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Morningstar | Airbus Turns on the Afterburners and Leaves the A380 in Its Jet Wash

Airbus delivered its A380 cancellation announcement with 2018 results that crushed consensus and our expectations. The company's adjusted EBIT in the quarter landed at EUR 3 billion versus consensus of EUR 2.4 billion. The A320neo premium, a $0.05 improvement in maturing hedges, and higher A350 pricing drove profits higher. The A330 and A220 as well as research and development spending partially offset these tailwinds. Given the strong 2019 outlook--the adjusted EBIT guide of around EUR 6.7 billion came in EUR 500 million above our estimates–we're moving up our forecasts and our normalized margins. As a result, we anticipate our EUR 106 fair value increasing by around 10%.

On the A400M program, management concluded that customer negotiations and this agreement should be approved and finalized during the first half of 2019. This rebaselining resulted in another charge--this time around EUR 436 million. The A400M ate up about EUR 1 billion of cash during 2018 (about the same as 2017) and we thought cash burn would moderate, but it looks like the program will consume another EUR 1 billion of cash (EUR 500 million in 2019 and EUR 500 million in 2020). Although we've been here before, we think A400M charges may finally be a thing of the past.

Management also announced plans to cancel the A380 in 2021. The program termination resulted in a EUR 463 million charge. We believe large additional charges are unlikely and management is guiding to a neutral cumulative cash flow impact over the next three years as restructuring costs and the forfeiture of customer advances are offset by inventory release. Airbus restructured its A380 reimbursable launch investments during 2018, and it looks like this might not be a significant issue since management didn't mention it. We'd also note that the A380 cancellation will remove an estimated annual EBIT headwind of EUR 100 million. In exchange for its A380 cancellation, Emirates placed an order for 40 A330-900s and 30 A350-900s.

Airbus is probably allowing Emirates to shift around advances from the A380 to the A350 and A330 orders, and we think the carrier's purchase plans are strategically significant. The A330 order helps shore up this program, which only booked 27 net orders last year (nine ceo variants and 18 neo variants). Two flagship carriers are now A330-900 customers: Delta and Emirates. The A350 deal with Emirates makes us wonder what the carrier will do with its memorandum of understanding to buy 40 787-10 aircraft from Boeing. We think it's conceivable that Emirates might not firm up this MOU, which is material, since converting it into orders would increase the 787-10 firm backlog by about 25%. The A350 order is also good news considering Etihad Airways' recent move to cancel its 42 A350-900 orders.

Commercial aircraft deliveries for 2019 are pegged at a midpoint of 885 compared with 800 aircraft in 2018 and our forecast before the call of 872 aircraft for 2019. We estimate that the A320 will account for more than half of the commercial aircraft delivery increase this year, with Airbus hitting rate 60 per month in 2019 followed by rate 63 in 2021. The adjusted EBIT guidance stands at roughly EUR 6.7 billion. We were at EUR 6.2 billion going into the earnings call. Airbus targets EUR 4 billion of free cash flow this year, which came in about EUR 800 million higher than our initial forecast. Less A400M cash burn contributes about half of the improvement relative to 2018 levels of EUR 2.9 billion of free cash flow; higher operating profits drive the remainder. Slightly higher capital expenditures and a step up on the A220's cash burn should partially offset these positive elements. According to management, less inventory growth could provide some upside to this cash outlook.

Turning to the other businesses, the helicopters segment and defense and space business turned in adjusted EBIT margin improvement for the full year. After controlling for divestments, helicopters posted a flat year-over-year evolution in revenue and the book/bill came in above 1.0 times (gross orders were up 18% year over year) thanks largely to defense order strength–notably the U.S. Army Lakota (51 orders) and the NH-90 (29 orders). Helicopters is also booking orders now on the H-160 twin-engine medium helicopter (15 orders in 2018) and anticipates certification in late 2019 and then deliveries in 2020. Despite the solid order intake on the defense side of the helicopter business, management remains cautious on the civil and parapublic helicopter market.

Backing out the dilution from the A400M, the defense and space business is running at double-digit margins currently and the business posted solid revenue growth during 2018 thanks to space activities and military aircraft. Encouragingly, the flagship Eurofighter program looks better positioned to capture follow-on orders after the Lockheed F-35 was removed from Germany's ongoing fighter competition. The Eurofighter is now the frontrunner in our view to replace the country's aging Tornado fleet and could garner about 90 orders should it beat out Boeing's F/A-18. Management also highlighted its agreement with Dassault to develop a next-generation fighter aircraft for the European market and that development contracts have gotten underway. We think Brexit further solidifies this partnership between Airbus and Dassault, who are erstwhile competitors in the fighter aircraft market.