American’s Fall Could Make Boeing Falter


Although the congressional supercommittee’s colossal failure this week points to the near certainty of massive defense cuts, few analysts are shedding tears for Boeing (NYSE:BA) right now. One reason is nearly $40 billion in aircraft orders it has booked this month alone. But trouble looms for Boeing in the fine points of this summer’s 200-plane deal with struggling American Airlines parent AMR Corp. (NYSE:AMR).

Back in July, American ordered 460 new narrow-body aircraft, splitting the order with Airbus, which got the other 260. The deal could eventually be worth a total of nearly $40 billion, including options on 465 additional planes. Previously flying a Boeing-only fleet, American was able to gain enormous concessions from both manufacturers. Boeing and Airbus earmarked $13 billion in lease financing to fully cover the first 230 planes so American wouldn’t have to try to raise financing on its own deteriorating credit.

Airbus is selling American its popular next-gen A320neo jets, which premiered last year. To keep American happy, Boeing dumped its original plan to launch a new, fuel-efficient narrow-body like its Airbus rival. AMR preferred new engines on the existing 737 airframe to avoid potential delivery delays on a new model.

The upgraded Boeing 737 MAX will sport fuel-efficient LEAP-X engines from CFM International, a joint venture between Safran and General Electric (NYSE:GE). But when it comes to commercial aircraft, the task of deploying new engine options is far from plug-and-play. Boeing opted to outfit the MAX with the largest available LEAP-X engine to optimize performance. But for a turbofan that large, Boeing must lengthen the plane’s nose landing gear by six to eight inches in order to avoid contact with taxiway lighting, according to Flightglobal.

Apart from the airframe changes, the decision to re-engine could come back to bite BA from a competitive standpoint, since the 737 MAX might have trouble going up against the A320neo.  A potentially bigger threat to Boeing might be COMAC’s new C919 jet, set for test flight in 2014. China’s state-owned aircraft manufacturer plans to launch the new jet with the same LEAP-X engines Boeing is using.

Airbus also will begin outfitting its A320neo with the LEAP-X engines in 2014. With three manufacturers competing for the same buyers with similar airframes and the same engines, Boeing likely will have to make AMR-like concessions for future deals — particularly in the Middle East, where BA is projecting dramatic sales growth over the next decade.

However, BA’s first test might be closer to home as rumors late Tuesday had Boeing and Airbus vying for an estimated $15 billion deal from United Continental (NYSE:UAL) for up to 130 new narrow-body jets.

Boeing’s concessions looked like a good deal back in July when the aircraft giant penned the American agreement — AMR was trading at nearly $5 a share then, and bulls were predicting the stock was destined to double. Since July, myriad troubles and bankruptcy rumors have strafed the stock, which has dropped 67% since the deal was announced.

AMR stock was teetering on the edge of a new low on Tuesday, dropping more than 6% on news that a federal judge had dismissed its antitrust lawsuit against the travel booking firm Orbitz. If AMR is unable to pull out of its tailspin, Boeing could take a significant hit.

But Boeing does have cushion, given how it’s piling up huge aircraft deals left and right. Last week, Indonesia’s Lion Air inked a deal with Boeing for 230 narrow-body planes at a price tag of $21.7 billion — beating out the $18 billion worth of 777s Emirates Airlines ordered at last month’s Dubai Air Show.

And Boeing still boasts solid fundamentals. It has a market cap of nearly $48 billion, a price-to-earnings-to-growth ratio of 0.88, which suggests the stock is undervalued, and a current dividend yield of 2.6%.  The stock was down nearly 2% with the broader market on Tuesday.

Bottom Line: Boeing’s fierce competition with Airbus in the single-aisle aircraft market could force the U.S. defense/aerospace giant into increasingly lower-margin deals that require it to pony up juicy financing terms. That would weigh on Boeing’s margins at the worst possible time — as federal defense spending cuts kick in.

Watch closely to see how much Boeing has to sweeten the pot for UAL in the upcoming narrow-body deal in order to preserve its market share. With the inevitable loss of defense revenue from the failed deficit reduction talks, BA is seeking cost-cutting measures in other areas, including the possible closure of a military modifications plant in Kansas that could have been used to assemble the 737 MAX.

Despite winning record-size orders in recent weeks, Boeing still has plenty of unsettled skies ahead.

As of this writing, Susan J. Aluise did not hold a position in any of the stocks named here.

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