The commercial aviation industry is on a high and Airbus (NASDAQOTH:EADSY) investors would be hoping to get their money's worth. But how well is Airbus capitalizing on the demand? One possible way to judge this is through the company's cash generation. Often earnings numbers do not tell the whole story owing to accounting adjustments and one-off items, so investors like to look at cash flow trends to gain a deeper understanding. Airbus' free cash flow generation has faltered in the recent past. But, now with big order wins and epic backlog levels, can investors expect this trend to reverse?
Backlog is rising
Airbus' commercial plane-making unit makes for more than two-thirds of the company's revenue. In the first nine months of 2014, the company delivered 443 jets against 445 in the corresponding period last year.
Although new order intake has slowed down from last year's levels as seen in the chart below, net orders of 791 jets has crossed the full-year delivery guidance of approximately 626 aircraft. This means a book-to-bill or orders-to-deliveries ratio of more than one signifying that the number of unfulfilled orders or backlog is increasing. Companies and their investors prefer growing backlog levels as it indicates steady revenue over the coming months and years.
Free cash flow trends
Before we find out how backlog could boost cash flows, let's take a look at Airbus' free cash flow trend in the past three quarters.
Airbus generated negative free cash flow in 2013 and the trend continued in the first two quarters of the current fiscal year. But the company pleasantly surprised analysts by reporting positive numbers in the third quarter, despite carrying out operational activities such as A350's certification and the maiden flight of A320neo.
Yan Derocles, an analyst at Oddo Securities, told Bloomberg, "Nobody expected that, it shows they've got a lot better control of their working capital." Airbus has made good progress with its working capital management, which rubbed off on the positive free cash flow numbers.
Higher A380 deliveries also aided cash generation during the quarter. Airbus delivered eight A380s, two more than the third quarter of 2013. The jumbo jet's list price of $414.4 million is twice that of a wide body, and four times that of a narrow-body aircraft. Though aircraft makers offer discounts on the list price, even then a couple of higher deliveries of the super jumbo did result in better cash flows.
Can rising backlogs boost free cash flows further?
Airbus has reaffirmed its guidance of breaking even on free cash flow before acquisitions in the current year. This indicates that it's targeting to generate free cash flow of more than 2 billion euros (around $2.5 billion) in the fourth quarter. Other than working capital management, Airbus is possibly convinced that there wouldn't be any massive charge from the A350 program as the aircraft is scheduled to enter service soon. Rather, its deliveries would help generate better cash flows.
Cash flows can get an even bigger boost as Airbus is working toward increasing the production rate of some of its planes. It's under-construction plant in Alabama will open in 2016 with a output capacity of four planes a month in the beginning and reach eight in time. The plant in Tianjin, China may also augment capacity to eight from four a month now. Other than enhancing capacity, Airbus is hastening manufacturing to raise output. Faster production would also mean that Airbus would need to stock less parts for the planes in production, which would free working capital and boost cash generation.
The chart below breaks out Airbus' current backlog into different aircraft, gives their current production rates and scheduled increases. Airbus can even afford to be more aggressive and think of further increasing production rates on the basis of the burgeoning order book. This would help the company churn cash even faster.
Riding on solid commercial jet demand, Airbus' order wins are outpacing deliveries. The growing backlog makes a good business case for the company to consider raising production levels. Investors would surely like to see Airbus monetize its huge backlogs faster and generate steady positive cash flows. This could give them more confidence about putting their money in this stock.
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