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Airbus Takes a Risky Course and Holds the Line on Production

The Motley Fool logo The Motley Fool 9/26/2020 Adam Levine-Weinberg
a large passenger jet flying through a cloudy blue sky: Airbus Takes a Risky Course and Holds the Line on Production © Provided by The Motley Fool Airbus Takes a Risky Course and Holds the Line on Production

Airbus (OTC: EADSY) ended last month with a whopping 7,501 commercial jet orders in its backlog. That's close to a record high and represents more than eight years of production at 2019 production rates.

This big order backlog hasn't shielded Airbus from the COVID-19 aviation downturn, though. The European aerospace giant has been forced to cut production significantly this year. With air travel demand showing no signs of recovery so far, Airbus faces pressure to cut output even further. So far, it is resisting this pressure, according to a recent Reuters report. This is a risky strategy that could pay off if demand rebounds meaningfully within a year or so, but could backfire otherwise.

Airbus has reduced production

Airlines across the world are bleeding cash and have cut capacity dramatically. As a result, even those that had aggressive growth or replacement plans entering 2020 now have no need for new jets in the near term. This led to a sharp drop in aircraft deliveries at both Boeing (NYSE: BA) and Airbus last quarter.

a large passenger jet flying through a cloudy blue sky: An Airbus A350 flying in front of a cloud. © Airbus An Airbus A350 flying in front of a cloud.

Boeing is radically slashing production to match demand. Wide-body production will decline by about 50%. Demand for freighter and military variants of the 747, 767, and 777 is the only thing preventing an even bigger output cut. Meanwhile, it plans to gradually ramp up 737 MAX production to a rate of 31 per month by early 2022. That would still be 46% below its previously planned production rate of 57 per month. But with more than 450 737 MAX jets in storage waiting to be delivered, it can't go any faster.

Airbus has also reduced its near-term wide-body production plans by nearly 50%, albeit from a lower base. However, it made more modest adjustments to its narrow-body output, cutting A320-family production by about a third and making only token adjustments for the A220.

Trying to avoid further cuts

The A220 and A320 narrow-body families have massive backlogs relative to their pre-pandemic production rates. Nevertheless, many industry figures believe Airbus is still over-producing in light of growing evidence that the current aviation downturn will be longer and deeper than many airlines had initially projected. Airbus isn't heeding those warnings, though. It recently decided to maintain A320-family output at a rate of 40 per month following an internal review of production plans.

There are at least two reasons why Airbus may be loath to cut narrow-body production further. First, additional production cuts could endanger suppliers and force Airbus to reduce its workforce further, jeopardizing its ability to increase output again when demand recovers. Second, the big backlog for the A320neo indicates that while airlines are eager to defer deliveries now, there could easily be another supply shortage for the type by the middle of the decade.

a large commercial airplane flying in the air: An Airbus A320neo flying over a body of water. © Airbus An Airbus A320neo flying over a body of water.

The big risk for Airbus is that it's building at a rate exceeding current demand. For example, Delta Air Lines (NYSE: DAL) is one of the best-capitalized airlines in the world. It just raised $9 billion backed by its loyalty program, boosting its cash and investments balance to more than $20 billion. Nevertheless, Delta wants to defer at least 40 Airbus aircraft deliveries previously scheduled for 2020, according to Bloomberg.

As of February, Delta was scheduled to add 66 new Airbus jets to its fleet this year. It took delivery of just 10 jets from Airbus in the first eight months of 2020; so far in September, it has taken five more. Despite having plenty of cash to pay for additional deliveries, Delta is sticking to its plan to minimize capital expenditures this year.

If Delta is playing hardball about near-term jet deliveries, it's safe to say that airlines with weaker balance sheets are negotiating order deferrals even more aggressively. With many airlines at risk of bankruptcy, Airbus has to tread lightly when it comes to enforcing sales contracts.

A precarious balance

It's certainly possible that maintaining production rates at current levels rather than cutting further will pay off for Airbus, even if some completed planes sit in inventory for a while. To continue with Delta as an example, the airline already retired its MD-88 and MD-90 models this year, and is scheduled to retire its 737-700 and 777 jets before 2021. This puts 105 of its 898 mainline aircraft -- as well as at least 17 other planes -- out of commission. If a vaccine is widely available within a year, driving a meaningful rebound in traffic in the second half of 2021, Delta could need to replace these retired planes in a hurry.

If many other airlines find themselves in a similar situation, Airbus could make substantial market share gains relative to Boeing by maintaining higher production through the crisis.

That said, the risk in Airbus' plan is clear. It isn't likely to find buyers to take delivery of 40 A320-family jets a month in the near term. If it builds jets with plans to deliver them in 2021, it will face a huge near-term cash flow headwind. And if airlines are still accepting few if any aircraft deliveries a year from now, it could wind up in severe financial distress.

Adam Levine-Weinberg owns shares of Delta Air Lines. The Motley Fool recommends Delta Air Lines. The Motley Fool has a disclosure policy.

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