple of weeks ago when they stated that there would be overcapacity in the wide-body marketplace. Are they correct, or is this a temporary condition that will right itself before 2020? The answer is it depends on which aircraft models you are looking at. The order books for the new technology 787 and A350 are quite solid, with delivery positions sold out for quite while. But for other programs, such as A380 and 747-8, an order would be met with a much faster delivery from the OEMs, as these airplanes are not selling well at all. But the key to the supply-demand balance for wide-bodies centers on two of the most popular models, the Airbus A330 and the Boeing 777, which are currently produced at 9 and 8.3 aircraft per month, respectively. The Re-Engining Effect But both of these models have re-engining programs on the drawing board, taking demand away from the existing models - the Airbus A330neo and the Boeing 777-X. New models for these programs are destined for market entry in the 4th quarter 2017 and first quarter of 2020, respectively. However, given airline preference for more modern technology for 20-25 year investments in new aircraft, the final months of production for the existing A330ceo and 777-300ER models have not yet been spoken for, creating a potential supply-demand imbalance in favor of supply. Airbus and Boeing have each announced that they will cut their production rates for these aircraft, albeit Boeing’s explanation of “inserting blanks” into the production line rather than announcing a rate cut challenges logic. Nonetheless, it appears that additional cuts may be needed if orders do not come in to fill the gap. Let’s look at the current production rates, and how low production may need to be cut if no further orders are gathered until the new models arrive. The following table shows the current production rate, months until new model introduction, aircraft that will be produced during that period, the current backlog, and the gap that Airbus and Boeing will need to fill. Aircraft A330 777 Current Production Rate 9 8.3 Months until New Model Introduction 25 52 Aircraft Available at Full Production 225 432 Current Backlog 185 235 Gap - Orders Needed to Fully Sell Out Production 40 197 The table shows that Airbus needs a few more sales for its A330 to avoid a rate cut before the 2017 introduction of the neo, and that Boeing needs to sell nearly 200 777s prior to introduction of the 777-X in early 2020. Neither seems likely to do so, producing an oversupply situation. For Airbus, the urgency is time. It is difficult to move aircraft in a short time frame, and Airbus is facing sales of 1.6 A330ceos per month to match current line capacity. We don’t believe they will make it, and will likely be about 25 units short at A330neo entry into service. That would require a cut from 9 to 7 units during the 4Q 2016 and first 9 months of 2017 prior to the neo EIS. For Boeing, with a bit more time, the daunting challenge is increasing demand. With 197 orders required, they need additional customers who want the current model, despite major performance improvements with the new models. That’s typically done with price concessions. Can the Freighter Market save Boeing? With the 777, Boeing has an advantage in that they have been much more successful with their freighters, outselling the A330F 160 to 42. There are rumors that Boeing is discussing a potential order for 100 aircraft with FedEx. While these aircraft are likely to be deeply discounted, as the last models of the type, such an order could reduce the order gap considerably and enable Boeing to keep production rates higher for the existing 777 models while the 777-X is being introduced. Our view is that Boeing will likely obtain about one half to two thirds of the units needed to fill production capacity, with the former if a FedEx order doesn’t come through, and the latter if it does. With the luxury of additional time, Boeing can continue at its current production rate through 2017 without difficulty. But in 2018 through early 2020, Boeing may need to reduce its monthly rate by 3-4 aircraft per month should the additional orders not materialize, or risk unsold white-tail aircraft. Cash Flow The 777 is currently one of Boeing’s cash cows, but airlines are balking at acquiring additional existing models close to the introduction of a new and improved version - particularly given the substantial economic improvements projected for the new airplane. Boeing relies on the 777 for positive cash flow, and the aircraft earns high margins. With a drop-off in demand and production in the 2018-2020 time frame, this could put pressure on Boeing. This may underscore the ramp-up of narrow-body production to record levels, despite a potential bubble in demand that we’ve previously described on our site that could burst before 2020. Of course, this is also offset by increased production rates for the 787, which after multiple delays has a strong backlog and customers who have waited longer than planned for the aircraft. Boeing delivered 112 787s in the first 10 months of 2015, a rate nearing 12 per month. But after multiple delays and customer concessions, the 787 is not yet generating the margins Boeing initially envisioned. Airbus appears to be in somewhat better shape, with fewer aircraft to fill before new models arrive. But a slower than expected ramp-up in A350 production, due to some supply issues, may also impact Airbus cash flows. In addition, with models of nearly identical size, the major differences being technology and range, the A330neo and A350 are competitors for some routes. Delta, for example, purchased both, using the less expensive A330 for medium-haul transatlantic routes, and the A350 for long-range intercontinental routes. The question is whether there will be room for both models, long-term. The Bottom Line It appears that the current models headed for re-engining will hit some headwinds before the new models arrive, and will be unlikely to “sell out” the production capacity. This will force rate decreases at both Boeing and Airbus to better match supply and demand. The question now is how large those cuts will need to be, and for how long.

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