EADSF - Boeing: The Real China Message

2023-03-13 11:00:00 ET

Summary

• The market prospects of Boeing in China should not solely be viewed through the lens of geopolitical tension.
• Realities of the Chinese market include a dependency on Boeing that will not be undone any time soon and aspirations to become self-sufficient for which Boeing is of importance.
• The Chinese airplane market is so big that lost sales in the market are difficult to be compensated for as shown in market forecasts.

I have received several questions regarding some points brought up in the report, which I will address in this counter report. I’ve been working on data collection and processing for months now to do an elaborate reporting on the implication of the US-China, and even with a big dataset, the issue is so complex that it might take more time to actually be able to provide a data supported deep dive analysis, but with the data at hand I can already answer some questions regarding the prospects of Boeing ( BA ) in China and potential near-term losses.

Boeing Defense: Is There Upside?

With the situation in Ukraine there has been expansion in defense budgets, more particularly in Europe. What we're currently seeing is that Boeing solutions, they're not extremely high in demand. Boeing has a defense business that has been having big challenges due to fixed-price development contracts, which forced the company to reorganize . In some way, if Boeing re-invents it engineering innovative capabilities it can benefit. The current situation, however, is that modern problems provide modern solutions and Boeing doesn’t provide a lot in that area. As part of the German increase in the Defense budget, the F-35 became the preferred selection while Boeing was selected for the longer overdue CH-53G replacement while losing a potential sale of 30 F/A-18E/Fs and 15 EA-18Gs. So, what seems to be happening is that with expanding defense budgets the pricey F-35 is being preferred over what should be a cheaper F/A-18. So, countries are willing to pay more for a more modern defense solution.

The interests currently lie in missile defense, hypersonics and fighters and the reality is that Boeing does not have the more modern solutions in that area or has been selected to provide the solution. In those areas, data from the evoX Defense Monitor shows that Boeing has a 19.3% share in the contract awards since 2018, and if we look which products are getting those contracts we can conclude that with the exception of the F-15EX it are all contracts for older products. So, Boeing is primarily gathering contracts for older products.

The more modern F-15EX is a fighter jet that countries with no ability to get cleared for F-35s might be interested in or when the F-35 is an overkill. For instance, Israel has requested F-15EX for activities for which the F-35 is "too much fighter jet." India is a possible candidate for the F-15EX as well. Boeing will put a halt to F/A-18 production in two years. Most contracts, around 85% of all contracts, that Boeing received over the past years were for sustaining and modernizing the existing fleet and the fact that Boeing will stop production of the F/A-18 by 2025 shows that higher defense budgets is not necessarily something that will directly result in an improved demand profile for specific popular fighter jets.

The Future Vertical Lift program has been separated into various subprograms and the Boeing-Sikorsky solution lost from the bid that Textron ( TXT ) entered. Where Boeing has some bigger opportunities in my view are some contracts on which it already incurred losses including the MQ-25 tanker drone and the fighter jet trainer aircraft , which Boeing ended up winning years ago. Another opportunity is the MQ-28 drone which could be in demand to be paired with fifth- and sixth-generation fighter jets.

So, while demand for defense products is certainly there it seems to be mostly focused on areas where Boeing does not provide the best solutions.

If we look more specifically at Taiwan what we see is that Boeing has just $718.3 million in contracts for Harpoon Coastal Defense System. In total, including known FMS sales to Taiwan there is $47.7 billion in contracts to Taiwan since 2017. Boeing only accounts for roughly 1.5% of that. While I would like to say that defense opportunities are big and indeed when viewed broadly they are, for Boeing getting a piece of the pie is more challenging due to their product line up and the products that are actually high in demand at this point. There's no big overlap between those two.

Boeing Order News: Not So Much About Diversification

Boeing and Airbus recently announced tentative agreements with Air India for the sale of more than 500 aircraft when options are included. Important to note is that these orders are still pending finalization. I discussed that in detail in a separate report . I cannot speak for the figures that others use, but I have received comments from readers pointing out that the value I provide is way lower than can be found elsewhere and that is indeed true. The reason is simple: While other analysts go by list prices which are significantly higher than the sales value of the aircraft, I go by the market values.

There also is the notion that manufacturers can diversify away from China or that some orders such as the order from India can replace the missed sales from China. That's just simply a flawed reasoning that holds particularly true for India where Boeing actually has to repair some of its market share due to the demise of Jet Airways while competitor Airbus seemed to have bet on more airlines in India selling them commercial airplanes.

What also should be kept in mind is that forecast demand for China is magnitudes bigger. So, there's literally no chance that Boeing could truly pivot or diversify in a successful way. Putting it differently: If hypothetically Boeing were able to capture just a third of the Chinese market in an unrestricted scenario and we should now consider that to be lost, it would have to capture the entire Indian market to make up for that. It’s easy to approach every airplane sale for Boeing as an offset to China, but that's simply not the case. There are small areas where Boeing could concentrate on to offset some sales but it really is not the case that we are seeing offset sales running in the hundreds of units. Simply because a significant number of sales also is to just maintain share in the market excluding China. Boeing for instance lost sales from Qantas and Air France-KLM, but I rarely hear people saying that sales in other markets are offsetting the lost sales to those customers. The China offset argument is something that it just brought up way too often without viewing the realities of the market.

To provide additional scope, I have looked up the numbers of Boeing 737 aircraft that have a place with the big Chinese airline groups. These numbers include the younger Boeing 737 MAX but the bulk of these aircraft are the older Boeing 737 Next Generation which need to be replaced in the coming years. Just that replacement potential covers 60% of the demand that comes from India. If you have to share that market with a competitor, namely Airbus, there is no way in which you can offset cover 51% of demand for aircraft but in China this is 58%. So, incorporating growth with the current installed base in mind Boeing sales in China should be 3,150 aircraft in the single aisle market. In other words, India with its full demand forecast of 2,000 single aisle aircraft can never offset what Boeing would be losing over the longer term in China… not even if it would magically capture a 100% market share in India.

The Real Beijing Message For Boeing

China indeed intends to become self-sufficient in their need for commercial airplanes. That's no secret and Boeing knows it, so does Airbus. The notion that Boeing would be restricted from the market or no longer would be able to maintain share in the market is something that could be true but misses a lot of context. Among the six biggest airline groups in China, Boeing has a total of 1,575 aircraft or 45% of the market. 80% of the Boeing fleet are Boeing 737 Next Generation airplanes and there are 103 Boeing 737 MAX airplanes. This already shows that replacing Boeing in the market is going to be a significant challenge. Airbus supplies around 100 aircraft per year to China, COMAC intends to reach 150 aircraft per annum in the coming five years. Even if those projections are realized, Boeing and Airbus cannot even replace the Boeing 737 Next Generation fleet. Aircraft replacements are driven by demand and age of the aircraft with further deliveries for growth. What we see is that Airbus and COMAC don’t have the capacity required to service the Chinese market, not even when viewing the combined production for the coming years. So, we don’t even have to speak about replacement and growth requirements.

China knows. They know it very well. When Boeing started remarketing some of the nearly 140, it shocked China and they responded fast . When China started coming out of lockdown late last year, it also quickly cleared the Boeing 737 MAX. So, the real message that China is sending is that for the foreseeable future they do need Boeing airplanes in the same way they need Airbus airplanes. That also can be derived from our research to find out how many airplanes have returned to service. What I found is that 21% or 20% of the Boeing 737 MAX airplanes that already were delivered to China have entered service while preparation are ongoing for another six airplanes. The direct message that China is sending Boeing is that they need those airplanes to support their market. Boeing has been very clear that the first step would be to support customers reintroducing the MAX to the fleet and that is happening now and if demand further strengthens, China will grow even more interested in taking the pre-built 140 MAX aircraft.

Initially the reintroduction of the Boeing 737 MAX has been a bit slow. That could of course be driven by geopolitics, but the fact is that the airplanes need to be reworked and crews might require additional training on the reworked flightdeck and its functioning. So that introduction is somewhat slow, possibly exacerbated by the fact that while there was absolutely no demand for new airplanes China accepted deliveries of over 200 Airbus airplanes. At the time, with demand for air travel being low it carried more value for China to strongarm the Boeing 737 MAX and keep it grounded. With high fuel prices and increasing demand that is no longer the case… and the COMAC C919 that is going to eat market share from Boeing: One has been delivered so far.

So, yes over time the C919 should get a piece of the pie but it's not happening yet. You can look at the past years and say that Boeing only delivered X aircraft, giving away market share to Airbus. Reality is that the past years were littered with impacts from the pandemic and the problems on the Boeing 737 MAX and Boeing 787 resulting in an inability to deliver the airplanes that are high in demand in China on a normal day. Looking at the years from 2015-2018, we see that despite the geopolitical tension between China and the US, Boeing actually delivered more airplanes to China than Airbus with a 57% market share. So, you can really question how big that market share erosion is really going to be going forward. When the China and the US were battling on trade daily, even then China carved out the tariffs in such a way that it would still have access to US built airplanes.

President Xi has been elected for his third term and while the geopolitical tension is not going to fade overnight, it also provides a window for a more constructive dialogue with the West and primarily the US allowing for future Boeing sales. China likes to flex their buying power for commercial airplanes, so as part of a more constructive dialogue we could see Boeing airplane orders and fresh deliveries.

Boeing As Part Of A Self-Sufficient China System

One thing that is quite often overlooked is Boeing’s role in China’s aim to become self-sufficient for their air travel needs. Boeing has actually partnered with COMAC over the years and most recently in 2022. That's Boeing’s way of allowing itself access to the Chinese market and it shows that Boeing is not going to fade fast from that market. COMAC still has a lot to learn and Boeing has a delivery center in the US that can help China expand its aircraft manufacturing and completion foot print domestically. Not allowing Boeing to enter that market will strangle China’s ambition to produce its own aircraft. They have the C919, but realistically that's an airplane that suffered delays so there still is a lot that China can learn in the areas of development, testing and serial production.

Let’s say that ties do not improve with the US. Then the reality is that the US can kill the delivery of all in-demand aircraft to China overnight. What binds the Boeing 737 MAX, Airbus A320neo and COMAC C919 is that they are all powered by CFM LEAP turbofans and the Airbus A320neo can be powered by the PW1100G geared turbofan from Raytheon Technologies ( RTX ). If things don’t improve, the reality is that just by providing export bans on turbofans the US can bring the Chinese air travel market as well as airplane manufacturing aspirations to its knees. That's certainly not something that President Xi wants as he has to keep a middle class happy and grow that middle class for prosperity in China.

What's Boeing Stock Worth?

Driven by cash flow projections towards mid-decade, I do believe that Boeing stock is worth at least $240 and possibly even $300 providing 20 to 50 percent upside from current levels on the assumption that Boeing is able to deliver on its projections.

How Much Does A Boeing 737 MAX Cost?

The Boeing 737 MAX has a list price of $121.6 million, but its actual sales price is closer to $52 million.

Conclusion: Boeing Needs China, China Needs Boeing

If you consider the full picture, I think the only conclusion can be that China is not a market that you can replace. You can offset it in very remote order campaigns, but the Chinese aircraft market is so big is that you have it or you don’t but offsets are so big that other geographical regions provide little space for offset orders. That's an oversimplification that does not recognize the reality of the different geographical markets.

The data shows that even when the US and China were playing hard on trade, Boeing was still delivering more airplanes to China than any other jet maker. So, while I do understand the concern over the longer term you could really wonder how big of an impact the Sino-American relations has when considering the full picture which includes aircraft demand, aircraft availability and aircraft manufacturing aspirations within China. Boeing plays a role in that. A role that towards the end of the decade cannot be simply replaced by a manufacturer which delivered one airplane to customers so far.

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