EUR 850.00 For Business Accounts Only

Morningstar | A350 Lifts Airbus 2Q Results; We Love the Fundamentals but Shares Are Fully Valued. See Updated Analyst Note from 26 Jul 2018

Solid execution, working through launch pricing, and the introduction of the 1000 variant on the A350 program enabled Airbus to double its adjusted EBIT year over year this quarter to EUR 1.15 billion. The company’s other businesses also registered year-over-year margin expansion but due to Airbus’ dominance--which has increased to 75% of revenue--we calculate that defence and space and helicopters only accounted for about 12% of profit growth in the quarter. Airbus closed the C Series acquisition, renaming it the A220; the program accounts for about EUR 3 of our fair value estimate.

Management updated guidance for adjusted EBIT to EUR 5 billion down from EUR 5.2 billion, attributing the change to the A220’s inclusion with management anticipating an EUR 300 million EBIT headwind over the back half of 2018. Over the first half of 2018, Airbus burned EUR 4 billion of cash before acquisitions, divestments, and financing compared with EUR 2.1 billion of negative cash flow during the same period last year. However, cash flow in the quarter came in stronger than we were expecting, and management stuck with full-year guidance calling for cash flow similar to 2017 levels of EUR 3 billion but stipulating that this was before A220 integration, which creates an EUR 300 million headwind. Hitting the cash target depends greatly on reaching the 800 aircraft (before any A220s) delivery objective.

We think the A320, Airbus’ primary profit driver that accounts for more than half of operating earnings, remains a challenge but we maintain the company can achieve 520 deliveries on the program (neos plus ceos) this year. The other pillars of our thesis are clicking into place with capital expenditures down year over year this quarter after dropping in the first quarter as well. That said, even after incorporating higher commercial aircraft margins in our forecasts, we view shares as fully to slightly overvalued relative to our new fair value of EUR 104 per share.

Airbus delivered 303 aircraft in the first half of the year; this means it needs to ship about 500 aircraft over the remaining months to hit its 800 aircraft delivery target; we think it can do it for three reasons. First, Airbus shipped nearly 60% of total annual deliveries during the back half of 2017 and 2016, so this is nothing new. Second, GTF engines are now available and the parked aircraft are declining from their peak in late May. Third, June deliveries portend well for hitting the 2018 delivery target with 67 narrowbodies shipped in the month, the highest monthly rate ever achieved by Airbus.

Although demand remains light for large widebodies like the A350-1000--noting that the larger A350 did pick up 12 orders and commitments at Farnborough--we think the A350-900 variant should see increased demand over the next few years as older, smaller widebodies reach retirement age. Following the recent update in Airbus and Boeing's long-term market forecasts, we note that Morningstar continues to forecast higher demand for small widebodies than either manufacturer, coupled with comparatively lower demand for large widebodies.

This market trend will be even more important for the struggling A330neo aircraft. The A330neo continues to lose share to the 787 in the market because of what we think are Boeing's efforts to clear the way for the potential introduction of a next-generation midsize aircraft. While firming up of the AirAsia order at Farnborough certainly alleviated some of our concerns, we think that the firm order backlog for the A330neo will stand at around four years of production at the end of this year. Moreover, despite Uganda Airlines' letter of intent at Farnborough for two A330-800 neos, we believe that this variant may not proceed because its firm backlog still stands at zero following the Hawaiian Airlines cancellation.

Airbus management confirmed on its call that it anticipates hitting rate 60 in 2019 on the A320. But significant confusion still seems to exist around the rate 63 number (an annualized level of 725 aircraft on Airbus' 11.5 month narrow-body production calendar) being thrown around in the media. We believe the best way for investors to think about the 63 production rate is that it represents a call option on higher narrow-body production: Airbus’ supply chain has committed that it can go to this level but suppliers might not appreciate Airbus calling this option right now. Moreover, we think Airbus will wait until A320neo deliveries get back on track later this year before making any moves to push the supply chain toward higher rates. We’re forecasting an A320 monthly production rate of 61 in 2019, rate 64 in 2020, and rate 67 in 2021.