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Morningstar | Airbus 2018 Guidance Loses Altitude but Shares Take Off Anyway. See Updated Analyst Note from 31 Oct 2018

Although Airbus lowered its 2018 guidance, shares increased nearly 6% as strong operational execution on the A350 and the pricing premium on A320neo drove profits up year over year. Despite the rally in shares, narrow-moat-rated Airbus is still trading at a slight discount to our fair value, which has been increased to EUR 106 from EUR 104 to account of the time value of money since our last update.

Airbus' adjusted EBIT (operating profit) rose to EUR 1.6 billion compared with EUR 0.7 billion last year with margins doubling to 10.2%. The A350 and A320neo ramp drove this profit growth. The former continues to ramp up nicely and management confirmed that it will hit rate 10 per month by year-end, which vindicates our forecast calling for break-even program profit contribution during the first half of 2019. A320neo deliveries were up year over year at 222 this quarter, as Airbus began to recover from GTF engine delays. This led to higher operating profit thanks to the pricing premium on the A320neos entering the mix. Revenue rose 20% year over year thanks to 52 more commercial aircraft deliveries this year combined with higher defense revenue.

However, management moved 2018 guidance down. The full year delivery target was reduced due primarily to lower A330 deliveries linked to delays on Rolls Royce's Trent 7000 engine. Specifically, management changed its wording for delivery guidance from over 800 commercial aircraft delivered excluding A220 (C Series) models to around 800 including the A220. Due to lower A330 deliveries and the A220 incorporation, which is creating 300 million headwind this year, Airbus is now guiding to 2018 free cash flow below EUR 2.95 billion with management apparently targeting EUR 2 billion. But Airbus held the line on adjusted operating profit guidance of EUR 5 billion. We think lower A330 profits are being offset by excellent execution on the A350's recurring costs and less dilution than originally anticipated from the A220.

Airbus is burning through cash, which isn't that unusual, but the negative EUR 4.2 billion free cash flow before customer financing and divestments has been exacerbated by delays on A320neo engines and by A400M costs. Airbus still anticipates the A400M program to burn through about EUR 1 billion of cash during 2018; the company had delivered 12 transport aircraft at end of third-quarter 2018. It appears that negotiations on new A400M contract terms with launch customers is proceeding a bit slower than expected. However, management maintains that even if the interim agreement expires at the end of November without a comprehensive renegotiation, this won't have an impact on 2018 results. Next year the A400M should consume less cash--probably around half of the 2018 cash burn we think--but this may be partially conditioned on the renegotiations. Airbus also contributed EUR 1 billion of cash to its pension plan this quarter and management flagged the possibility of further contributions during the fourth quarter of this year.

We think a net book/bill of 1.0 times will likely prove elusive for 2018 with only 256 net orders booked to date versus a delivery target of around 800 aircraft. Widebody demand in particular remains soft and Airbus has landed only 58 net orders year to date. We attribute this weak order intake to delays with the Rolls Royce Trent 7000 engines on board the A330neo combined with customer concerns that problems on the Boeing 787 Trent 1000 engine will bleed over into the Trent 7000, which is a derivative of the former. Specifically, we believe this is causing customers to either take a wait-and-see approach or to just order GEnx powered 787s in lieu of an A330neo. In addition, the sudden resignation of Eric Schulz as chief salesperson last month after less than a year in the position--Airbus veteran Christian Scherer has taken over the head sales role now--certainly isn't helping matters.

Turning to the largest widebody aircraft, the A380, deliveries to Emirates are caught up in a dispute between Rolls Royce and the airline over pricing and fuel burn performance, which may cause delivery delays. Management confirmed that the A380 currently sits at zero profit contribution but that the ramp down to six aircraft deliveries by 2020 will likely create EUR 100-200 million of profit and cash headwind annually. We don't see Airbus being able to get back to breakeven at its currently envisioned production rate of eight A380s next year and we think at least 10 aircraft deliveries annually--something we don't envision occurring--are required to get back to breakeven.

Management confirmed going to rate 60 (on an 11.5 month production calendar) on the A320 during 2019. In addition to the engine delays on the A320, higher levels of automation, the inauguration of a fourth final assembly line in Hamburg, and the production complexity of the highly customized A321LR cabin are creating challenges on the A320 ramp. But Airbus seems to have control over its internal challenges and has moved to ring fence the A321LR production in order to keep its manufacturing lines humming along. On the A330 program, management again mentioned a delivery target of around 50 aircraft for 2019 and we think that if Rolls Royce recovers, this target is achievable. However, based on our forecast of 50-60 A330ceos in the backlog going into 2019, Airbus doesn’t have a significant buffer of legacy A330ceos to backfill missing neo deliveries.