A quality stock powered by a fair wind

The Toulouse-based company operates in an effective duopoly in the market for commercial aircraft with US-based aerospace giant Boeing (US:BA), although other players such as Brazil’s Embraer (BR:EMBR3) enjoy niches in other markets, such as smaller regional and business jets.

Airbus’s commercial aircraft business generates 69 per cent of revenue, with a defence and space arm contributing 19 per cent and a helicopter unit generating the remainder.

Airbus has moved into the ascendency over Boeing in recent years and now enjoys a bigger share of the market, according to Chris Seymour, head of market development at consultancy Cirium. “It was 50:50 [but is] currently around 57 per cent Airbus, 43 per cent Boeing,” he noted earlier this month.

The reason for this has been a well-documented set of production problems at Boeing, which ultimately led to two fatal accidents involving the 737 Max, its biggest-selling model. Aviation authorities in the US grounded the 737 Max fleet for nearly two years and the US Department of Justice fined Boeing $2.5bn (£2bn), saying that its executives “chose the path of profit over candour” by concealing problems with part of its flight control system that was linked to the crashes.

This had already slowed Boeing’s deliveries prior to Covid-19, which proved a struggle for both companies. With their fleets grounded and struggling to stay afloat, airlines either postponed deliveries or cancelled orders. After seeing a 29 per cent drop in revenue, Airbus had to raise around €15bn (£12.9bn) in new debt to stay solvent.

To stem cash burn of €6.9bn in 2020 (before M&A and supplier financing costs) the company announced 15,000 lay-offs, leading chief executive Guillaume Faury to declare that the company was dealing with “the gravest crisis the industry has ever experienced”.

In the short term, the move paid off – the company was cash-positive by the end of the year – but as the skies reopened and demand roared back both Airbus and Boeing have struggled to get back up to speed. That is partly due to an aviation industry that was “creaking even before Covid” according to Phil Seymour, president at consultancy IBA.

Alongside Boeing’s Max issues, there were problems with Rolls-Royce’s Trent 1000 engines used in wide-bodied planes, as well as CFM’s Leap engines and Pratt & Whitney’s GTF engines.

Then, in the early stages of the pandemic, thousands of blue-collar workers left the industry – either voluntarily or compulsorily. This not only occurred at the two big plane makers, but also throughout a complex supply chain with “hundreds, if not thousands, of vendors”, IBA's Seymour says.

As it struggles to ramp up production, Airbus has been forced to shift its goals. Last year, it scrapped a target of delivering 700 commercial aircraft, citing a “complex operating environment”. It ended up delivering 661, almost a quarter below 2019 levels. Its 2022 turnover was 16 per cent below its pre-pandemic high, although the operating margin held above 8 per cent, from an average of 3.3 per cent between 2013 and 2019. 

Orders are picking up

Orders are picking up at a blistering pace. A mammoth 500-plane order from Indian low-cost carrier Indigo in June – the biggest single commercial plane order in history – has pushed up Airbus’s orders to 1,257 for the year to August, more than double the 624 signed by Boeing. Between them, the duopoly has already generated more orders this year than in each of the past four years, and there are still more than three months to go.

With delivery levels constrained, order books now stretch out years ahead. At the half-year, Airbus reported a record order backlog of 7,967 planes. At the current delivery rate of 43 planes per month, this would take the company over 12 years to fill, more than a year more than Boeing’s similarly colossal backlog.

Although smaller suppliers plan to boost production, it would still take seven years to deliver all of the most popular narrowbody planes on the books if these higher rates are factored in, reckons Cirium’s Seymour.

This means airlines are jostling to secure delivery slots stretching years in advance, either by firming up existing options or placing new orders for delivery years in advance. Ryanair (IE:RYA), which predominantly flies Boeing planes, recently inked a deal for 300 737 Max-10 aircraft. Deliveries won’t begin until 2027, the deal took years to negotiate and even stalled in 2021, after chief executive Michael O’Leary accused Boeing’s management of being “delusional” over its pricing expectations.

Both Airbus and Boeing try to keep their pricing secret. And although list prices are easy enough to come by – Ryanair and Boeing said their deal was worth $40bn at list prices, which works out at $133mn per plane – airlines never pay the sticker price. Price cuts are expected for bulk orders, and in general the bigger the order, the greater the discount.

Pricing power

The length of Ryanair’s negotiations is an indication that airlines’ pricing power has strengthened. Cirium’s Seymour, whose consultancy provides advice on actual prices paid, says industry financiers recently told him the market was running ahead of the valuations that both his firm and other appraisers were assigning to new planes.

Many multi-year contracts have escalation clauses that allow the plane makers to increase prices, and these are being fully implemented without negotiations. “I think Boeing and Airbus are playing hardball,” said IBA’s Seymour. “And they probably need to, to cover previous year losses. Ultimately, if an airline does want to walk away, there’s going to be another who will step in.”

Another sign is M&A activity in the aircraft leasing sector, as companies buy out competitors to gain access to their order books. The plane makers frown on this, though, and in some cases have clauses that can nullify or cancel deals.

The improvement in profitability has led to a re-rating of Airbus’s shares, which are up nearly 40 per cent over the past year. However, they are still priced just below their five-year average of 21 times Factset consensus earnings forecasts. With improving margins, huge barriers to entry in its core product and growth seemingly nailed on for years to come, Airbus has the hallmarks of a quality, long-term compounding stock.

Demand shows no sign of slowing. Airbus’s global market forecast envisages air passenger transport growth compounding at an annual rate of 3.6 per cent until 2042, which translates into a market-wide demand of 40,850 planes, around three-fifths of which will be needed to meet future growth, and the balance to replace old jets. Although some analysts think China will eventually look to serve its own market, which could reduce the duopoly’s hold, this is still a long way from happening – state-owned manufacturer Comac’s first passenger jet only made its maiden flight in May.

Boeing also continues to be hobbled by a series of production flaws. The latest is nowhere near as serious but involves some reworking to 737 Max planes, resulting in what chief financial officer Brian West said could be deliveries “at the low end” of a 400-450 target range this year.

Airbus still has some way to go before it reaches galloping speed, but in the short term at least, it looks set to add a few more lengths to its lead over its transatlantic rival.