Last Friday, European aerospace giant Airbus (NASDAQOTH:EADSY) announced that it will expand production of its best-selling A320 family of jets to a record pace of 60 per month by mid-2019. That represents a 43% increase from the current production rate of 42/month.
This is the third A320 production increase announced in the past two years. Airbus has already planned production rate increases to 46/month as of Q2 2016 and to 50/month by Q1 2017. However, the move to 60/month is by far the company's boldest step -- and it comes with a good deal of risk for Airbus.
Narrowbody backlogs are soaring
It's not very surprising that Airbus wants to ramp up A320 production. Since Airbus launched the reengined A320neo in late 2010, sales have taken off. It got a big head start, bagging 1,348 net orders in 2011 as Boeing (NYSE:BA) dithered for nearly a year over whether to offer a competing reengined 737 or to design a brand new plane.
The sales momentum has continued for Airbus, which has collected new orders at a rate of about 1,000 per year for the last four years. As a result, the A320 backlog (including both current-generation and neo models) has soared to 5,502 airplanes as of September 30.
In light of this massive backlog, Airbus' current A320 production rate -- which is a little more than 500/year -- is clearly inadequate. Even with the previously announced increase to 50/month (600/year), the backlog would stretch for more than nine years. Raising production to 60/month will allow Airbus to get planes into its customers' hands faster.
Suppliers will be stretched
One potential pitfall of Airbus' aggressive production increase schedule is that it will put strain on the supply chain. While Airbus is increasing A320 production by 43% over the next few years, Boeing has also committed to raising its 737 production rate from 42/month today to 52/month by 2018. Both manufacturers are also ramping up production of widebody aircraft.
As Airbus debated the move to 60/month, officials at suppliers like Safran (which through its CFM International joint venture will build jet engines for both the 737 MAX and A320neo) cautioned that they couldn't necessarily handle additional production increases in the desired timeframe.
Airbus says that it has worked with suppliers to make the production increase possible. There's little to no margin for error, though. And since airplanes depend on so many components, a shortage of just one component could snarl production.
Is there enough long-term demand?
The biggest potential risk, though, is that the recent surge in demand for single-aisle aircraft isn't sustainable in the long run. Many analysts expect Boeing to match Airbus' production increase to 60/month for its 737. That would have the two manufacturers pumping out about 1,440 single-aisle jets annually by around 2020.
However, Boeing has projected demand for 26,730 single-aisle planes over the next 20 years. Airbus is actually more conservative, projecting demand for 22,927 single-aisle planes over that same period. Yet even Boeing's more aggressive figure is less than the 28,800 planes Boeing and Airbus would build in a 20-year period with both producing 60/month.
This doesn't even include planes built by smaller manufacturers. Brazil's Embraer participates in the single-aisle market with its E190 and E195 models, of which new versions are coming in 2018 and 2019, respectively. Bombardier's CSeries jet is almost ready for its first delivery after numerous delays, while China's Comac rolled out its first single-aisle plane this week -- the first delivery is expected in 2018 or 2019.
None of these planes will approach the A320 or 737 in sales volume. (Comac's C919 probably has the best prospects, with more than 500 orders on the books and strong support from the Chinese government.) But together, they could potentially account for annual production of at least 200-300 planes.
Thus, unless the growth in air travel demand exceeds even Boeing's bullish forecasts, there will be a mismatch between production capacity and demand at some point in the next 20 years -- especially if Boeing matches Airbus' increase.
The key is capital efficiency
In one respect, Boeing is more at risk than Airbus in the event that production gets ahead of demand growth. That's because its 737 backlog stood at 4,243 planes at the end of September: roughly 23% fewer than Airbus has on order.
On the other hand, Boeing has a big advantage in that its investments in automation could allow it to build 737s at a rate of 63/month on its three production lines in Renton, Washington. By contrast, Airbus already builds A320 family aircraft in four locations across the world and it will have to add a new assembly line at its Hamburg plant to support the latest production increase.
This means that the incremental investment necessary for Boeing to boost 737 production to 60/month is likely to be smaller than what Airbus will need to spend to reach the same rate. As a result, if Boeing needed to trim production in the late 2020s, it could do so without taking a big writedown.
The risk for Airbus is that if the recent surge of orders turns out to be an unsustainable bubble, it will have invested money in factory space and tooling that will be superfluous a decade after it is ready. Airbus is making a bold bet on growth with this production increase -- but we won't really know if the investment will pay off for at least 10 years.
Adam Levine-Weinberg owns shares of The Boeing Company. Adam Levine-Weinberg owns shares of and is long $30 calls on (and The Motley Fool recommends) Embraer-Empresa Brasileira. 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.