Farnborough Air Show (FAS) Preview - likely to reinforce our cautious view on Civil Aerospace
FAS will take place July 11-15th in the UK. Air shows tend to be dominated by Civil Aero (CA) news rather than Defence, and this preview is focused on CA only. In recent months we have been increasingly cautious on CA stocks. We expect a subdued FAS, with relatively low orders, discussion on recent softer news flow (air traffic, airlines, growing macro/political risks), and a big focus on short-term execution challenges. We can flag one positive: with sterling at c30 year lows vs the $, for US visitors the entry tickets and hot dogs will be a lot cheaper.
* Increasingly soft news flow from airlines and on the global economy: As we
have argued in recent notes, the CA cycle remains at a strong absolute level,
with large backlogs, record airline profits, and above-average global air traffic
growth. But, share prices tend to be driven by incremental data, and the
direction of news flow has been much softer recently. (1) Airlines have flagged
weaker yields and excess capacity (Table 2). (2) Some airlines have deferred
existing orders (Latam Airlines, Delta) or delayed plans to place new orders
(Garuda Indonesia). (3) On June 2, IATA reduced its forecast for FY16 global
traffic growth to 6.2% from 6.9%. (4) We believe the Brexit vote, and likely
negative consequence for European GDP growth, brings downside risk to
IATA’s recent traffic forecast, airline profits (we have already seen warnings
from IAG and EasyJet), and potentially, civil aero aftermarket sales and aircraft
deliveries. (Figure 1 shows recent airline sector performance across the globe.)
* We don’t expect many orders at FAS: There are always some new orders at
air shows. But the usual pre-show trade press speculation about possible orders
has been noticeably lacking in recent months. In addition, neither Airbus nor
Boeing appears to be planning to launch any new products, which usually
stimulates new orders. Boeing is considering narrowbody options with some
combination of MAX 7.5, MAX 10 and middle-of-the-market offering in the
mix, but it is still early and we don’t expect announcements at FAS.
* Execution risks will be center stage: Large jet OEMs and suppliers have their
hands full with multiple late-stage development programmes (A330neo, 737
MAX, 787-10) and programmes in the early phase of a major production ramp
(A320neo, A350). Whilst these products should be drivers of long-term growth
and profits, staying on schedule and on cost is always a concern. Airbus seems
to be facing the greatest short-term challenges (A320neo, A350, A400M).
* Other civil end markets have risks: (1) Companies are likely to reiterate the
increasingly challenging markets for business jets and civil helicopters. (2) CA
aftermarket growth in Q1 16 averaged 7.8%, the best quarter since Q1 14. We
attribute this to the lagged effect of lower oil prices and good air traffic growth.
This bounce could last a few quarters but we remain wary of long-term
structural pressures and recent softer data (macro / slower air traffic growth).
* Supplier profitability in the spotlight. OEMs -- especially Boeing -- are
working aggressively to take cost out of the supply base, potentially generating
margin headwinds at suppliers. This issue does not lend itself to any major
development at FAS but we expect it to be a topic of discussion at the year’s
biggest gathering of investors and industry participants.