Starting in September 2015, Boeing (NYSE:BA) plans to build sixteen 747 airframes per year, down from the current rate of 18. This is the latest in the series of cuts that the company has announced in the past couple of years. In 2013, Boeing cut the production rate twice, which reduced annual output from 24 a year to the aforementioned 18. The airplane manufacturing giant has said the latest tweak is a minor change -- one that will help it run a "healthy" business. Boeing is confident that there is still a market for this iconic aircraft. But how real is this market? What are the areas of concern for Boeing investors? And is there a silver lining?
Two problems with the 747
It's a double whammy: On one hand, demand is waning; on the other, there's technology obsolescence. Boeing extended the life of the 45-year-old 747 aircraft eight years back when it launched the 747-8 edition. The new model was 18 feet longer than the outgoing version and carried new General Electric GEnx-2B engines to enhance fuel efficiency by 1.8%. But it failed to make any significant sales impact. So far, Boeing has bagged orders for 51 passenger versions and 68 freighter versions of the 747-8. The modest demand has been more skewed toward the freighter version called the 748-8F, which made Boeing CEO Jim McNerney grudgingly admit in an earnings call in January 2014, "I think cargo is the thing that will keep it going for a long time..." But demand for exclusive cargo aircraft has decreased. Lots of cargo now piggybacks on passenger aircraft, squeezing the market for exclusive freight planes.
On the technology side, with fuel-efficient twin-engine planes available in the market, flying the four-engine fuel-guzzling jumbo jet doesn't make much sense anymore. This is true for both passenger and freighter planes. The chart below provides a snapshot of how the 747-8 passenger version fares against Boeing's popular 777 wide-body plane and the 777X, which will enter service toward the end of the decade.
Among dedicated freighters, too, we see a shift in preference for the leaner cargo planes:
A big charge coming?
Boeing has a deferred cost of $1.9 billion on the 747 program and an unamortized $518 million in tooling costs. In accounting terminology, this means the company has already incurred these costs, and under Boeing's program accounting methodology, the money will be recovered if it can sell a total of 1,574 747s. To date, Boeing has bagged orders for 1,537 units of the 747, of which it's dispatched 1,501 planes (through December 2014), and 36 are pending delivery. So, the company is short 37 orders. The recent production cut raises questions about the weakening demand outlook of the aircraft, and the possibility of a big charge that Boeing would need to book if it fails to meet this 37-plane shortfall. This could make a dent in earnings.
Is there hope?
As fellow Fool contributor Adam Levine-Weinberg wrote recently, there could still be a small market for the 747-8 passenger aircraft as leading Persian Gulf airline Emirates adds capacity at its Dubai hub. Another Middle East airline, Etihad, recently pioneered the flying hotel concept, housing luxurious hotel suites in a jumbo jet. While both carriers have preferred Airbus' A380 so far, the 747-8 saves more fuel and costs less to operate than the A380. So, these airlines might consider the 747-8 at some point. The jumbo jet could also attract other airlines operating out of busy hubs, like London's Heathrow or New York's JFK, that want to add quick capacity.
For the 747-8F, an important development is the improving outlook for the freight market. The International Air Transport Association recently forecast that over the next five years, freight volumes would experience compound annual growth of 4.1%. The growth rate has been just 0.63% annually since 2011. While it's unlikely the 747 would get a big boost from this development due to the reasons discussed above, it could result in a few orders. Bloomberg recently reported that Boeing is in talks with Azerbaijan's Silk Way West Airlines for the sale of three 747-8Fs.
Anything that helps Boeing bridge the 37-plane order shortfall will be welcomed by the company and its investors. If Boeing can keep its 747 assembly lines open till 2018, it could also hope to receive two orders for replacing the U.S. president's Air Force One.
A surmountable task
A production-rate cut in any business is never good news, and usually sets alarm bells ringing. While a market for the jumbo jet is still possible, many orders are unlikely to materialize. Boeing investors would be happy if the company could land at least a few more orders to minimize the loss on account of deferred costs. It would then be a fitting farewell for the 747, to be fondly remembered as the "Queen of the Skies."