Description

1) Execution risk is much lower than investors fear

Due to their utter failure last decade with the wide-body A380 program, Airbus has taken a slow and conservative approach to execution on its new A350 program. Everything is on track, well ahead of prior precedents the A380 and BA 787. Airbus also learned from BA’s problems with the 787: Airbus slowed design and production, increased coordination with the supply chain, took more in-house, and slowed testing and production ramp.  Airbus took their delays in the design phase, to avoid cost overruns. BA took their delays after finding problems with a total cost of $15bn.

Their A320 Neo series has minimal design changes. It is a mid-cycle upgrade to the A320 offering improved speed and 15% more fuel efficiency. The only parts that are new are the engines and the wings. Engines are now technically ready. Only risk is scaling up and cost overruns.

They have had problems with engines, but the technical issues are small because of how far along the design and testing phase we are. A realistic worst case is that execution costs them €1 in EPS in a given year and they catch up thereafter. given I am €1 ahead of street next year, i think there is ample room for execution problems.

2) Bulls focus on €8 EPS in 2020. But that is not even close to maturity on the A350 program and A320. There is a legitimate path to €12+ in EPS in the early/mid 2020s. Possibly €15

the A350 will only be EBIT breakeven in 2020. by 2023/2024, it should add another €2 in EPS tailwinds. Therefore, €8 EPS is not the normal EPS. by the time we hit 2019, investors can point to €10 in EPS which will support valuation. Absent a recession, 2023 EPS should be > €12. Possibly €15.

This implies Airbus will be similar to Boing in revenue, margin and EV once their programs reach maturity. This forecast makes sense as both will have two large successful programs and split the market 50/50.  It would make Airbus a double over 4 years.

3) Recession risk is not that bad because the backlog is 2x normal and air traffic continues to grow faster than production

 the secular story of airline traffic growing 2x GDP will still hold. A recession will defer orders but not lead to many cancellations. 1) Normal backlog is 3.5 years. right now, the backlog on the A320 is 8 years based on 2020 production levels and it is 6.5 years on the A350. There is ample room for orders to slow before future deliveries decline. For the backlog to normalize to 4 years the A320 backlog could decline 50% and the A350 backlog could decline 33% 2) BA and Airbus are building for 4.7% traffic growth, vs 5.2% long-term average and 7.0% recent trend. 3) The airline industry is more profitable and the risk of airline bankruptcies is lower. The impact should be less than 2009, which was not bad. That said, the stock would see a material drawdown in a recession.

4) the secular tailwind driving air traffic growth is real

Demand normally grows at 5.2% annually. Lately it is 7.0% on cheaper oil, the rise of low cost carriers, the secular shift away from material goods to experiences and EM demand. I believe > 5% is likely in the next 10 years on a continuation of the same trend. BA and Airbus are planning for < 5% demand growth, which should support delivery growth in the 2020s. > 5% traffic growth translates into > 4% deliveries growth given 1% more seats per plane. This should provide a buffer should APAC EM growth slow

5) even with a recession along the way, 2023 EPS should be €10-15. Realistically, towards the high end

Production is fairly well known given the backlog, assuming cancellation are not enormous in a recession (see above). Margins are based on company targets and the precedent that BA is currently setting. We should expect both to have similar revenue, margins, FCF and ROIC. this would support > €12 in EPS.

At 15x EPS, Airbus should double over 3-5 years. 15x is fair given that production will still grow given the secular tailwinds. Airbus has many years before it reaches peak EPS and will not need to invest in a new program until at least 2026.

Catalyst

EPS

Orders and deliveries

monthly global IATA air traffic growth

execution on engine supply chain issues (UTX, SAF FP, GE)