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AIR FP - Airbus


handycap5
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I like Airbus's common stock as a 3-4 year investment. I expect to at least double my money. Reasons for my thinking in no particular order:

 

1) it is reasonably priced on the current numbers. I think the company will be earning around 4 euros a share in 2016, 13.5x the current price.

2) it is very exciting on the numbers when one looks forward several years. i believe they will earn 7.40 euros a share in 2018, using current hedge book and exchange rates. There are 3 primary drivers of the lift in earnings. 1) FX. Airbus sells in dollars and has 40% of costs in non-USD, primarily Euros. And I think this understates "real" exposure once one accounts for Euro suppliers wrapped in USD contracts, which will be renegotiated over time. In 2018 on, the previous hedges start to fall-off, when I expect the earnings power to double. 2) The A320neo is going to be more profitable per unit then the ceo, i guess 2 million Euros per unit. 3) with 8 years of backlog and a strong rationale to minimize the toehold for the C919, Airbus is going to increase rate. These incremental units are going to come on at higher incremental margins.

3) Airbus used to have below average management and corporate governance. CEO Tom Enders appears to be doing a good job with costs and the French and German governments appear to no longer meddling with the business.

4) Good management decisions have led to selling non-core assets, particularly Dassault. The company has said it will use the proceeds to buyback 10% of their stock.

5) this is a world-wide industrial business with a duopoly structure. Underlying demand grows 5%+ pa, it has done that for 30+ years. But demand has ticked up a little above this rate, as reflected in current production and all time high backlogs, due to Chinese and other Asian demand (backlogs are very diverse, due to Europe and NA fleet replacement). load factors world wide are 80%+, all time highs since the dawn of the jet age, and not something that changes quickly without a significant recession. Unlike steel mills and aluminum smelters, where the Asians also had a huge increase in demand, prospects for the Chinese satisfying their own demand for commercial aircraft are dubious and many years in the future. And Boeing and Airbus seem to agree that the way to capture today's opportunity is to do relatively modest improvements to current programs, rather than moonshots, increase rates and prices, and lower the cost of the supply chain. I think margins and earnings will surprise.

 

there is a lot of interest on this board for RR, TDG, HEI. i find AIR FP much more attractive, either because the price-value relationship is much more attractive (such as TDG) or is better positioned for the future (such as RR). and somebody smart was willing to pay a fulsome price to buy a 30% op margin business building castings, forgings and fasteners for the aerospace industry (without the potential of significantly increasing margins, he/she must have been pretty confident on future revenues for the next many years).

 

but what do i know? i welcome the constructive criticism of those who don't think buying into the commercial aerospace OEM business located in Europe is a smart thing to do, particularly if you have an interesting data point to add...

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Haven't looked at airbus or boeing, but curious why you think it is better positioned than RR. Part of the thesis on RR - they will dramatically increase market share of installed engines during this cycle. So they are a levered play on airbus' wide body order book.

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Boeing & Airbus will both get competition from Eastern manufacturers, those planes, however, will still be powered by GE or RR engines. Choose wisely!!

 

every business is competitive. the jet age appears to be a technology break which changed the industry structure. since 2000, you have a stable 50/50 duopoly. now, you have unusual demand from Asia, all-time high backlogs, OEMs that are shifting from revolutionary to evolutionary development programs, are matching each others intensity on wringing out costs from the supply chain and improving their financial results, and have a rationale to burnoff backlog.

 

Hazy predicts C919 will be a potential competitor outside China in a decade. Prospects for a Russian-Chinese multi-aisle are possible outside a decade, and would need $25B+ USD investment. RR will be dealing with Boeing and Airbus for many many years, not the Russian-Chinese. like any business, there are things to worry about with AIR. But multi-aisle Chinese competitor is not one of them for me.

 

as mentioned, there are company specific reasons why Airbus will do very well in the next many years, which are not germane to RR or GE. and the price of the securities are much more attractive for the OEMs than the engine guys. one can buy AIR or RR, i find the former more attractive.

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I think it’s essential to remember that just about everything is cyclical. There’s little I’m certain of, but these things are true: Cycles always prevail eventually. Nothing goes in one direction forever. Trees don’t grow to the sky. Few things go to zero. And there’s little that’s as dangerous for investor health as insistence on extrapolating today’s events into the future. - Marks

 

 

So where are we in the aircraft cycle? Record profits for the airlines. The lowest oil prices have been in years. A strong order book that will provide planes well into the future. What could go wrong, right? 

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I think it’s essential to remember that just about everything is cyclical. There’s little I’m certain of, but these things are true: Cycles always prevail eventually. Nothing goes in one direction forever. Trees don’t grow to the sky. Few things go to zero. And there’s little that’s as dangerous for investor health as insistence on extrapolating today’s events into the future. - Marks

 

 

So where are we in the aircraft cycle? Record profits for the airlines. The lowest oil prices have been in years. A strong order book that will provide planes well into the future. What could go wrong, right?

 

very good. you don't usually get to pickup worldwide duopoly industrial businesses with underlying volume demand growing 5% with extremely high barriers to entry trading at 13.5x next year's earnings with reasonable prospects of doubling those earnings over next few years. why so cheap? because some people are afraid of "the cycle."

 

i should start by saying, the history of the industry is cyclical and their are lots of inputs that go into the ST demand equation, some of which are imponderable: load factors, fuel prices, financing costs, platform development, currencies, airline profits, etc. etc. this is not buy it when its down on their luck investment (btw, i like those investments too, but everyone i look at is buggy whip like - but if you have one - would you please share it?).  so one must be willing to own possibly longer than i have in mind - and i'm comfortable with that.

 

the underlying demand and earnings power growth i believe is very real. volume has grown for many years at predictable and consistent rates after smoothing out recessions. business value grows every year. i value based on what i think is most likely to happen (my 7+ Euro EPS in 2018) and my "normal earnings power," which is slightly below this. either way, i won't be impaired. my best guess is normal demand was 1,130 units in 2014, versus 1,352 delivered, so 20% above normal (but this is very crude as it is unit and not seat based - Asian demand skews toward single-aisles - there is a lot of water over there and tickets are priced like bus seats). i see future build plans as continuing above normal, then returning to normal trendline in/after 2020. it is easy to play with the  numbers yourself (see GMO's from Boeing/Airbus and wikipedia page on airbus/boeing competition).

 

10 years ago, i saw an alcoa deck of expected WW aluminum demand factoring in the Chinese growth in GDP/capita - prospects were 6%+ volume growth indefinitely. unfortunately, the Chinese saw the same numbers and built too many smelters, so it was a terrible decade for AA smelting. the same underlying dynamics are now driving appetite for Boeing/Airbus products, but the Chinese are a decade away from competiting outside China. Most importantly, domestic and WW load factors are at all time highs. they went from the high 60s in the 1990s to the low 80s today (partially because it is too expensive to fly around empty seats with expensive fuel). These are real people, with real money in their pocket, fulfilling a real underlying need by filling a finite number of seats. It would take many years of significant overproduction to bring load factors anywhere near their historical levels (LT, ignoring SARS, 9/11, those type events).

 

i share your apparent prediliction to be cautious of investment opportunities where end market demand is not below normal. but i try to skeptical and not cynical. my skeptism was alleviated in this case, largely because others underappreciate the earnings power, the security is priced so attractively, and the financial position and the underlying growth in the business allows for holding through disappointments.

 

howard marks and bruce karsh are primarily distressed debt security investors. they look for financial excesses on businesses that have solid underlying LT prospects, and this has allowed them to earn their equity-like returns in debt instruments. they profit from financial excesses in cyclical but fundamentally sound industries. they won't have an opportunity with AIR's debt, but maybe TDG's; i don't find anything in howards quote contradicts the attractiveness of AIR. i'm not being pollyannaish - it may just not be attractive to you.

 

one last thing, it is ambiguous whether Boeing and Airbus want lower or higher oil prices (holding all else equal, particularly the state of the world). they are selling fuel efficiency, so some oil inflation from here ($50 brent) is probably to their benefit.

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Took a quick look at Boeing. Looks like a good business but deeply cyclical. I assume Airbus is similar. You are making a bet on where we are in the cycle. If we are near the peak, 13.5x is very expensive.

 

You seem confident that we are mid-cycle, but I'm sure you know that deep cyclical's are very tricky.

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Took a quick look at Boeing. Looks like a good business but deeply cyclical. I assume Airbus is similar. You are making a bet on where we are in the cycle. If we are near the peak, 13.5x is very expensive.

 

You seem confident that we are mid-cycle, but I'm sure you know that deep cyclical's are very tricky.

 

thanks for the note. yes, as an arms dealer selling capital goods to combatants in a very tough industry, one can expect cyclicality, definitely in orders, and possibly in deliveries (though I note, Airbus has never had to lower rate - but I'm sure they will at some point). and as mentioned in a comment, i think current production is above a guess at normal today, extrapolating from past deliveries and the GMOs of the OEMs (btw, BA's GMO from 10 years ago was a tad bit rosy, but not much, and the world has had the severest recession since 1929 - not too shabby!).

 

here are my points on the cycle:

1) sometimes the future doesn't look like the past, and this may be one of those moments. If china, india, and asians writ large are really as wealthy as they seem, this is a one-time sustainable increase in underlying demand. 1.4B chinese, maybe only 100 million have seen the inside of an airplane. if you treat past production like a chartist exercise, you will reach a different and negative conclusion. but if you sit and think about it for a while, you may reach my conclusion. butts in seats are very different from cement and steel going into towers.

 

as an analogy, think about US residential housing construction. one can count heads, households, structures, people sleeping on sofas and with their parents (currently 21MM) and look at these relationships over time. Even though normal new starts at 1.5MM is a small percentage of total structures of 120MM, it tends to gravitate over time toward an average. and one should expect that in the future...unless we suddenly had 100MM additional people living in tents out in the Midwest who had suddenly come into some money. then one would expect to spend some of their new found wealth on their houses, and one would rationally expect normal starts to go above 1.5MM. that is the case with the Asians and air travel.

2) load factors! look at this plotted over time too and factor that in to your thinking.

3) backlog. there is no historical precedent for current backlog. factor that into your thinking too...i wouldn't bet on this alone, but it certainly adds support to my argument.

4) PCP - i question Buffett would have bought PCP if he thought the industry was way above normal.

 

lastly, AIR is more attractive than BA for the reasons in my original post, which are company specific.

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4) PCP - i question Buffett would have bought PCP if he thought the industry was way above normal.

 

I think you are right but the economics for PCP, TDG, RR are different. Less reliant on OEM sales. I have hitched my horse to RR but I should study Airbus too.

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Thanks for the idea, I'm always happy to see ideas in Europe presented even though I'm not hooked on the valuation. Looking back over the last 10 years, Airbus seems to have generated roughly 13b FCF (it has been really lousy in the last 3 years) while revenues have doubled. Any idea what capex will look like going forward - steady state/growth?

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Thanks for the idea, I'm always happy to see ideas in Europe presented even though I'm not hooked on the valuation. Looking back over the last 10 years, Airbus seems to have generated roughly 13b FCF (it has been really lousy in the last 3 years) while revenues have doubled. Any idea what capex will look like going forward - steady state/growth?

 

great question. this is not a situation and business you can look at the past and simply project forward, because specific programs are too important. "investment" is capex, but even more importantly, operating losses as programs get up to speed. has a cash curve, not dissimilar to a sterotypical VC investment. see the december 2014 investor day "ball chart" for details.

 

quick summary: a350 is burning cash/capital, and this will go up not down next 1-2 years, peak and start coming down. my 2018 7+ euro number has them losing money on a350 before impacts of FX (my model is still using 1.35 exchange rate and then adjusts for the FX changes). the a320 is HUGELY profitable, and this is very positive as rate goes up. A330 profitability is going down, will come back to historical levels but nothing exciting. and the a380 is too small to matter, probably loses money in the projection period (some charge for the re-engine).

 

remember, boeing has program accounting (unit on their website) and airbus has unit accounting - much more conservative.

 

airbus is a much better company than it was 10 years ago. the a320 is basically a parity plane with the 737, both wisely re-engined rather than greenfield. the a350 will be too expensive, but sunk costs are behind us, it will be a great program. a330 is a middling product to try to have something to compete with the 787 (on price, not on capability), and the a380 is a non-profit charitable program, like tithing at church. all this you can get from the sell-side brokers, this industry is so well followed, everyone has numbers, and the OEMs are very sophisticated in communicating with the street and their supply chain.

 

the key on the numbers is to understand the impact of FX. hint: i built my model in USD, because that is how i think the business really works...

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Thanks. I don't have much to add regarding specific planes and where the company/industry is going, but if everybody agrees (secular tailwind, past mistakes not getting repeated), and there's enough information out there, what is the market missing? Does it come down to FX (the stock has moved up more than the dollar versus the euro it seems)? Obviously the market doesn't need to be wrong for it to be a good investment, and I'm not trying to put the idea down (I know very little about the industry), just trying to ask the obvious question.

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Thanks. I don't have much to add regarding specific planes and where the company/industry is going, but if everybody agrees (secular tailwind, past mistakes not getting repeated), and there's enough information out there, what is the market missing? Does it come down to FX (the stock has moved up more than the dollar versus the euro it seems)? Obviously the market doesn't need to be wrong for it to be a good investment, and I'm not trying to put the idea down (I know very little about the industry), just trying to ask the obvious question.

 

i can't add much above whats already been written above except that the market has been wrong in the past on many situations that seemed highly probable to me. i love having an information edge or key insight, but rare and certainly not required. i guess i just think about how the business works, play with the numbers, and think it is very attractive opportunity, and one priced so that if i'm wrong i won't be impared. i think i bought a fast growing conservatively financed worldwide duopoly business with crazy high BTE (787 cost $25B!) at 5x where the earnings are going to be in 4.25 years - pretty straight forward.

 

for what it is worth, i've talked to several people whose full-time job it is to understand how this works, and i don't think they understand it either. so i'm not surprised the average opinion expressed by the market doesn't get it. but who knows, maybe i'm wrong...time will tell...

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I've been thinking abou Airbus for a bit and trying to get comfortable with the high barriers to entry/capital intensive qualities that seem to go hand in hand.

 

On one hand you have Google search where someone like Microsoft couldn't spend enough to create a better product through Bing. And even if it is better there's no guarantee that people will use it. Google is able to spend relatively low amounts of capex to generate massive returns on capital in perpetuity for that particular business.

 

You couldn't spend enough to recreate Airbus, but how's the cash supposed to make its ways back to shareholders?  At some point aren't we going to see another massive capital spend for the next generation and so on?  Price to earnings means little in my view, you have to do a discounted cash flow on the cycles and try to get a big discount to the net cash generation. It takes a lot of work to figure that out, not sure if that's the right approach though.

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I've been thinking abou Airbus for a bit and trying to get comfortable with the high barriers to entry/capital intensive qualities that seem to go hand in hand.

 

On one hand you have Google search where someone like Microsoft couldn't spend enough to create a better product through Bing. And even if it is better there's no guarantee that people will use it. Google is able to spend relatively low amounts of capex to generate massive returns on capital in perpetuity for that particular business.

 

You couldn't spend enough to recreate Airbus, but how's the cash supposed to make its ways back to shareholders?  At some point aren't we going to see another massive capital spend for the next generation and so on?  Price to earnings means little in my view, you have to do a discounted cash flow on the cycles and try to get a big discount to the net cash generation. It takes a lot of work to figure that out, not sure if that's the right approach though.

 

good comments. there is a lot there, i'm going to be brief.

 

google is a special business with very significant network effects and branding effects (i.e. coca-cola). not very analogous. google is worth a lot more.

 

Boeing and Airbus advantage is more traditional scale advantages, though i think there are some switching costs, etc. that advantage them. these plane programs cost a fortune to start-up and incremental rate increases continue to possible (737 is still assembled in the same footprint as the original production in the 1960s at much higher rate). it seems that the world wants more than 1 commercial aerospace company, but doesn't have room for more than 2. doesn't mean others won't eventually enter because they feel they have to own "commanding heights" of an economy, but it won't be a rationale economic decision that brings them into competition. how much should the duopoly OEM aerospace companies make? how much should a duopoly railroad make? i think the former aspire to raise their profit levels, just like the latter did.

 

historically, these programs have been quite speculative and risky (read sporty game). i think they are much less so today. and once the a350 is in at rate production, i think all the big risks to the industry in terms of programs will behind them for a while (excluding C Series, et al). in 10 years, there the world will change again and we will have to reappraise.

 

i don't like the CF metric for this business - though wall street does. programs are too cyclical, so are the cash flows with down payments, etc. so airbus will make no cash this year because they are investing in the a350. i think that investment is money good, so earnings is a better number to work with, in my opinion. in theory, DCF is better. in practice, i don't trust any of the numbers after a few years.

 

a few years ago, i looked at boeing over a 10 year period (boeing has very difficult accounting) - a friend said "the earnings never become cash" - i had to look into it. it put me at ease. from memory and not accurate, they had used something like 3/4 of their accounting earnings for dividends and net repurchases. yet they had launched the 787, were producing at higher rates with higher earnings, and arguably had a better competitive position. the accounting earnings reflected the increase in owner wealth. my hope is the next 10 years at airbus look a lot like the last 10 for boeing. boeing has a $93B USD market cap, Airbus a 44B euro market cap.

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  • 5 months later...

Lots of widebodies coming off lease in the near term (say 1-3 years). Most the reports of cheap aircraft being sold are primarily part-outs (delta). Ultimately everything depends of where you think we are in the aircraft cycle. Is there more growth to come or is everything already priced to perfection?

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Lots of widebodies coming off lease in the near term (say 1-3 years). Most the reports of cheap aircraft being sold are primarily part-outs (delta). Ultimately everything depends of where you think we are in the aircraft cycle. Is there more growth to come or is everything already priced to perfection?

 

Newbie here, would you mind expanding a little more on the "aircraft cycle"?

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Demand for aircraft has an economic cycle which is related to but distinct from broader economic cycles.

 

This particular aircraft cycle feels weird because historically narrowbody and wide body demand track one another, but this time around the wide body market has really ripped without narrowbody following.  Tbh I don't really know what to make of it.

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  • 1 month later...

Demand for aircraft has an economic cycle which is related to but distinct from broader economic cycles.

 

This particular aircraft cycle feels weird because historically narrowbody and wide body demand track one another, but this time around the wide body market has really ripped without narrowbody following.  Tbh I don't really know what to make of it.

 

Several points on "the cycle" (some of which have been made above):

 

1) selling a capital good typically involves cycles, and a downturn (whether for exogenous or endogenous reasons) is possible.

2) i have gotten comfortable with what i pay for the stock and what i get in the business by "normalizing" production and margins, and i feel very well protected.

3) industry is producing and will produce "above normal" for the next many years (even the Boeing and Airbus 20 year forecasts imply this). but with 5% underlying volume growth in the industry, today's overproducing rate quickly becomes the "normal" rate.

4) demand is above normal and this may remain true for many years. this is partially due to the Asian middle-class emerging and the fact that there is so much water over there (driving and boating are not fungible means of transportation). it is also partially due to 30 years of under investment by the industry collectively, as demonstrated by WW load factors.

 

In summary, I may be wrong, but in my opinion, the Airbus-specific improvements to the business (and the price of the stock) far outweigh the possibility of being "wrong" on the timing of the cycle. Those who consider the investment solely through the lens of "the cycle" may miss an opportunity (which also explains why the opportunity may exist)...

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What do you think normalized pre development margins are? How are you estimating that? What is history. The current market structure had been around for a long time and it's not clear to me the duopoly had functionally changed once you adjusted for all of the projects.  It just seems like an up cycle

 

Punching out A320s on a fully utilized assembly line is very profitable. Take utilization down a bit and that changes a lot.

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What do you think normalized pre development margins are? How are you estimating that? What is history. The current market structure had been around for a long time and it's not clear to me the duopoly had functionally changed once you adjusted for all of the projects.  It just seems like an up cycle

 

Punching out A320s on a fully utilized assembly line is very profitable. Take utilization down a bit and that changes a lot.

 

Nevermind Embarier, Bombadier, and etc. developing aircraft to go H2H against the incumbents. Boeing had to give United a major cut rate deal to sell 737-700s vs. the C-Series. Delta with a major C-Series purchase in the last month. But who knows maybe the Chinese don't trust the Brazillians and Canadians.

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Supposedly to get the c-series sold to delta pratt had to give them a perpetual monopoly on third party mro, and bbd's price was insanely cheap on top of that.  It doesn't seem like real competition, especially when everyone other than delta wanted the simplest fleet possible. But the incumbents are enough to keep returns low.

 

I thought erj had said they weren't interested in moving up a size!

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What do you think normalized pre development margins are? How are you estimating that? What is history. The current market structure had been around for a long time and it's not clear to me the duopoly had functionally changed once you adjusted for all of the projects.  It just seems like an up cycle

 

Punching out A320s on a fully utilized assembly line is very profitable. Take utilization down a bit and that changes a lot.

 

The 777 and 737 had unit accounting gross margins in the low to mid 20s by reputation. Tough to generalize because this is a low volume industry (relative to most other industrial businesses) and each program is positioned differently. For instance, the 737 has been on the same frame since the 1960s, so we can be sure that is very profitable. The A380 will never recoup its losses. The 747 may struggle going forward, but there was a moment in time that Airbus believed they needed to develop the A380 to compete with Boeing. Things change over time.

 

The market structure has been 50/50 since the early 2000s (Airbus has never dropped rate). Last 16 years had a boom, financial crisis, high oil, 2 very expensive development programs, increased single-aisle Asian demand, steadily improving world-wide load factors (which is and remains important), and Airbus move to a more for-profit corporate form (which is important). I see the current structure as the most attractive it has been since the 707.

 

Yes. Rate helps. There is very high operating leverage. But one can adjust for rate and margin to get a guess at "normal" earnings. Like I said, not a "buy when down on your luck" investment.

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  • 3 years later...

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