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Don’t Panic Over Weaker Jet Orders

Even with faltering demand for large wide-body jets, we still see investment opportunity in firms exposed to the strength of the narrow-body market.

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Aerospace data firm Ascend recently hosted an update on the aerospace market. The company was sanguine on current market dynamics but warned that indicators are flashing orange. Our nuanced view posits that larger wide-body jets remain the biggest concern for  Boeing (BA) and  Airbus (AIR), but narrow bodies look more secure. Regional jet growth looks underwhelming, but  Embraer (ERJ) still enjoys a commanding position. We point to Airbus,  Safran (SAF), and  United Technologies (UTX) as the three names that will benefit most from the narrow-body upcycle.

This year will see flat to declining commercial jet backlogs for the first time since 2009. But we don’t see order weakness as a reason to panic, particularly in narrow bodies. According to Ascend, narrow-body backlogs cover planned production rate increases to about 60 aircraft per month through the end of this decade, giving us comfort that rates will move up. Backlogs represent 9.5 years of production, and this cushion combined with hundreds of Airbus A320 and Boeing 737 operators provides manufacturers with potent risk-management levers. We note that manufacturers put these levers to good use in 2009-11, moving delivery rates up in the face of weak demand. In addition, Ascend displayed data showing a healthy narrow-body lease market, with used values still slightly above fundamental values.

As we have argued previously, the wide-body market is vulnerable because of faltering demand, excess capacity on international routes, and a wave of Airbus A330s and Boeing 777s potentially coming off lease over the next few years. According to Ascend, open wide-body slots will begin materializing as soon as 2018. The 777 drives this gap between production plans and backlogs. These 777 challenges plus a more mature 787 ramp-up puts Boeing in a difficult spot with its wide bodies. Year-to-date demand for wide bodies has been underwhelming, with a book/bill of just under 0.6 for Boeing and Airbus.

Ascend touched on regional jets, noting that deliveries are likely to bump along close to recent levels and order books provide a five-year cushion for manufacturers. The big news recently was the delay of the Embraer E-175 E2 entry into service by one year to 2021 as a result of scope clause restrictions not lifting. This lack of scope clause relief effectively means that the heavier Mitsubishi MRJ 90 and E-175 E2 will not be allowed to enter regional carriers’ fleets. Some analysts seem concerned about the scope clause restrictions remaining in place, but we see it as a net positive for Embraer over the near to medium term; the Brazilian company’s E-175 E1 version, which is scope clause compliant, is best in class, clearly beating out the Bombardier CRJ900 in terms of passenger comfort, and Mitsubishi doesn’t have anything existing to compete with it.

Much of what we postulated in August (see “Narrow Bodies Equal Fat Profits: How Investors Can Profit From the Aerospace Boom”) remains valid. We acknowledge that the commercial aerospace upcycle is long in the tooth now and production hiccups around United Technologies’ Pratt & Whitney geared turbofan engine have spooked investors. However, large backlogs, prudent airline supply and demand matching for shorter-haul domestic travel, a diverse customer base, a healthy lease market, and active backlog and production planning management from the manufacturers means we still expect a narrow-body production ramp-up.

Our forecast for 2019 of 53 aircraft per month for Airbus and 52 aircraft per month for Boeing (using a 12-month calendar for both) is below planned manufacturer increases but still represents a 20% increase over today’s narrow-body rates for Airbus and a 25%-plus increase over Boeing’s current rates. This will provide a tailwind to growth and profits for Airbus and Boeing over the midterm and create an installed base of serviceable engines for Safran and United Technologies over the longer term. Investors should stop worrying and learn to love the growth we see coming in the narrow-body market.

Chris Higgins does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.