On Thursday, Airbus (NASDAQOTH:EADSY) finally bowed to the inevitable and announced that it will end production of its A380 jumbo jet in 2021. The A380 production run will end with just over 250 having been built -- of which 234 have already been delivered -- a far cry from the 1,500-unit opportunity that Airbus initially envisioned.
The demise of the A380 means that Airbus will never recover its $20 billion-plus research and development costs. That said, it has been years since Airbus could reasonably expect to make a profit on the A380. Ending production sooner rather than later will allow the company to shift resources toward more promising projects, boosting future earnings and cash flow.
An airplane without a market
Airbus' rationale for developing a massive jumbo jet was that surging global air traffic would put strain on airlines' hubs, forcing them to use bigger aircraft like the A380.
This turned out to be a miscalculation. The development of more efficient small wide-bodies -- particularly Boeing's (NYSE:BA) 787 Dreamliner -- has allowed airlines to open up hundreds of new long-haul routes. More and more travelers can bypass the busiest hubs to get where they are going, obviating the need for airlines to shoulder the high operating costs of the Airbus A380.
Middle Eastern airline giant Emirates has been the exception that proved the rule. It operates the largest hub for international travel in the world and has used the A380 to deliver a high-end customer experience while rapidly adding capacity at its crowded Dubai hub. Only Emirates has the passenger volumes at a single hub to justify a substantial fleet of A380s. As of last month, it accounted for more than half of the A380s ever ordered and an even higher proportion of the remaining orders in the backlog.
However, Emirates is struggling to meet its financial targets and has no clear need for more A380s -- particularly because it plans to eventually move its hub to the more spacious Al Maktoum International Airport. The last straw was that the engines on its newest A380s haven't delivered the expected levels of fuel efficiency. As a result, even Emirates is finally ready to move on from the A380.
Emirates trades A380 orders for smaller wide-bodies
As of the end of January, Emirates had 53 outstanding firm orders for A380s. It will now reduce that order book by 39 aircraft. Between now and 2021, Emirates will take delivery of 14 more A380s. Japan's All Nippon Airways is also scheduled to receive three A380s this year. All of the remaining orders are likely to be canceled, paving the way for Airbus to discontinue A380 production in 2021.
The good news is that in conjunction with canceling its A380 orders, Emirates ordered 40 A330-900neos and 30 A350-900s from Airbus. That means a tentative agreement to buy 40 Boeing 787-10 Dreamliners struck in late 2017 is probably dead in the water.
Whereas Airbus has been struggling just to break even on the A380, the A330neo and A350 are quite profitable. However, the pace of A330neo sales has been quite slow. Emirates' order will significantly boost the backlog and may also give other airlines the confidence to commit to this model. That will allow Airbus to maintain or even increase its A330 family production in the coming years.
The A350 has a healthier backlog, but with Emirates' regional rival Etihad Airways recently deciding to cancel 42 orders, every new sale is important.
Positioned for profit growth
In its Q4 earnings report, Airbus reported a special charge of 463 million euros related to ending A380 production. However, Airbus' underlying results improved dramatically in 2018 relative to 2017, with adjusted operating profit nearly doubling to 5.8 billion euros. Falling production costs for the A350 family and rising A320neo production drove most of this increase.
The outlook for 2019 and beyond is even better. Airbus expects its adjusted operating profit to rise by about 15% this year. Meanwhile, adjusted free cash flow is on track to reach 4 billion euros, up from 2.9 billion euros in each of the last two years.
This will still leave Airbus dramatically less profitable than Boeing. (Boeing expects to produce about $15 billion of free cash flow this year.) However, it is finally on the right track. The A350 program's profitability should continue to improve over the next few years. The new Emirates order could eventually pave the way for a rebound in A330 family output. Finally, winding down A380 production will free up factory space for Airbus to build even more A320neos.
Airbus still needs to prove that it can stay disciplined on pricing and costs in order to grow its earnings further. But discontinuing the slow-selling A380 is definitely a good start.