by Vinay Bhaskara and Chris Sloan
SEATTLE – When former GE Aviation executive Kevin McAllister took over as the CEO of Boeing Commercial Airplanes (BCA) last November, he was replacing a legend at Boeing: Ray Conner.
Conner had started with Boeing back in 1977 as a mechanic on the 727 program and had risen to the position of CEO at BCA in June 2012 after James Albaugh stepped down.
Under Conner’s leadership, BCA resurrected its technical execution and retained parity with Airbus (if not leadership) in the widebody market. At the same time, Boeing fell behind Airbus in the narrowbody market, driven primarily by the weakness of Boeing’s offering (the 737 MAX 9) in the so-called Middle of the Market (MOM).
Exogenous conditions have also changed around BCA – a moderating world economy and low fuel prices have, at least temporarily, sapped demand for new orders at Boeing and Airbus after years of record purchasing activity.
So as McAllister enters the seventh month of his tenure atop BCA, he must grapple with subpar market conditions and Boeing’s very real challenges with the MOM. Recent shifts in Middle Eastern market conditions could also affect the status of the 777X given that more than two-thirds of its backlog is concentrated in that region of the world.
Airways was present at Boeing’s pre-Paris Airshow briefings in Seattle last week and heard commentary from McAllister and Ihssane Mounir, BCA’s VP Global Sales and Marketing.
In their remarks, McAllister and Mounir touched on a wide range of topics including Boeing’s various aircraft programs, the NMA, and the Bombardier dispute at the ITC.
On current market conditions
McAllister cited data from Q1 2017 suggesting that the market is in decent shape:
First quarter 2017 traffic growth came in at 7% and capacity growth came in at 5%, which bodes well for supply/demand… This is a very healthy industry in the long run with 41,000 planes coming into the market. Driving this is a significant replacement cycle. I feel good about our 5,700 aircraft backlog… First and foremost our priority is executing on our deliveries.
Our view is that the long-run projections are more or less right, perhaps 10-15% too high under the new fuel price market equilibrium ($40-60/barrel West Texas Intermediate).
The problem is the timing of the market – there is a glut of aircraft either on order or out in the market today. The planes supporting that 7% traffic growth and 5% capacity growth were purchased 3-7 years ago, and airlines are well stocked to grow at a reasonable pace (given GDP growth) over the next 3-5 years.
That is the period, particularly for the 777X (and to a lesser extent for eliminating the 787’s deferred production costs) that causes the most worry. But the 787 program and 737 programs will be fine in the long run. The worry is the cash flows (or lack thereof) on the 777X and whether that squeezes NMA development.
On the need to focus on execution, downsizing, and supplier relationships
McAllister also reiterated Boeing’s focus on execution and developmental excellence even as some criticized the company for downsizing.
First and foremost is executing on our delivery priorities… We are investing in our people: providing new tools, new competencies, empower the culture, accelerate learning, driving decisions to the factory floor away from just offices… Automation is important. It’s as much about safety and ergonomics as it is about the bottom line… When we took 777 production down, we had to make reduction in head count. The vast majority was voluntary. Rightsizing has been an action taken all around our business. Management is affected, not just the people on the factory floor making our progress.
McAllister also spoke about the need to adjust Boeing’s supplier relationships even as the carrot of the NMA (new medium-sized airplane) dangles in front of them:
We need same kind of accountability with our suppliers as we do internally within Boeing. We are putting a lot of focus on energizing our supply chain… We have not made any decisions on suppliers [for the NMA]. We want to take the time to synthesize the learnings from previous programs: the good, the bad, and the ugly. We’re taking a hard look at the right competitive supply chain.
On the importance of China and free trade
Mounir re-iterated the importance of China to Boeing’s present and future: “China is the 2nd largest market for us. It’s 25% of our sales and 33% of 737 sales. It will soon be our number one market.”
It will be interesting to see how Boeing balances this against the threat of a Chinese, a Sino-Russian, or even a Sino-Canadian commercial aircraft offering. Even if it is not there today with the COMAC C919, at some point China will figure out how to manufacture a commercially-viable airliner.
At that point, the Chinese market may diminish and much of the Asian market will at least split into three (for both political and commercial reasons). This is a couple of decades away, but in the aviation industry that isn’t actually that long.
Mounir also made predictable comments about the importance of free trade: “Free trade promotes more sales. Everyone in DC is tuned into this.”
The latter sentence doesn’t bear much resemblance to reality though Mounir has to say it that way lest he offends the administration. We’ll leave our criticism of the Trump administration’s myopic and mind-numbingly idiotic approach to trade policy for another time and forum.
On the Bombardier ITC dispute and Boeing’s relationship with Delta
Mounir’s comments are rendered a bit ironic by his follow-up commentary on the ITC dispute with Bombardier: “When you price airplanes, you price them to compete in certain markets. If someone is giving away airplanes for free, I have a problem with it.”
First and foremost, the notion that Boeing has never undercut competitors on pricing doesn’t necessarily hold water. Second, free trade (which we agree with) comes with this caveat – sometimes other countries subsidize goods that they sell to American consumers and companies.
Now, in reality, this is really good for the economy because it means that other countries are subsidizing our consumption (we get cheaper stuff) and/or making our companies more cost efficient. But it’s a pretty natural outcome of free trade. You can’t say that you want free trade and then condemn Bombardier in the same breath.
Both McAllister and Mounir also tried to downplay concerns about the relationship with Delta.
Delta has smart people and will make judgement based on best product for their mission. Our dispute is with Bombardier and its predatory pricing, not Delta. We have no issues with this important customer.
I won’t comment on the relationship between Delta and Boeing. But I will say Delta is a very important customer. We will continue to support them and compete vigorously for their business.
We are not as convinced, given that Boeing winning the case would cost Delta hundreds of millions of dollars in cash. The good news for Boeing is that Delta’s corporate demeanor under Ed Bastian seems to be to take things less personally, so in the long run, we think this will turn out okay. But it would be a stretch to say that everything is hunky dory.
On the 777 and 777X
Mounir downplayed concerns about the state of the 777X backlog, pointing to replacement cycles that would begin in 2022-23.
When you look at the replacement cycle that will kick in for widebodies in 2022-23, the early 777-300ERs will have to be replaced. There will be a surge in Chinese demand when the next “5 Year Plan” kicks in. The prospect of China sales (of the 777X) are dramatic. I also think Lufthansa comment about 777X deferrals are being taken out of context. There have been no discussions to defer them. Every one of our 777s has potential to be replaced by a 777X, along with A380s and 747s. Emirates 777X are just replacements not growth.
McAllister reiterated Mounir’s comments: “I like what I see in terms of the replacement market for [large] widebodies in early the next decade.”
Our view is certainly that the long run demand for the 777X is pretty robust – it is the most economical very large aircraft (VLA) offered on the market today, and that includes Boeing’s own 747-8 and Airbus A380 and A350-1000.
The 777-9X and A350-1000 will largely split the large widebody market over the next decade plus, with the A350-1000 used by customers for whom the 777-9X is a touch too big.
The problem for Boeing is less the long run demand, and more the potential of being unable to sell out the plane in 2020 and 2021 if some of the deferrals from the Middle Eastern carriers come to fruition. If you look at the large 777-300ER customers that haven’t ordered replacements, they aren’t exactly likely to place massive 777X orders anytime soon.
Air France-KLM (57 frames) isn’t in sterling financial shape and has already ordered the Airbus A350 (no A350-1000s yet). Turkish Airlines (33 frames) is facing the same financial woes as its Middle East peers (and has lost more tourism traffic), making it unlikely to buy more lift anytime soon.
Air China (23 frames), China Southern (10 frames), and China Eastern (18 frames) will all buy the plane, but will likely do so on a timeframe set by the Chinese government. The 777-9X is too big for Air India (15 frames) and Jet Airways (10 frames).
Japan Airlines (13 frames) has ordered the A350-1000 as a 777-300ER replacement. Aeroflot’s (15 frames) ability and desire to purchase the 777X is restricted by geopolitics, though perhaps less so under the current U.S. presidential administration.
Air Canada, with 19 777-300ERs and 6 777-200LRs is a credible buyer for both the 777-9X and the 777-8X. Saudia (with 33 frames) is also a credible buyer, but its 777s are newer and don’t fit an early 2020s replacement timeline.
Eva Air (33 frames) is a credible customer as well but has very young 777-300ERs that it used to replace 747s. And Korean Air (20 frames) is again a credible buyer with a very young 777-300ER fleet. There may well be an additional 200-300 orders amongst that group and other customers like American Airlines and United Airlines (20 frames and 14 frames but very young fleets).
The problem is that none of them are likely to be for 2020-2022 delivery. The 777X has a timing problem, and that may prevent Boeing from getting back to 8.3 aircraft/month anytime soon.
McAllister tried to downplay the difficulty Boeing has had bridging the 777 Classic to the 777X: “2017 is sold out (of 777 delivery slots). We feel good about 2018-19. A number of sales campaigns out there so we’re in good shape for those years.”
We outline this in our 777X yesterday.
On the 737 program
McAllister used the forum to take a deserved lap of victory on the 737 MAX: “We feel good about where we are on, on execution with upping the ramp rates. We managed well through the Leap engine issue.”
The 737 MAX may have very real sales challenges, particularly for the MAX 9, and we are not convinced that the MAX 10 is a home run. But you can’t fault Boeing for the development and rollout execution it displayed – night and day with the 787 and even Airbus with the A320neo.
On the NMA
We addressed Mounir’s and McAllister’s comments in our NMA analysis published yesterday.