Taking Stock Of Boeing

Given the woes and turbulence being felt the globe over due to rising oil prices, the effect still reverberating throughout the aerospace and airline sectors means that aside from a huge cloud of uncertainty, the direction and underlying fundamentals supporting both sectors is headed for yet another cyclical change.

“I think oil is going to have to go a bit over $150 a barrel before it forces a world-wide recession, which is when you would expect to see business travel start to taper off,” says Airbus’ John Leahy.

Already, the likes of JetBlue Airways and AirTran Airways have deferred delieveries of their A320 and 737 orders respectively, as major US airlines enact a groundswell of system wide capacity cutbacks. Likewise, Boeing Commercial Airplanes President & CEO Scott Carson noted that some carriers had arranged for deliveries to be rearranged.

Images courtesy of Boeing

Given the rapid intake of narrowbody orders since 2005, deferrals provide a small window of opportunity for other carriers to take earlier deliveries.

A report from Goldman Sachs outlining additional concerns facing the industry and in particular,  Boeing, pushed the stock down to its lowest level in two years.

Two points raising concerns about Boeing are at odds with the general market consensus.

• Expecting weaker macroeconomic environment and record fuel prices to hurt airlines - translating to a slowing in the order book
• Belief that there is more risk to the 787 program than is currently priced in as the airplane has yet to enter flight test phase, “where historically most issues on development aircraft are found”

With respect to the first point, the marketplace has for the better part of two years already considered a slowdown in orders for Airbus and Boeing, not least because the period 2005-7 has seen record orders for both manufacturers. Equally, pricing pressures from rising oil costs is already dampening demand in the United States, where airlines are cutting back system capacity and introducing a plethora of “ad-hoc” charges to generate revenue.

Further, as airlines across the globe seek to streamline operations and lower costs in the face of high fuel costs, the potential catalyst for intra-nation airline mergers negates the need to operate older airplanes while at the same time dropping routes deemed unprofitable. For those airlines that have managed to phase out older jets while taking delivery of newer, more fuel efficient ones means that these are less likely to be involved in consolidation or mid-term acquisitions of any further airplanes until demand rises against a backdrop of lower fuel and ticket prices.

The second point is perhaps more controversial and contestable.

In the full glare of the media spotlight, the 787 is not the only airplane Boeing makes. While we agree that composites have been in use for over half a century, the 787 may have broken the “conventional norms ” by using composites as its primary structure, one can surmise that the flight test program will invariably bring up some “unknown unknowns“, to coin a phrase from former US Defense Secretary Donald Rumsfeld.

Critically, the delays to the 787 program has allowed Boeing to refine, define and thoroughly test the airplanes systems in as many varied laboratory experiments as possible under a vast array of conditions and flight simulation rules. Any risk to the 787 pertains largely to the validation of the projected performance during the course of flight testing. The basis of the 787 is to reduce cost for operators - missing performance targets makes it that much more difficult to rectify on future derivative models.

Empirical data illustrates that while dynamics during flight tests can alter, there has not been any instance in development of any major commercial airliner seating 100 or more passengers  where the flight tests have unearthed a litany of unexpected behaviours that later go on to hinder certification and service entry. Rather, the true fact is that simulations, whether by use of wind tunnel modelling or on computer systems pick up prediction areas of concern before an airplane even takes to the skies.

As to whether the market has priced that into consideration can be argued either way. Target prices provide a variety of indications about the company, not just about the value it presents to shareholders or the value in the sector. In contrast to EADS, we’ve already seen Joe Campbell at Lehman Brothers state the company is a liability, valued at “less than zero”. It is unfair to label Boeing stock as overpriced, particularly when the quality of its order book is at much less risk of cancellation in comparison to Airbus. Further, Boeing does not have any airplane program hinged on one or two big orders. One only look at Emirates holding a colossal 58 A380’s on firm order out of just 200 for the entire A380 order book. Emirates features again with Qatar Airways in being the only two clients for the ailing A350-1000, an order which Airbus is clinging on to.

In short, we disagree with the view presented by Goldman Sachs. It appears to have done nothing more than stir up volatility so stock can be bought cheaply. Lest we forget, Goldman Sachs not long ago held out a target price of nearly $90 a share. There has been no tectonic shift to warrant a cut of a third of that stock price. It just doesn’t add up or make sense.

Boeing is not a one-product company, nor is its success solely reliant on the outcome of the 787 Dreamliner. By all means, it is a barometer of the company’s strategic direction, but while legacy airplanes like the 737NG, 747 and 777 continue to evolve, expand and generate profits with each and every order received and airplane delivered, it is unfair to assess the wider organisation based on what essentially amounts to a media feeding frenzy on the 787.

11 comments June 26th, 2008