In the commercial aviation duopoly, Boeing (NYSE:BA) and Airbus (NASDAQOTH:EADSY) have posted robust sales and record profits in the previous fiscal year, and they are hungry for more orders. But given that most of the demand is originating from emerging countries, risk of sudden cancellation of orders by low-cost carriers is casting a dark shadow on the duo's fat order books. As updates of new orders start pouring in from the ongoing Farnborough Airshow, let's find out if we need to take the good news with a pinch of salt.
The current backlog
Boeing and Airbus reported a healthy backlog past year, and they have racked up their order count considerably in the current year. At the end of the first six months, Boeing's net order count stands at 499, and Airbus' at 290. As of June 11, backlogs were an impressive 5,199 and 5,457 aircraft for Boeing and Airbus, respectively.
Remarkably, almost one-third of this backlog comprises orders from Asia, and this could grow over the coming months. The Centre for Asia Pacific Aviation (CAPA) has projected that the South Asian low-cost-carrier fleet will increase by around 20% this year.
Asian carriers under pressure
There has been phenomenal growth in the capacity share held by low-cost carriers, or LCCs, in Southeast Asia, rising from 3.3% in 2001 to 58.6% in the first quarter of 2014. This unprecedented growth is estimated to continue in the long term, according to Boston Consulting Group (BCG). But it has led to interim overcapacity problems for the existing South-east Asian airlines. CAPA states that mounting overcapacities could make LCCs consolidate and reduce order books.
In the beginning of 2014, airlines reported immense pressure on their load factors and yields, which led to a stream of immediate cancellations or deferral of aircraft deliveries. The expansion rate of LCC fleet in Southeast Asia this year has been slashed by around three percentage points as the largest low-cost short-haul operator of the ASEAN region, AirAsia, has adjusted its fleet expansion plans and deferred seven A320 deliveries. Indonesia's Tigerair Mandala also followed suit by dropping its plans to add three A320 aircraft in 2014. More cancellations and deferrals might be on their way as Jetstar Asia and Lion Air take measures to slow down fleet expansion in the year.
Such disruptions could continue for the remaining part of the year as the performance of several Asian airlines has moved into a lull phase. Asian airlines' profits have plummeted to $3.2 billion in 2013 from $11.1 billion in 2010, according to The International Air Transport Association.
A short-term obstacle?
While observing recent trends, we should keep in mind that these moves by Southeast Asian LCCs are near-term measures to tackle their falling yields and profits, and they may not have a bearing in the long term. In a Financial Times report, Nick Cunningham, analyst of Agency partners, said that the weakness encountered in developing countries' financial markets would not affect Boeing's or Airbus' production in the short term.
Agencies like CAPA and BCG are unanimous in their upbeat outlook for Asia as need for passenger fleet is rising with the burgeoning middle class taking to the skies. Narrow-body aircraft are the mainstay of LCCs, and the behemoths are moving the rate of production of this category as it comprises more than 75% of their present backlog -- Airbus is boosting its A320 production from 42 to 46 aircraft per month, and Boeing is moving its 737 production up to 47 from 38 per month. They aim to increase output to above 50 per month in the near future to enhance delivery rates by roughly 20% -- from the present 1,400 to around 2,000 -- within the next five years.
Also, the aero majors are busy reengineering their jets to make them more efficient. Boeing's 787-8 is lighter and 20% more fuel proficient than the 767. This is extremely attractive for the LCCs as they get to reduce their operating costs significantly. Though there could be postponements in the coming months due to budget issues, in the longer run, these fuel-efficient aircraft are bound to find more takers. The 787-9 will be Boeing's proud exhibit at Farnborough, and Airbus is likely to announce the A320neo program at the event.
Irrespective of the headwinds, Boeing and Airbus are jacking up production rates as they are keen to fine tune their massive backlog with delivery timelines. It's true that if cancellations and deferrals from Asia keep escalating in the coming months, Boeing and Airbus might have to rethink their production rate. But their long-term strategy of building fuel-efficient jets should eventually reap returns.
Top dividend stocks for the next decade
The smartest investors know that dividend stocks simply crush their non-dividend paying counterparts over the long term. That’s beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor’s portfolio. To see our free report on these stocks, just click here now.
ICRA Online and Eshna Basu have no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.