Wednesday, April 6, 2016

Boeing's Commercial Jet Unit Is Manufacturing An Artificial Crisis

As an analyst, my job is to assess a company’s business prospects and market position. That usually involves taking a critical approach, pointing to problems and weaknesses. But this year’s strange pronouncements from Boeing Commercial Airplanes lead me to the opposite role: I’m here to reassure. BCA, and the jetliner market, are in better shape than BCA management seems to think.

Last week, BCA CEO Ray Conner warned of job cuts necessitated by fierce price competitions from Airbus. “Their biggest weapon that they’re using in the competitions today is price,” Conner told BCA employees. “They are attacking us with price in every single campaign. And as a result of that, you know, we’re being pushed to the wall.”

That’s right. Airbus, BCA’s only real competitor, is using price to compete. Who knew? But this wasn’t the first warning BCA has sounded this year. In early February, Conner warned that job cuts were needed to lower costs, to allow the company to regain lost market share. As of last week’s announcement, numbers range from 4,000 to 8,000 job cuts, primarily in the executive and management ranks.

This year’s BCA guidance directly contradicts the very optimistic tone in Boeing’s fourth quarter 2015 earnings call, conducted just a few weeks before Conner’s dark outlook. Boeing Company CEO Dennis Muilenburg said in the call that production rate concerns were due to 2016 being a “transition” year. “It’s really important that we…look out over the next several years, you’ll see that revenue will grow, you’ll see that deliveries will grow as we execute on the backlog,” Muilenburg stated. That outlook hardly calls for thousands of job cuts, especially since managers can come in handy during times of product line transition.

But Conner’s latest warnings doubled down on the gloom, with an almost Trump-like economic world view. See Dominic Gates’ Seattle Times account for a good summary of BCA’s recent market pressure anecdotes.

The problem is that the plural of ‘anecdote’ is not ‘data.’ Conner’s notion of lost market share is simply not supported by reality.  Last year Boeing delivered 762 jets worth over $60 billion, while Airbus delivered just 635 jets worth $43 billion.  In terms of market share by value, that was BCA’s best performance since 2002.

Orders have been strong too, with 868 received last year. While Airbus scored 1,139, a higher percentage of Boeing’s orders are for more expensive twin aisle jets, meaning a much closer ratio. Also, so far this year Boeing has brought in 107 orders, while Airbus’s net total is just 11. While BCA’s profitability declined last year to a 7.8% operating margin from 10.7% in 2014, much of this was due to an $885 million pre-tax charge on the troubled 747-8 program.  And of course these margins are considerably higher than Airbus’s.

Best of all, as Muilenburg noted, the company’s backlog is extremely robust – 5,758 jetliners. This, too, undercuts Conner’s notion of price pressure as a chronic problem. The prices of jets included in a firm commercial backlog are set, and generally not negotiated downward. While backlogs aren’t always completely secure, the company now has 7.5 years of production at current rates with known pricing.

Regarding the current market share battles that have Conner upset, it’s important to note that these represent efforts to secure incremental demand on top of this huge backlog. And it’s hard to convince airlines to pile on more orders when most of them have ordered what they need. Industry book to bill over the last decade has averaged nearly 2-1 (19,382 orders and 10,767 deliveries between 2006 and 2015). No industry sustains a greater than 1-1 book-to-bill indefinitely.

Are there areas of weakness in BCA’s product portfolio? Does BCA face some serious challenges? Absolutely yes to both.  The A321neo is outgunning the 737MAX9, and Boeing needs to think about a new Middle of Market (MoM) product.  Airbus has improved the quality of its twin aisle offerings in other segments too.

Production rates for BCA’s higher profit margin 737NG and 777 are going down, while its less profitable 787 (and soon the 737MAX) are ramping up.  There’s a challenging world macroeconomic environment. Less expensive fuel may lead airlines to re-think their fleet replacement plans.  And Boeing still needs to deal with the $29 billion overhang of 787 deferred production costs.

But then again, none of these challenges undercut BCA’s strong fundamentals: The backlog is at a record high, BCA’s products are doing very well, and there’s a strong new product development pipeline.

It’s important to stay competitive, so perhaps these dire-sounding warnings from BCA are understandable. Aside from damage to worker morale – not really a consideration at BCA in recent years – what’s the harm in emphasizing austerity and risk? Well, consider the damage in terms of message sent to customers, aircraft financiers, and investors. Investors see a crisis. It’s an artificial crisis, but not all investors are aware of that.

As for Boeing’s jet customers and financiers, they’ve been told that Boeing airliners have lost their competitive edge, and it has all come down to a price-driven commodity market. If you say you have to compete on price, then you don’t feel confident that you have quality products that can be differentiated from the competition. I can’t imagine sending a worse message.

Finally, I’m baffled by any public talk of job cuts.  If a company needs to fire anybody, so be it.  But BCA also says that layoffs are a last resort, only to be implemented if attrition doesn’t work.  If the job cuts are merely attrition, why mention them at all?  Why not continue sending the corporate message that the market is fine, and that BCA’s jets are competing well? Aside from worrying investors and customers, talking about job cuts serves no purpose whatsoever.

(Richard Aboulafia - Forbes)

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