Top Pair Trade Thesis: Buy Boeing, Short Airbus (NYSE:BA)

British Airways A 320

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Historical stock price performance

The following chart tracks the change in stock prices compared to the S&P 500 (SPY). The S&P is in orange compared to The Boeing Company (NYSE:BA) price in blue and Airbus SE (OTCPK:EADSF, OTCPK:EADSY) in red, from 2017 to the present. In 2018, the last year before the Max crashes and the pandemic, Boeing generated a cash flow of $13.6 billion compared to Airbus’ cash flow of $4 billion. The high cash flow led Boeing to surpass Airbus in this period. The pandemic led both stocks to crash more than the S&P 500 Index.

Boeing and Airbus stock history

Stock Price History (Seeking Alpha)

The second chart demonstrates that in June Boeing performed better than the S&P 500 or Airbus. Although, in that period, better performance was losing less money. Boeing management has made large stock purchases in the last year in anticipation of the resumption of 787 deliveries.

Boeing and Airbus 1 Month chart

One Month (Seeking Alpha)

Boeing Evaluation

Citi reported on July 1 that Boeing has removed 10 787s from storage and is test-flying them in what they believe is preparation for delivery to customers. Delivery of about 15 of these planes would mean a cash flow positive profitable third quarter. The resumption of 787 would send the stock soaring.

Boeing Products

All the major product lines – 737, 787, and 777X – have been negatively impacted by FAA actions. The Boeing products are described below.

737

The 737 reentered active service about a year ago. The quality is high, with planes available for service 99% of the time. However, new production has been slow. Currently, Boeing is attempting to achieve the 31 new-units-a-month level in the third quarter. This production rate will be increased in 2023 and 2024.

In May, production was halted for 10 days. When Boeing has parts missing, they now halt production rather than continue manufacturing the product and then going back to add the parts. The 737-production line has a series of sub-assemblies so employees can work in the sub-assemblies until parts arrive for the main assembly line. They hope to achieve the 31 new unit level in the third quarter. This production rate will be increased in 2023 and 2024.

Modification of the 737 units in inventory is proceeding even more slowly. Boeing has said that it anticipates that most of the inventory will be delivered by the end of 2023. On May 30, 737s were delivered but only 3 units were from inventory. Boeing’s inventory of the 737 totals 320 units. Modification needs to be drastically speeded up. David Calhoun, the CEO, said Boeing is becoming more experienced in modifying inventory units so that it is easier to forecast the resources and time needed to make these modifications.

Boeing is developing the Max 7 and 10 series. These programs must be certified by year-end or Boeing will have to request a variance in the law to allow the plane to enter service. The Max 10 is critical to compete with the Airbus A320XL and the longer-range A320XLR. Max 10 matches the A321XLR in passenger capacity but not range. It is competitive on shorter routes. The Max 10 is the highest priority project at Boeing. The FAA’s much more rigorous certification program has created a shortage of engineers. Boeing is planning to meet the year-end certification, but if it fails, it expects to be able to get a variance on this law. If it doesn’t, it is shut out of an important segment.

Narrow-bodied aircraft make up the bulk of the shipments. In the first quarter, Boeing delivered 95 aircraft. The 737 comprised all but nine of these aircraft. The other nine were large wide-body designs. The 737Max came out later than the competing Airbus A320 neo. It has always been considered an interim aircraft until Boeing can develop an innovative design. Yet, despite that, the 737 is holding its own in the market. In 2015 the 737 had 41% market share. In 2021 its market share rose to 44%. The Max 8 sells more units than the comparably sized A320neo.

787

Boeing is hoping that 787 deliveries will resume in the third quarter after the submission of their plan to produce 787s and inspect and modify existing 787 in airline use during normal maintenance. Work on the 787 will include approximately $2 billion of abnormal production costs. The 787 previous write-offs of $3.5 billion in the fourth quarter of 2021 along with the extra $2 billion of abnormal costs put the 787 program into a loss. However, that is misleading. The 787 cost about $ 32 billion to develop and that cost was slowly working down under the Boeing program cost system.

As deliveries resume, the program will turn back to profitability. Boeing has 1500 787s in service. Currently, the inventory is 120 units with an order backlog of almost 500 units. Boeing has consolidated production in one plant in South Carolina. They plan to increase production to about 5 a month from the current level. It is likely that later in the decade, 787 productions should be further increased and the profit margin increase as the abnormal production costs are worked in 2023.

Delivery of a unit from inventory will increase cash flow by roughly $175 million per unit, so the resumption of the 787 deliveries will eliminate negative cash flow.

777X

The 777X was planned for shipment in 2000. Engine delays slid that date to 2001 and additional testing moved the plane schedule. The plane has flown 2000 hours, but the FAA has not allowed at to enter certification. There is a shortage of engineers because of the demand for enhanced certification. Boeing does not have the engineering staff it needs so delivery has now slipped to 2025. 777X also has been required to meet European safety standards that were not included in the original plan. In place of the high 777 productions, Boeing is now producing only three 777 freighters per month. It plans to introduce the 777 8 freighters in 2027.

767

As part of the Air Force tanker program, Boeing developed an improved 767 freighter. Tanker and the freighter have a backlog of one hundred units. This will produce a profit from this program which has generated so many write-offs. The 767 planes, like the last of the 747’s, are purely freighters.

Commercial aircraft delivery projection.

Boeing has not provided a projection of 2022 profits or deliveries. However, Brian West, the CFO, said that full-year cash flow would be positive. First-quarter will be the cash flow and profit trough, with cash flow improvements in the following quarters.

The chart below starts with the actual shipments in the first quarter of 95 units. In the second quarter, I assumed 737 productions would hit Boeing’s target of 31 newly built units per month and add 10 refurbished units. I increased the number of refurbished units by 10 in each of the following quarters. The biggest assumption is the restart of 787 deliveries in the third quarter. The results are shipments of about 500 to 550 units for the year. A refurbished unit generates cash from reducing inventory as well as profits so there will be a strong positive cash flow from the forecast like this.

Boeing Projected 2022 Deliveries

Products Q1 Q2 Q3 Q4 Full Year

737 85 103 113 123 425

787 0 0 20 20 40

767 5 5 5 5 20

777 3 6 9 9 27

747 1 2 2 1 6

TOTAL 95 116 149 158 518

Table by Author

Defense and Global Supply

Consistent with Brian West’s forecast that the first quarter would be the troth followed by quarters of increasing profitability, Boeing charged off $1.3 billion from the defense in the first quarter resulting in a $900 billion dollar defense loss on $5.5 billion of sales. It is likely that the second quarter will have sales of approximately 5 to 6 billion dollars with an operating margin of approximately 6%. Global Services should be similar to the first quarter results of $ 4.3 billion and $ 600 million of earnings from operations.

Risks and Opportunities

Risks

The Max 7 and 10 need to be certified by year-end or they will need a waiver to allow their later development. I believe that if they are not completed by year-end there will be a waiver, and this will not be a serious problem. But, if they don’t, it really locks them out of a market that is growing.

The refurbishment cost to update the 737 and the 787 are hard to estimate. These costs could be much higher than estimated in the financial plan.

Opportunity

Sales of the wide-body versions could continue to grow at unusually fast rates.

Airbus Evaluation

Airbus is a well-managed company. It did not have the cash flow generation to match Boeing. Its problem has been the lack of wide-bodied airliners which provided so much cash flow to Boeing. Like Boeing, it was hard hit by the pandemic. Its supply chain was also hurt. Airbus recovered faster than Boeing. It had drastically fewer regulatory problems, so it was able to increase production rapidly. Its strength was in the Narrow Body segment, where it has had an advantage since before the pandemic with its latest version of the A320, the A320neo (New Engine Option).

Airbus has now achieved a 45 per month production rate on the A32neo. Airbus has the advantage of producing 14 A320 units more than Boeing 737 production. It will move to 65 units per month in mid-2023. It expects to move to 75 units per month by mid-2025.

In addition, Airbus acquired what it calls the A220, a smaller jet airliner, and it is increasing production. The 220 does not have a direct competitor in the Boeing line. The closest plane would be the new Max 7 Series, which has the same fuselage width as the rest of the 737 lines. When the A220 reaches its planned six planes a month, it will be producing a total of 51 narrow bodies compared to the last 31 Boeing 737s. Airbus plans to continue increasing the A220 production. Boeing will see deliveries from its inventory of 320 737s.

Narrow-body aircraft are becoming increasingly popular in the post-pandemic world. Airbus has also introduced the A 321XL which is a larger plane that uses the same body as the A320. In addition, they have introduced plane A 321XLR which is a longer-range version of the A 321XL. Boeing does not have a direct competitor through the A321 XLR. They have a version the Max 10 which can carry the same passengers that do not have the range. The first flight of the A 321XLR it is scheduled for year-end.

It has two wide-body lines. The first is the A 330, which is similar to the Boeing 767. With a wider cabin, it was considered a better passenger plane than the 767. The Boeing 787 is designed to knock out the A330. Airbus upgraded the A330, and it remains in the market as a passenger and freighter aircraft. To counter the 787, Airbus came up with what they called the ultra-wide body A350. The A350 has two versions, the larger of which competes in the same size category as the 777 markets. Boeing redesigned a new 777X with a composite wing and new more efficient engines.

After the pandemic and the Max crashes, Airbus resumed manufacturing the A320 neo, as Boeing was trying to restart production of the 737 Max. This was very similar to the situation that existed when Airbus introduced a 320 neo about a year and a half before the first Max came out.

Airbus strategy

Airbus’ rapid increase in production achieved a high stock valuation. What makes Boeing attractive is the huge inventory that Boeing hopes to turn into deliveries which would result in higher profitability. Airbus needs to have more production to counter that commercial aircraft. Its production rate has been slower than the market expected causing the stock’s performance to drop. Boeing’s stock has been outperforming Airbus for the last month.

Airbus Delivery Forecast

Airbus has committed to delivering 720 aircraft this year. Looking at the first five months’ shipments, it is hard to see how they will achieve their goal. The A220 Is increasing its production to five a month and will increase further but there should be a spot where production stabilizes before growing again. The A 320 add 321 are being produced at 45 for the entire quarter in the third quarter. Wide body shipments are hard to increase. This scenario produces a delivery total that is 76 units below Airbus’s projected 2022 deliveries.

Airbus Projected 2022 deliveries

Products Q1 Q2 Q3 Q4 Full Year

A220 11 12 15 15 53

A320 109 125 135 135 504

A330 6 6 6 6 24

A350 16 11 18 18 63

Total 142 154 174 174 644

Table by Author

Airbus Technical Issues

Airbus stock declined 3% on June 22 the day when Reuters published an article on the lawsuit about surface problems on the A350. The picture below shows the damage to a Qatar airliner. This grounded aircraft with large patches of peeling paint has exposed copper wiring and composite wing components.

Qatar grounded the A350s, saying that they represent a potential safety risk and refused to take other A350s on order. Airbus calls this a minor cosmetic problem. They are adamant that it does not propose any safety risk. They claim that the paint is caused by anti-lightning chemicals in the paint and that it is a trade-off in using composite materials. Qatar points out that the 787 composite aircraft does not have the same problem and it does have lightning protection. Airbus does not want anything to interfere with a highly expensive A350 program. They offer no fix to this problem. Nor do they have a solid explanation for a problem it has, and the Boeing 787 does not.

The Boeing 787 shim issue that grounded the plane is about the thickness of a sheet of paper. Yet the FAA demanded action that caused Boeing to spend $5.5 billion. The European Air Safety Agency (EASA) proclaimed A 350 as safe, and other airlines are flying it.

The FAA and the transportation department are embarrassed by the poor performance of the 737 Max. They believe it is politically advantageous to inspect Boeing zealously and that’s what they’re going to do. The EASA has always believed it needs to promote the welfare Airbus and other European aircraft companies that won’t change either. At the end of the day, the A 350 must be fixed. While it’s expedient to ignore the problems, it will cost Airbus in sales and additional price concessions. If the surface defect were cheap to fix, Airbus would have fixed it. The defect is probably structural and the cost to fix is likely to be considerable.

Boeing and Airbus Financial Comparison

Airbus had a strong performance in the first quarter. However, the growth between the first quarter and the second quarter projection was relatively modest. It was a good solid quarter, but the market was expecting much higher performance and it’s an indication that they will not make the year’s projection.

Boeing’s performance in the first quarter was terrible partly by design. The business wrote down $1.3 billion in the defense area. Without that write-down and with modest additional business mostly on the 737 the company did much better. In the third quarter when they restart of 787 deliveries, that business should take off.

Q 1 Results Q2 Projection

Billion of Dollars

Airbus growth Boeing growth Airbus Boeing

Revenue 12.5 15% 14.0 -6% 13.00 16.00

Net Income 1.3 2% (1.5) N/A 1.5 .50

Table By Author

Conclusions

Boeing stock should surge with an improvement in the second quarter largely due to the expectation of growth from the 787 restarting of deliveries. It is very difficult to project how high the stock will surge because the stock will be driven by expectations of future earnings. However, it is reasonable to expect a surge with the announcement of the resumption of the 787, which could be as much as 20% of the stock price from $140 to $170. At one time, the stock reached $400 a share. With the expectations of the 777X, it is not impossible that many elevated earnings will drive the stock price higher into the mid-decade

Airbus does not have a radical change. Its business will struggle with lower than projected deliveries along with problems on A350. Thus, Airbus should decline in the second and third quarters probably about 10% from $99 to $89.

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