EADS held an investors Day this week; here are takes from two who attended.
Airbus presentations may be found here.
EADS is holding its annual Global Investor Forum. We describe key themes from Day 1, which focused on EADS overall and Airbus. A key message we took away was that EADS is headed toward governance changes that should make it a more normal company.
We now expect reduced government involvement with independent directors becoming the majority on the board. The free float is planned to rise from 49% to 70%. Although the sale of shares may depress the stock in the near term, long term it is positive.
Margin upside remains the key value driver for EADS, with higher margins likely on A320 and A330 from cost reduction and pricing. A380 performance appears to be improving. We see the main risk as the A350 production ramp in H2 2013.
Summary. We attended the EADS Global Investor Forum in the UK. Given that Airbus is the primary competitor to Boeing in manufacturing large commercial aircraft, its outlook is important to the suppliers in our coverage universe. Overall, we believe the key highlights of the forum on day 1 were 1) demand for airplanes remains strong as Airbus now says 2014 is overbooked for A320 2) the A350 and A320neo developments remain on track 3) Airbus has about 300 A320 current engine option airplane slots to sell in 2016-2017 that could see some pricing pressure and 4) Airbus is intently focused on reducing its costs which could lead to some pricing pressure for suppliers. In particular, Airbus highlighted Spirit Aerosystems as a supplier that has been challenged on the A350. For the suppliers in our coverage universe, we believe the positive commentary on a stronger 2014 and the order backlog should give investors increased confidence in Boeing and Airbus production ramp ups despite recent economic weakness. In addition, while Airbus has focused on reducing costs, we believe pricing pressure has been continuous for the suppliers in our coverage universe and do not expect substantial changes in the profitability of work for Airbus. We continue to be positive on the commercial aerospace suppliers based on the OEM upturn.
A350XWB. Airbus confirmed its schedule on the aircraft with first flight in mid-2013 and entry into service in H2 2014. We do not know how many aircraft Airbus plans to deliver in 2014, but the company did say that one of its two launch customers, Singapore Airlines, has shifted its planned aircraft deliveries into 2015 leaving only Cathay Pacific to receive the aircraft in 2014.
A320neo. Airbus continues to highlight its re-engined narrow body A320neo as superior to Boeing’s 737MAX. The company believes that its larger fan size allows total cash operating costs to be 3.3% better than the 737MAX. Boeing of course calculates different economics and can show its offering is superior to the A320neo. Airbus said it has about 300 open delivery slots for the current generation A320 aircraft before production transitions to the A320neo in 2017. Not surprisingly, most of these appear to be at the end of A320ceo production in 2016-2017. The company said that its 2013 and 2014 delivery slots are now fully booked (and 2015 is nearly so), an improvement from the company’s Q3 earnings conference call when there were still 2014 delivery slots available.
Backlog Growth in 2013. Airbus has about 7.5 years worth of production at planned rates (similar to Boeing’s production in backlog). Management thinks this long backlog has reduced the cyclicality of the airplane manufacturing business since 2004. On the other hand, Boeing has said it desires to reduce its backlog such that it can deliver airplanes on a more timely basis to customers.
Focus On Cost Reduction Could Mean Pricing Pressures For Suppliers. Airbus is targeting a 10% EBIT margin by 2015 (excluding A350 losses and the impact of a weaker Euro) and is aggressively looking to take out costs. As part of its cost reduction efforts, Airbus will have reorganized its plant management process beginning in January 2013. The new structure empowers plant managers with increased authority to manage production problems. At the same time, Airbus has implemented a single procurement organization to more effectively and efficiently manage the costs of the supply chain.
The initial analyst take is below. Note the pension comments in JP Morgan; this helps explain why Boeing wants to shift new hires to a 401(k) program from a Defined Pension Plan.
Boeing reported a very strong Q3, particularly related to its outlook for the year. For the year, the company has raised guidance for defense revenues, defense margins, and operating cash flow. We see cash generation as a particularly important area of focus for Boeing. Although Boeing Commercial Airplanes guidance was unchanged, we will be looking for more insight on progress on the 787 during the earnings call – we see the 787 as central to the long term performance story. High margins in defense are consistent with our view of strong margins across the defense sector as companies (including Boeing) focus on cost reduction.
Boeing reported Q3:2012 EPS of $1.35, above consensus of $1.13 and our expectations of $1.03. Boeing attributed the EPS beat to “strong core operating performance”. Boeing raised 2012 EPS guidance by $0.35-$0.40; to $4.80-4.95, up from $4.40-$4.60. The size of the EPS guidance increase is encouraging because it suggests even better performance in Q4.
Sales for the quarter were $20.0bn, in line with consensus of $20.0bn and our expectations of $20.1bn. Boeing raised sales guidance for the year up $500M-$1bn, to $80.5-$82bn from $79.5-$81.5bn on expectations of higher Boeing defense sales.
Boeing reported 3Q12 EPS ahead of its consensus, raised its 2012 EPS guidance to a range above consensus, and generated strong orders and cash flow in the quarter.
3Q12 reported EPS of $1.35 compares to consensus of $1.12 and GS at $1.15. The tax rate was 550 bps below our estimate, which added roughly $0.10. Boeing’s reported segment operating profit is 8% above our estimate which was above consensus.
Total revenue of $20.0bn was 1% below our $20.2bn estimate, as Boeing Commercial grew 28% and Boeing Defense declined 4%. But total EBIT margin of 7.8% was 70 bps ahead, with Commercial 20 bps better and Defense 150 bps better.
Free cash flow in the quarter was $1.18bn, implying FCF/NI of 1.14X. It is up from $564mn qop and $104mn yoy.
Total company backlog increased sequentially to $377.6bn from $373.8bn. BCA book-to-bill was 1.41X, while BDS was 0.76X.
Boeing raised its full-year 2012 EPS guidance to $4.80-4.95 (ahead of consensus of $4.72) from $4.40-4.60. Even when adding the $0.10 tax benefit in the quarter to consensus, the mid-point of the new range is still above the Street’s prior expectations. Boeing raised its revenue guidance to $80.5-82.0bn from $79.5-81.5bn. It reiterated its BCA margin guidance, but raised its BDS margin guidance by 25 bps. Operating cash flow guidance was raised to >$5.5bn from >$5.0bn. The 2012 787 + 747-8 unit forecast of 70-85 was reiterated.
Boeing put up a solid quarter with a big headline beat and higher guidance, but the pension expense outlook is even worse than we had expected. Defense margin drove the operational beat and a lower than expected tax rate contributed as well. Boeing delivered the preliminary 2012 pension guidance we had expected, and it is a whopper. Pension expense is expected to be up by $1 bn, about half of which is driven by previously inventoried expense. We had anticipated that the inventoried pension could provide incremental headwind, but not by nearly this much. The difference between this and our current 2013 estimate could be worth another 55 cents of EPS. We anticipate that management will offset some of this with some combination of share buybacks and pension contributions, but we believe that full capital deployment plans will not be discussed until at least December; so, GAAP EPS estimates for 2013 are likely to drop in the coming days.
EPS of $1.35 exceeded our estimate by 24 cents and consensus by 23 cents Relative to our estimate, EBIT accounted for 14 cents of upside, with defense margins comprising nearly all of it. Tax contributed another 9 cents. Management raised 2012 EPS guidance from $4.40-4.60 to $4.80-4.95
BCA EBIT of $1,153 mn was 4% ahead of our estimate on margin strength. We estimate the core operating margin (ex R&D and the low margin 787 and 747-8 programs) was 17.3%, in line with our 17.2% estimate. We had had some concern that a 737 block extension during the quarter could provide some pressure, but this did not materialize. R&D was also modestly lower than expected, contributing to the overall 30 bps margin beat. BCA margin guidance remained ~9.0% despite the 9.9% YTD level. Q4 period costs could provide some headwind, but we believe there is plenty of conservatism in this guidance.
Q3 at $1.35 included $0.10 from lower tax rate: Q3 EPS at $1.35 including $0.10 benefit from lower 29% tax rate. Upside relative to our model came from BDSS (Defense) as BCAG (Commercial Airplanes) came through overall in line with our expectations. BCA margins at 9.5% with pre R&D at 13.8% diluted by higher 747-8/787 deliveries. We estimate pre R&D margins ex 747-8/787 at 17%, in line with Q2. BDSS revenues down 4% vs our -8% while 10.5% margins were 100bps better than our model. FCF at $1.2B or 113% of net income dragged down on $1.8B inventory build and $750M pension contribution.
787 cash costs improved by ~$15M per unit: 787 deferred production grew by $1.1B, slightly below prior quarter on similar production. While we need further details for precise calculation, we estimate deferred production per unit improved by $15M relative to Q2. BCAG reported a $1B unit accounting loss reflective of 747-8 and 787 losses, much higher than $144M in Q2 on seven additional 747-8 and 787 deliveries.
A350 Launch Aid: The US Trade Rep says it has the documents outlining $4.5bn in launch aid for the Airbus A350, according to a Reuters story. Predictably, Boeing and the USTR have gone in to overdrive. The A350 was excluded by the WTO from the long-running trade dispute because it wasn’t included in the original complaint filed in 2004–which is kind of obvious since the program didn’t surface until 2006. But Airbus contends that launch aid wasn’t ruled illegal in the WTO findings, just how it was implemented. Airbus contends that any launch aid for the A350 is structured in compliance with the WTO rulings of the 2004 case. The US contends launch aid itself is illegal. Whether it is or it isn’t, we don’t like launch aid or any other form of corporate welfare (see Boeing 787) and we don’t think a solvent company like Airbus (or Boeing) should be getting any.
Bombardier strike at Lear Jet unit: Machinists voted to strike at Bombardier’s Lear Jet unit. BBD hardly needs this. With cash flow demands peaking as the CSeries development enters the final stretch, and with demand for regional airliners off, this is an unneeded headache.
Embraer Demand: Wall Street analysts were pretty unhappy following the Embraer investors day last week. EMB gave no signs of willingness to cut production next year. There are 100 slots and only about 75 orders, with few in sight. Backlog is shrinking. EMB is hoping to land big orders from either Delta Air Lines or American Airlines for the E-Jet, but we’re not aware of any Delta campaign (and in any event, the airline favored the CSeries in the aborted campaign of a year ago). American is in such disarray there is no telling when, or if, it will pursue an order.
EADS-BAE: Bernstein Research doesn’t think this merger should happen. The excerpt from a note issued today:
We believe that it would be best for both companies if this proposed merger does not happen. But, we see the merger as worse for EADS than for BAE. Both companies describe scale as an advantage (e.g. better leverage of R&D), but we have never seen scale in itself as an advantage. Specific issues are:
- Shareholder interests. EADS shareholders typically own the stock as a play on commercial aircraft OE growth through Airbus. Increasing the scale of defense assets, with some in particularly challenging markets, is likely to take some investors out of the stock. We find BAE Systems shareholders as generally focusing on the high dividend. The combination with EADS, which does not pay a high dividend, places the current BAE Systems dividend level at risk in 2014. The disclosure of merger discussions also raises questions about the sustainability of cash flow and the divided, as we have found investors questioning why BAE would accept the EADS offer if its cash outlook were robust. BAE Systems CEO Ian King has countered this by stating (with EADS CEO Tom Enders) that this deal is “borne out of opportunity, not necessity”.
- Synergy potential. We view the potential synergies between EADS and BAE Systems as low given very little overlap between their businesses and restrictions in technology transfer from US programs. From an EADS standpoint, we expect that this combination would result in a stronger international marketing organization, provide some limited cost savings in indirect personnel and sourcing, and provide some improvement for the defense electronics portion of EADS’ Cassidian business (only about 2 billion euros in revenue). But, given the limitations in capturing these synergies and their relatively small size, we do not see them as justifying a merger of this scale. For EADS, this is particularly true, since it would pay a premium for BAE shares and be buying into some particularly difficult market exposure (e.g. US Army equipment, defense IT/services). In addition, we see disruption as inevitable in a deal of this size, as it could lead to a loss of some key personnel, changes in government relationships, and problematic integration steps (e.g. IT Systems), even though the overlap is relatively small.
A day after it became public Qantas Airways canceled 35 Boeing 787-9s, it might be worthwhile giving a thought or two.
The Wall Street Journal has a good story (unfortunately, paid-subscription, though it may show up via Google News) looking at the impact. We also received some media calls on the topic.
We’re not nearly as gloomy as the general reaction. In fact, we sort of shrug about it. The cancellation is because of Qantas’ own problems, not because of anything with the 787 program. QF’s issues have been a long-time coming, in much the same way as US legacy carriers.
QF’s cancellation gives Boeing two choices with these slots: resell them to an important, strategic customer or “close up” the production line and reduce some delays to other customers. Either is an acceptable alternative.
Had these been 737 or 777 cancellations, nobody would have blinked an eye. But because it is the troubled 787 program, a lot of hand-wringing goes on. We think it’s overdone.
Doug Harned at Bernstein had this to say in a note issued today:
Questions about the strength of the 787. The Qantas cancellation should not be taken as any indication that 787 demand is weaker. At planned production rates, it appears that there are few slots available for 787 deliveries until 2019, which makes these earlier slots very valuable. We understand that Boeing has been looking at approaches to raise production rates for the 787, given the strength of demand – not something Boeing would be doing if it saw the production ramp as at risk. Because we believe that Boeing originally priced its 787s too low, we expect that the Qantas slots will be taken by other airlines, potentially at higher prices. There have been comments in the press (e.g. WSJ) that this cancellation is a blow to the 787-9 (as distinct from the 787-8). We do not believe that is the case, as we have found customers more interested in the 787-9 than the 787-8, although its availability comes later in time.
SPEEA and Boeing: charges and counter-claims
Here’s the next round in the continuing debate.
Bernstein Research published this chart detailing how Airbus and Boeing differ on the performance improvements they predict.
There is, of course, no way to know who is correct until the airplanes enter service.
We hear the A320 sharklets are performing better than advertised (Aviation Week actually reported this a while back as well). If the figure we’re hearing proves correct, the neo and MAX should have parity.