"You have to admit that lower oil is not good for somebody selling fuel-efficient airplanes," Morningstar analyst Neal Dihora said in a KPLU article. The slump in oil prices from $115 a barrel in June 2014 to around $50 a barrel six to seven months later threw a challenge at airplane manufacturers betting on fuel-efficient planes to drive future demand. But there are three charts that show that the American aircraft maker Boeing (NYSE:BA) has actually seen better times during the oil plunge.
Boeing's quarterly order trend
Oil prices started dropping in July, the very month Boeing recorded the highest order wins for the year, with gross orders for 324 jets. Of course, at that time, it was too early to know that oil prices would continue falling. In July the Farnborough air show was held as well; Boeing won orders and commitments for 201 planes at the show. Though commitments can go either way, Boeing's July gross order tally was impressive for sure.
What's more striking is that in November and December, when oil prices were coming down more sharply, Boeing reported 224 and 174 orders, respectively. The fourth quarter (October-December) turned out to be the second best quarter of the year, with 444 gross order bookings. In the past few years, soaring oil prices have been a big reason for airlines to upgrade their fleet with planes that consume less fuel. But Boeing's order trend shows that airlines went ahead with their purchases even when oil prices were strikingly low.
Fuel-efficient planes get maximum orders
Boeing's fuel-saving fleet consists of the in-service 787 Dreamliner, offering 20% more fuel savings over the 767 model it replaced, together with the upgraded versions of best-sellers 737 and 777. The 737 Max (service entry 2017) will reduce fuel burn by 14%, and the 777X (service entry 2020) by 12%.
For carriers, fuel is the biggest variable cost. As the upgraded versions burn lesser fuel than their predecessors, they are a sure shot money saver for airlines. But they also cost more than their predecessors. When oil prices fell, analysts opined that airlines will not prefer the costlier fuel-efficient models.
But Boeing's orders reveal that the 737 Max, 777X, and 787 together accounted for the bulk of Boeing's orders throughout 2014. In fact, the proportion was highest in the second half of the year when oil prices were dropping sharply.
Annual order activity unaffected by oil prices
In 2013, crude oil prices had remained above $100 a barrel almost throughout the year, and Boeing had got 957 gross orders for 737 Max, 777X, and 787. In 2014, oil prices stayed low throughout the second half of the year, and nearly halved from 2013 levels toward the year-end. Nevertheless, the order momentum for the aforementioned fuel-efficient planes remained as strong as ever in 2014 at 1,176.
Why is this happening?
At the fourth quarter earnings call, Boeing CEO Jim McNerney said, "Historically, we have seen aircraft orders more correlated to airline profits." Lower fuel prices are boosting airlines' profits, which makes a good business case for fleet expansion.
The International Air Transport Association (IATA) in December revised its 2014 net profit forecast for global airlines from $18 billion (given in June) to $19.9 billion. And for 2015, it predicted even higher profits of $25 billion. IATA believes the main reasons behind the rising profits are lower oil prices and stronger worldwide GDP.
As to why airlines would upgrade their fleets with costlier planes when they can keep their operating costs low even with the existing ones, let's consider the oil situation. No one expects oil to stay at these low levels forever. Fellow Fool analyst Matt DiLallo mentioned in one of his recent articles, "...according to OPEC Secretary-General Abdulla al-Badri, we've already hit bottom. Not only that, but he sees a real possibility that oil prices could explode higher to upwards of $200 per barrel in the future."
So it's best for airlines to use the profits to prepare themselves for future spikes in oil prices. The need to upgrade and expand fleets is imminent, so why not do it now when profits are higher?
Boeing has the last laugh...
Boeing gains when fuel prices are low as higher profits make it easier for carriers to support fleet replacement and expansion. And when fuel prices spike again, the carriers that survive the debacle will look for every possible means to lower fuel costs and buy more fuel-saving planes. It's a win-win situation for Boeing and its investors.