Last year's Dubai Airshow proved that Boeing's (NYSE:BA) 777X is in high demand, breaking industry records in racking up orders and commitments worth almost $100 billion (at list price) for 259 jets at launch. While Boeing takes pride in this fact, the huge popularity of the 777X has simultaneously raised concerns over the future of its predecessor; the 777. As one of Boeing's key revenue drivers, lower demand or a production cut for the 777 could soften the company's medium-term outlook.
The successor overshadows the predecessor
It's the same conundrum faced by early-adopters -- just when you line up your finances to order the latest gadget, along comes a new version. Unless airlines need to expand fleet capacity or replace existing fleets before 2020 -- when the 777X is scheduled to enter service -- they could defer a 777 purchase to get the upgraded version.
Boeing says the 777X to be 12% more fuel efficient and 12% lower on operating costs, which is a big draw for carriers: It holds the key to improve profits and expand margins. Consequently, selling the 777 has become difficult. This was visible in the latest Delta Air Lines' bid for 50 jets. Boeing offered its 777 to Delta, but the order went to rival Airbus' (NASDAQOTH:EADSY) latest offerings, the A350 and A330neo. Scott Hamilton of Leeham News and Comment told Bloomberg that no one is interested in planes nearing their end.
Boeing has pending orders for 273 of the older model jets that should be cleared in less than three years at the current production rate of 8.3 planes a month. This leaves a gap of three years before the 777X enters service and starts contributing to the company's sales. At current production rates, this is more than $54 billion in potential sales even after discounts, or nearly 62% of Boeing's 2013 sales.
Will 777 win new orders?
Boeing CEO Jim McNerney has said 777 demand is expected "to remain healthy through the end of this decade." Order books show Boeing has bagged firm commitments for 43 777s so far this year, while it is expected to deliver about 100 units . This means its book-to-bill or orders-to-deliveries ratio will be less than one, signaling a shrinking backlog. While McNerney believes orders for 40 to 60 777 units annually will support a smooth transition to the successor, a book-to-bill ratio closer to one will make investors more comfortable about the changeover.
Recently, there was some good news when Kuwait Airways announced its intent to purchase 10 Boeing 777-300ER planes. Boeing has acknowledged the order on its website, but will include it in the orders tally only when finalized. This could be one of the biggest orders for the 777 in 2014. There was only one other order for a similar number of planes from an undisclosed customer that Boeing reported in August. The win could be a good endorsement for the 777 under the circumstances, and attract other operators. Offering steeper discounts could also generate some order momentum.
Transitioning to the next-generation model is not a new problem for the aviation industry, and there is precedent to follow. If Boeing does not receive any further orders for the 777, the company could replicate the solution that has worked well for Airbus. The Toulouse, France-based company announced a pullback in production of its A330 after launching the A330neo. Boeing could similarly cut its production rate to facilitate a smoother transition to the 777X. The only problem being that a production pullback could impact Boeing's already strained cash flow.
Binding up the tale
Given the value propositions offered by the 777X, how many carriers would prefer a 777 over its looming successor is up for debate. However, some operators could be attracted by the deep discounts that Boeing might offer. Generating new orders to engage its production facilities would be the ideal solution; otherwise, a production reduction would be the only option. Slashing output never sounds right to shareholders, but the decision is part of the price one pays as the life cycle of an aircraft nears its end.
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.