05 October 2014
Last week, I wrote about Boeing's decision to ramp up 737 output to 52 per month in 2018. I sounded a cautionary note about long-term overcapacity, particularly if Airbus matches Boeing. But I'm starting to think there's no reason to worry; this announcement is far from certain to be executed. Consider the factors that could derail the ramp up:
First, we're talking about 2018. A lot can happen in four years. Over the past five years, single aisle production has been massively increased by a combination of three factors: low interest rates, expensive fuel (which makes new jets more appealing than keeping or buying cheap older ones), and fast growth in emerging markets (primarily the BRICs).
Today, the BRICs are down to just China; Brazil, Russia, and India have slowed their jetliner buys considerably. Interest rates are anyone's guess, but they can only go up. If Export-Import Bank funding goes away, that would also increase the cost of cash for jet customers. Fuel prices can only cause problems too—if they go much higher, that hurts airline profits; if they go lower, that increases the appeal of keeping older planes.
Also, what happens if there is a recession between now and 2018? The last one began a little over a decade before 2018. It would be nice not to have another significant economic downturn prior to 2020, history suggests that's not very likely.
Second, there's the problem of changing horses midstream. There's very little risk that Boeing and its suppliers can't execute on a ramp up involving a single jet family, but remember that the new MAX model is arriving right in the middle of this. The Seattle Times' Dominic Gates has a superb piece on the topic, citing 737 program manager Bev Wyse, "that by the time the rate hits 52 per month, fully half the planes rolling out — 26 jets — should be the MAX model." The MAX version involves a new engine and extensive airframe changes. The transition from NG to MAX could easily create major challenges, particularly when the company is building at a rate of more than two aircraft per day.
Third, if the shift to MAX production doesn't go as planned, or if there's any kind of delay to the MAX program, will there be enough demand for the current 737NG model to keep the production momentum going? Today, there are about 1,700 737NG orders on firm backlog. New orders have slowed markedly, and customer deferrals (in favor of waiting for the MAX model) may become an issue too. There won't be much margin for error, and even a six month MAX delay could result in declining output.
There's the very real chance that this rate hike announcement might just be an effort to promote investor confidence. Boeing's defense side is under heavy pressure. The profitable 777 twin aisle, also at record production levels, is set to decline in the next few years as customers wait for the 777X in the next decade. The 787 is a long way from turning cash positive. Thus, emphasizing 737 rate increases is one of the few credible ways Boeing can promise revenue growth, even if those rate increases are far from certain.
Our bottom line is that Teal Group is not changing its 737 forecast as a result of last week's announcement. We regard the 52 per month rate as a potential upside.