Last week, two of the largest European airline companies -- British Airways parent International Airlines Group (IAG) and Deutsche Lufthansa (NASDAQOTH:DLAKY) -- announced plans to reduce their aircraft spending. Under pressure due to high labor costs, the strong dollar, and vicious competition from budget carriers, both companies want to save money by keeping older planes in service while bringing in some used aircraft.
Obviously, this isn't good news for Boeing (NYSE:BA) and Airbus (NASDAQOTH:EADSY). Both aircraft manufacturers certainly preferred the order frenzy of a few years ago. Nevertheless, these moves by airlines to reduce capital spending aren't quite as disastrous for Boeing and Airbus as they may appear to be on the surface.
What the airlines are doing
Last Wednesday, in conjunction with Lufthansa's Q3 earnings report, CEO Carsten Spohr stated that the company was looking to buy more used aircraft in the coming years. This would allow it to reduce its capital expenditures after 2017.
Spohr explained that the combination of low fuel prices, new programs to extend the useful lives of existing aircraft, and good availability on the used aircraft market makes it a great time to pivot away from buying new aircraft. He said that Lufthansa was particularly interested in buying used aircraft for short-haul routes.
Meanwhile, at an investor meeting on Friday, IAG announced plans to reduce capital spending over the next five years by 1 billion euros. It will do so by extending the lives of the British Airways Boeing 747 and Boeing 777 fleets, squeezing in 52 more seats on some 777s that will be used for leisure routes from Gatwick Airport and buying more used aircraft -- for both short-haul and long-haul routes.
Narrowbody backlogs are huge
Efforts by Lufthansa and IAG to reduce spending on narrowbody aircraft won't hurt Boeing at all -- both companies use Airbus A320-family planes for short-haul routes.
However, Airbus doesn't have much to worry about, either. It has a backlog of roughly 5,500 firm orders for A320-family aircraft. That represents more than 10 years of output at today's production rate. Airbus plans to increase A320-family output over the next few years, but even at the peak production rate of 60 per month, it would take eight years to build that many planes.
Thus, if a few dozen orders are deferred, it won't impact Airbus' production plans. If anything, it could be helpful by opening up scarce A320neo slots over the next several years.
Furthermore, the austerity moves at Lufthansa and IAG are largely a response to expansion by European budget carriers like Ryanair, EasyJet, and Norwegian Air Shuttle. Boeing and Airbus are happy to sell lots of new 737s and A320s to those up-and-coming carriers, even if it means selling fewer to established airlines.
Widebodies will be replaced eventually
In the widebody market, order backlogs tend to be shorter. Thus, deferrals are more likely to negatively impact production.
However, Lufthansa is making most of its adjustments on the narrowbody side of its fleet. With a large number of aging four-engine A340s and 747s in its fleet, Lufthansa probably wants to take delivery of the Airbus A350 and Boeing 777X aircraft it has ordered to replace them.
IAG subsidiary British Airways seems more interested in keeping older widebodies in service and buying used widebodies. As a result, it is reviewing its orders for Boeing 787s and A350s between now and 2020. Fortunately, those models have longer backlogs than the A330 and 777 families, which haven't been selling as well recently. Boeing is nearly sold out on the 787 until 2020, while Airbus' A350 backlog stretches even longer.
Additionally, while British Airways is extending the lives of its 747 and 777 fleets, those planes will need to be replaced eventually. All of its 747s were built in 1999 and earlier, which means the last ones will probably leave its fleet around 2025. Meanwhile, most of British Airways' 777s were built between 1995 and 2001 and will become ripe for retirement in the mid-2020s.
Thus, while British Airways might defer some 787 or A350 orders by a few years, over the next decade it will need more widebodies than what it has already ordered. Even if it goes with used aircraft, that's not the end of the world for Airbus and Boeing. By taking up used planes from Middle Eastern and Asian carriers, British Airways would help make room for new widebodies in those airlines' fleets.
Order backlogs are a big insurance policy
When the last big aircraft order cycle peaked in 1999, the order backlogs at Boeing and Airbus were a fraction of their current size. That made both companies vulnerable to a temporary downturn in demand. Even today, aircraft types with shorter backlogs like the 747, current-generation 777, A380, and A330 have proven vulnerable to demand fluctuations.
By contrast, order backlogs for the 737, 787, A320, and A350 aircraft families are quite long. This serves as an insurance policy against short-term demand fluctuations for Boeing and Airbus.
The shifting fleet plans at British Airways and Lufthansa will mainly impact orders for the A320 and to a lesser extent the 787 and A350. Both manufacturers are well positioned to absorb some order deferrals over the next few years while waiting for a new replacement cycle to take hold in the mid-2020s.