The aircraft industry is experiencing a massive boom right now with demand in the Asia-Pacific region spiking and interest rates still fairly low. In this week's episode of Industry Focus: Energy, host Sarah Priestley and Motley Fool contributor Adam Levine-Weinberg dig into the situations of two of the sector's biggest players -- Airbus (NASDAQOTH: EADSY) and Boeing (NYSE: BA).
They discuss the differences between their models, and what these differences mean for each company's bottom line; some of the most important risks that investors need to know about in this industry; how Airbus and Boeing performed last year; which looks like the better investment for the next few years to come; and more.
A full transcript follows the video.
10 stocks we like better than Wal-Mart
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, the Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the ten best stocks for investors to buy right now... and Wal-Mart wasn't one of them! That's right -- they think these 10 stocks are even better buys.
Click here to learn about these picks!
*Stock Advisor returns as of February 5, 2018
The author(s) may have a position in any stocks mentioned.
This video was recorded on Feb. 8, 2018.
Sarah Priestley: Welcome to Industry Focus, the show that dives into a different sector of the stock market every day. Today, we're talking energy and industrials. It's Thursday, Feb. 8, and today we're going to be talking about plane makers -- specifically Airbus and Boeing. I'm your host, Sarah Priestley and joining me on Skype all the way from sunny California is senior Motley Fool contributor Adam Levine-Weinberg. Adam, thank you for joining me. How are you doing?
Adam Levine-Weinberg: Very good! Thanks for having me on the show!
Priestley: No, your expertise is needed in this industry. Today, we're going to be talking about the big two plane makers, Boeing and Airbus. Together, these two make up the majority of the $140 billion industry, which is just huge. The market is pretty fascinating right now thanks to a few factors: growing demand from the Asia-Pacific region, low interest rates. As such, it's enjoying really high demand, and this is creating all kinds of pressure on the manufacturers and their supply chains. So, by the end of the decade, Airbus and Boeing have to build 30 more planes annually to meet existing orders. And this is the industry's steepest production increase since World War II, which is incredible. How did they hold up in 2017, Adam?
Levine-Weinberg: Last year, we did see another record year of output for both companies. During 2017, Boeing surpassed Airbus in terms of deliveries, and that was the sixth straight year that Boeing won in the delivery race. But both companies, as I said, did beat records. And it looks like 2018 is setting up to be another year of record output for both companies. Also, looking ahead, the orders for the year were very strong, but still below the peak levels that we saw back in 2012 and 2014, when you had really, really high fuel prices forcing airlines to put in big orders for next-generation, more fuel-efficient planes.
Let's talk about Boeing first. Boeing delivered 763 commercial jets last year. That was up from 748 in 2016. That's about a 2% increase. The 737 family drove more than two-thirds of the volume last year with 529 deliveries. And that's been a key theme recently. The 737 and the competing Airbus A320 family are very versatile jets; they're ideal for routes that are less than about 3,000 miles, and they're very cheap to operate. They're much cheaper to acquire than larger jets that can fly farther. So that's where you're seeing a lot of these budget carriers expanding, this is really their niche. So, this part of the market has seen by far the most growth. Another factor that's enabling that is, as you're getting new planes with new technology, both the 737 and the A320 have new generations that the two manufacturers are switching to. That gives them even more range so that they can expand to destinations that weren't previously possible.
Looking at the rest of Boeing's operation, the company delivered 14 of its 747 jumbo jets, 10 767s, which is an older model of twin-aisle airplane, and then 74 777s and 136 787 Dreamliners. So, the 737 family, as I mentioned, was by far the biggest volume driver. It also accounted for more than 100% of Boeing's growth last year. For the 777, which has historically been one of Boeing's most profitable airplanes -- it can fly up to 8,000 miles holding about 300 passengers -- it saw a 25% volume decline last year. There's been a bit of a slowdown in the market for these larger aircraft. And on top of that, Boeing is coming out with a new version of the 777. That's definitely caused some airlines to pause and wait to decide whether they want the older model or wait for the newer, more fuel-efficient version.
Priestley: So, we could start to see some pent-up demand being exhibited in 2018 and 2019 for these?
Levine-Weinberg: Yeah, Boeing expects there to be a big uptick in orders and deliveries for the larger planes starting around 2020, both because of the new technology that's coming online, and also just based on the timing of when airlines are going to need to replace some of their older aircraft.
Priestley: Absolutely. And as you mentioned, a lot of the 737 demand is being driven by low-cost carriers. We're seeing that transforming the industry. People's want for cheaper flights. More affordable travel is really a boon, and it's creating so much demand.
Levine-Weinberg: Yeah. The combination of the rise of the middle class in a lot of these emerging markets, and then, the rise of these low-cost carriers that can offer tickets far cheaper than what was previously available has created a boom where you're seeing economies growing 5-7% and air travel growing twice that fast. So, it's really creating quite a bit of new demand for aircraft.
Turning to Airbus, they also hit a company record in terms of deliveries with that 718 commercial jets delivered in 2017. That was up from 688 a year earlier. Airbus is still trailing Boeing by about 6%. However, Airbus did gain some ground last year. And that's partially because Airbus actually has a larger backlog of aircraft on order than Boeing. It's using that backlog to support production increases. For Airbus, the tilt between its narrow bodies, the A320 family, and then its larger wide body planes was even greater disparity than at Boeing. You had 78% of deliveries being the A320 family. That totaled 558. Then, Airbus also delivered 67 A330s. That's its older model of wide-body jet. 78 A350s. And then, like the Boeing 747, Airbus' jumbo jet model, which is the A380, is doing quite poorly. There were only 15 deliveries on that during 2017, which was down substantially from the prior year.
Priestley: Which is strange, because when they first released this aircraft, there was so much hype around it. I know it was heralded as the next great aircraft, but it just hasn't delivered.
Levine-Weinberg: It actually just sort of happened that at the same time, Boeing and Airbus laid out different visions for how air travel would change. Airbus went with this massive plane that would be able to put more and more passengers through the biggest hubs, and Boeing said, "No, what people really want to do is be able to fly nonstop." So, Boeing created the 787, which is a much smaller plane that's more fuel efficient. For example, I think Qantas has said that they can fly two 787s between Australia and the U.K. for less than the cost of flying one A380. So, they can offer two different departure time options. Or, you can offer more nonstop routes than you could previously. That's really been siphoning some of the demand away from the A380, because when people have the option of now flying nonstop, they don't have to go through the big hub, so that means you don't need to put the larger airplane in there. So the real problem for the A380 right now is that there aren't that many airports that desperately need that amount of size. London's Heathrow Airport is one of the few exceptions, where it's really that crowded, and you need the bigger airplane. Dubai has some of the same constraints. But most airports just aren't quite that crowded yet. So, you're seeing a lot more demand for the smaller planes.
Priestley: We talked a lot about delivery figures here, because investors are tending to focus much more closely on these delivery figures and cash flow, almost more than order figures, in the current climate where they both have these huge backlogs. But, how were orders in 2017?
Levine-Weinberg: Coming into 2017, both Boeing and Airbus had very muted expectations. They told investors that they should expect to see lower orders than the previous year, probably not as many orders as deliveries. But, in fact, it was a very good year for orders. A lot of that demand materialized toward the very end of the year. So, Airbus recorded 1,109 net orders in 2017, which was its best result since 2014. Of that, the vast, vast majority were for that A320 single-aisle family. That was 1,054, compared to only 55 orders across all of its different wide-body models. Meanwhile, Boeing brought in 912 net orders, which was also its best result since 2014. And again, the 737 family was the big driver of those orders with 745 orders. But, Boeing did do significantly better than Airbus in terms of bringing in orders for its larger wide-body planes. It had 167 net orders spread across those four models, but more than half of those were for the 787 Dreamliner, which really has been the biggest growth driver for Boeing on that wide-body side.
Looking at a high level, this was the fifth consecutive year that Airbus outpaced Boeing in terms of net orders. During this whole time, Boeing has been producing more airplanes than Airbus. The result is that Airbus has been building up a backlog much faster than Boeing because of the combination of higher orders and lower production. So, Airbus ended 2017 with 7,265 aircraft in its backlog, compared to 5,864 for Boeing. Combined, this is eight or nine years of production at current rates. Even with some of the production increases that are planned, it's going to take five or six years at least to build most of these planes.
Priestley: To finish the year, then, Boeing wins in terms of delivery, Airbus wins in terms of orders. But, that delivery advantage probably shouldn't be overlooked. This year, we had Qatar Airways cancel orders for four Airbus planes that were months overdue at this point. That on-time delivery that Boeing has demonstrated, albeit very marginally, actually attracted those buyers to them with four orders for new 737 models. So, it just shows you that everything's to play for in this industry, and any advantage that they can offer in terms of reliability will win.
Priestley: Adam, out of the two of these plane makers, which do you feel has the advantage this year?
Levine-Weinberg: When you look at the two companies, obviously, we talked about how Boeing delivered somewhat more planes than Airbus, but Airbus is catching up, or at least, was catching up last year. And on the other side, you had more orders coming in for Airbus, and Airbus also has the larger backlog. The one thing that makes Boeing's relative performance look far better is its profitability and cash flow. Up until now, Airbus hasn't shown the ability to turn its high volume of aircraft production into big earnings numbers and big cash flow numbers. If you look at last year, Boeing posted a core operating profit of $9 billion, and free cash flow of $11.6 billion, both of which were well above its initial guidance and far above the prior-year figures. Airbus hasn't reported its full-year results yet for 2017, but as of its most recent guidance, it's expecting its operating profit which should come in around $5 billion and adjusted free cash flow of less than $2 billion. So, quite a bit behind Boeing in terms of profitability. In terms of the cash production, they're on completely different planets. That's really quite astounding. It's probably a combination of more efficient factories and supply chain for Boeing, and to some extent, stronger pricing insofar as Airbus may be offering bigger discounts to customers in order to build up this backlog, in this attempt to gain long-term market share from Boeing.
Priestley: Absolutely. Boeing has been making some fantastic moves. They've been cutting its workforce at their commercial aircraft unit, so they've actually lowered the number of employees that it takes to build one aircraft. They boosted production two-thirds over the past seven years while doing that. And like you mentioned, a lot of the issues for them to actually produce the finished product come from suppliers. They've been pressuring their suppliers for better terms. And there has also been a lot of consolidation within the supply chain, which will hopefully deliver results. And this whole supply issue absolutely should not be underestimated. A lot of Airbus' issues, like we talked about Qatar cancelling four planes late last year, that came from the Pratt & Whitney, which is a United Technologies Corp. subsidiary, failure to meet their engine deliveries. They only made 75% of the engine deliveries that they were supposed to in 2017. I think the executives joked that there were so many planes waiting for engines that they were now in the glider business. And, as you mentioned, the manufacturers collect most of the price of the aircraft when they ship, so waiting for these suppliers to get their act together is not good.
Levine-Weinberg: Yeah. Both companies definitely are very much focused on this. Another area where they've had some serious supply constraints has been on seating, and actually, lavatories has been a big supply issue recently. Boeing actually just formed a joint venture very recently to create its own seating company to build aircraft seats. It basically said that it needs to be in the business just to provide extra supply and make sure that it can meet its commitments to customers to get planes out the door. I think you could definitely see something similar at Airbus, because they've definitely been burned quite a few times in the last couple of years by suppliers saying they'd be ready for production increases and then not actually being ready.
Priestley: Absolutely. I think a lot of suppliers are seeing a tightening of their belts. A lot of the margins in this industry are actually felt further back in the supply chain. As you mentioned, Zodiac, which makes a lot of parts for Airbus, they agreed to be acquired by Safran. I don't think that's gone through yet. But, it demonstrates that the reason, the impetus for that arrangement, was to try and help them speed up their production. Very interesting for the whole manufacturing supply chain. But, what are you expecting for 2018 for both of these companies?
Levine-Weinberg: We're definitely going to see more growth for Boeing and Airbus. I think, in 2018 specifically, we'll probably see slightly higher production growth for Boeing. I'll get to the reasons for that in just a moment. Both companies are in the midst of increasing production on multiple product lines to meet this high demand that they've seen. Airbus, for example, is in the midst of the initial ramp-up period for its A350 jet. The first deliveries were just a few years ago. It usually takes a while as they work out the manufacturing kinks to get to the full production speed. This year, they're supposed to reach that, which is going to be 10 a month by the end of the year. Based on that production rate, they'd be building somewhere between 110 and 115 A350s on an annual basis as of 2019, whereas last year they delivered 78 A350s. Meanwhile, the A320 production rate is set to reach 60 per month in 2019. That's the fastest that any commercial jet has ever been built. That's up from 50 per month right now. So, that's going to be a big increase, but that's not coming during 2018. That'll be a 2019 thing.
Meanwhile, Boeing is in the midst of producing the 737 family of jets faster. They ramped up from 42 per month to 47 per month for 2017, and they plan to increase production to 52 per month later this year, and then up to 57 per month in 2019. Then, finally, Boeing also decided late last year to increase the 787 production rate from 12 per month now to up to 14 per month as of sometime in 2019. The result of all of that is that Boeing said it's going to deliver 810 to 815 jets in 2018, which would be up 6% to 7% year over year. There will be a little bit of growth on the 787 Dreamliner, but that's just going to be offsetting lower production for that 777, which, as we talked about earlier, is having a bit of a slowdown and a model transition. The vast majority of the growth, probably 100% once again, will come from that 737 family as the production rate goes up by five aircraft per month.
As for Airbus, it's also going to be increasing deliveries this year, but probably not quite as much as Boeing, just because that A320 family has now stabilized at 50 per month, and the ramp up to 60 per month is really going to happen more in 2019 than in 2018. And looking further out, you're going to see annual delivery totals for both Airbus and Boeing continue to increase year after year, at least through 2020, just based on the production announcements that they've already made. And when you look at the giant backlog that both companies have right now, you can certainly imagine either Airbus or Boeing increasing production for those high-volume A320 and 373 families yet again. Maybe not in 2020 because of these supply chain constraints, but possibly 2021 or 2022.
Priestley: It's a good position to be in, to have so much demand that you're struggling to make it. But, I know it can be incredibly stressful for the people on the shop floor that actually have to make these.
Priestley: If I were to ask you to put your money on one of these companies, which would you pick?
Levine-Weinberg: If I had to pick one, I would probably put my money on Boeing, just because the company has a really strong history of churning out cash flow, and there's still a lot of upside there from what they were able to produce last year. In one sense, Boeing is going to be a really humongous beneficiary of the tax reform law that went into effect in the U.S. very recently. It's not going to be paying taxes on the shipments outside of the U.S. anymore. And as it invests in new programs, it'll be able to deduct those costs immediately from its taxable income. So, it'll have a much lower tax burden than it would have otherwise been facing the next few years. On top of that, they have a very strong history of turning their backlog into enormous amounts of cash.
Priestley: It'll be interesting to see where they start to spend some of the money they've made from the tax reform, if we start to see more integration, which I think we can expect in the industry.
Priestley: All in all, 2018 is going to be an exciting one to watch for these two companies. Thank you very much, Adam, for coming on the show and sharing your extensive knowledge with us.
Levine-Weinberg: Thanks for having me on!
Priestley: That's it from us today. If you would like to get in touch, please feel free to email us at firstname.lastname@example.org, or tweet us on Twitter @MFIndustryFocus. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. Thanks to Austin Morgan for producing the show. For Adam, I'm Sarah Priestly. Thanks for listening and Fool on!