Qantas Cancellations Show Boeing’s Vulnerability To Macro Weakness

Qantas Airways has cancelled an order for 35 Boeing 787-Dreamliners worth $8.5 billion due to continuing uncertainty in the global macroeconomic environment and rising fuel costs. ^[1] The challenging business environment has forced the carrier to post its first annual loss in nearly two decades since its privatization in 1995.

For Boeing (NYSE:BA), the cancellation has produced another setback to its 787 program, which has suffered numerous production delays. And as a result of this cancellation, the profitability of the program will come under increased pressure. However, we believe that as growth picks up particularly in Asian economies, the 787 program has the potential to add significant growth to the top line of Boeing over the coming years.

We currently have a stock price estimate of $75 for the company, approximately 5% above its current market price.

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The challenging business environment causes the order cancellation

The continuing euro crisis has resulted in lower-levels of business activity in Europe, and this has directly impacted the demand for flights to and from Europe. As a result, several airlines have had to lower their capacities on these routes. In addition, the slowing growth in China, India and other Asia-Pacific countries has contributed to an overall decline in the growth anticipated in the global airline industry post the downturn of 2009. Also, higher oil prices have impacted margins for airlines severely. Oil (Brent crude) rose from a range of $70-$85 per barrel in 2010 to remain above $105 per barrel for most part of 2011. At present, it is trading at $110-$115 per barrel after declining for a brief period in the recently concluded quarter. Such a challenging business environment has caused the Sydney-based Qantas Airways to post its first annual loss of $257.4 million in the year ending June 30 2012. Thus, the order cancellation is primarily an effort on part of the airline to save on expenditures and add capacity at a slower pace in light of the uncertain macroeconomic environment.

Profitability under the 787 program comes under increased pressure

However, for Boeing the profitability under the 787 program, which is currently coping with production delays, has come under increased pressure with this order cancellation. The first 787 entered service in September last year, nearly three years after its original schedule. These delays in delivering the 787 aircraft to airlines has impacted margins for the company in the form of compensation paid to airlines for delays. Qantas, which should have received these aircraft by now, announced that it would receive $433 million in compensation for the delay and deposit return from Boeing.

However, 787 program has the potential to add growth over the long-term

However, Boeing still has a strong order book for the 787. After accounting for the Qantas cancellation it still has orders for over 800 787-Dreamliners, out of which it has delivered 14 by the end of last quarter. ^{[2] [3]} Also, going forward we anticipate that as growth picks up, particularly in the Asia-Pacific region, airlines will continue to place orders for planes to add capacity as well as to replace their aging fleet. And thus, the 787 program has the potential to add significant growth to the top line of Boeing over coming years.

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1. Qantas Deals New Blow to Boeing Dreamliner, August 23 2012, online.wsj.com [↩]
2. Boeing order and deliveries, www.boeing.com [↩]
3. Q2 10-Q, www.boeing.com [↩]