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The ripple effect
Defense Market Report
Exclusively for InvestorIdeas.com
By James Smith
October 20, 2006
The recent announcement by European aerospace and defense company EADS that the jumbo A380 to be manufactured by its Airbus unit will be delayed by an additional two years should put the fear of God into some investors with short-term horizons.
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If I held a position in EADS – or in a company or companies that derive substantial revenues from supplying parts to the A380 or its equally befuddled A350 program -- I would scan the activities of those companies big time.
On October 19, EADS closed at EUR21.15. The company’s 52-week high was EUR35.42; low was EUR16.75. Shares in EADS have lost 40 per cent of value since April 1st.
The recently announced A380 delays are certainly going to cause some operational problems for the launch customers and may even result in a number of cancellations for orders of the world’s largest-ever passenger jet. But aerospace is a long-term industry and Airbus and EADS will be around for a long time – longer than most of the people reading this report.
Depending on whether you are in for the long-term or the short-term, your response to this latest delay will be nonchalance, acceptance – or abject fear.
Rival Boeing had a string of bad luck some years back but has managed to pull off a turnaround that has now placed the US aerospace and defense company in the driver’s seat.
Airbus is in turmoil as are many of its suppliers. The company is also experiencing a credibility crisis, having been accused of releasing too little information on its delayed production too late.
EADS now says Airbus needs to sell 420 A380s to break even, up from a previous estimate of 270 aircraft. To date, Airbus has sold 159 A380s and the first aircraft is now due to be delivered in October 2007.
I don’t believe that Airbus will ever sell 420 A380s. The aircraft has a limited number of potential customers. There are only 35-40 airports capable of handling the giant aircraft.
Several companies that are suppliers to the program have already blamed the A380 delays on slippage. As an example of the dangers of putting too many eggs in one basket, French aeronautics equipment group Latecoere expects delays in the A380 to account for a 10 per cent revenue shortfall in 2007. And Pfalz-Flugzeugwerke (PFW), the German supplier to the aerospace industry, is reported to have decided to postpone its initial public offering in connection with the current crisis at Airbus.
The company had initially planned to go public during the first half of 2006, but later postponed the IPO to the second half of the year. PFW, which supplies parts for the A380, used to be part of Dasa, the German aerospace company which merged with European competitors to form EADS. German-US auto maker DaimlerChrysler has also indicated that it may have to revise its profit forecast in the wake of the A380 fiasco.
Airbus has had three chief executives in the last year and suffers from political infighting. With substantial ownership by various European governments, parent EADS is a victim of politicians fighting to keep jobs for their constituents, irrespective of whether sound business strategy prevails.
Louis Gallois, Airbus’ recently appointed president and chief executive officer, who replaced Christian Streiff on October 9 after just three months in the job, following the forced resignation of previous head Noël Forgeard, has a short timeframe to turn things around.
Less than a week before Streiff threw in the towel, Airbus outlined plans to regain its competitive edge and to counter the financial impact of the delay in the A380 programme as well as the weakening US dollar.
According to Airbus: “The objective of the (turnaround) program is to reduce costs, save cash and develop new products faster. The development cycle times are to be reduced by two years while the overall productivity is to be increased by 20 per cent. The program aims at annual cost savings of at least EUR2 billion from 2010 onwards and delivering some EUR5 billion in cumulative cash savings by 2010.”
Boeing is generally considered to be more experienced at cost-cutting measures than Airbus. But Airbus also has very complicated partnering issues and political issues that Boeing has never had to consider.
Boeing does not face the same currency issues as Airbus: the American manufacturer produces and sells in US dollars. There are calls for Airbus to become as much of a dollar-producer as it can be by influencing its supply chain to assume US dollar responsibility. Obviously, labor costs will have to remain payable in local currency, mainly the euro and sterling.
Rival Boeing is limited by its own success to some degree. Its long-dated order book for the B-787 means that, if an airline placed an order now, it would be unlikely to be able to take delivery of an aircraft before 2011.
The option for Boeing is to increase production rates for its aircraft programmes but this has always been a very risky approach.
A concerted effort by Airbus to win market share in the US is a suggestion several bankers are making. Advice to the Airbus team is to send sales executives out very soon to all of the US carriers likely to be ordering aircraft, offering them deals that they will not be able to refuse.
Key to winning these orders could be offering US carriers the right aircraft at attractive prices with finance attached.
A negative note for Airbus success in the US could arise, some believe, if Russian ownership in parent company EADS increases beyond the five per cent share bought by Russian state-owned bank Vneshtorgbank via the free float of EADS stock. There have been reports that Vneshtorgbank has further increased its stake in EADS, against the wishes of the German Federal Government.
Germany wants to stop Russia from becoming too powerful. Some German bankers welcome this increased interest in EADS, and Airbus, by the German government, commenting that Airbus has in recent years become more of a French company than a European company.
A stable and committed ownership of EADS will help to provide stability for Airbus and help the airframe manufacturer to define its future. But the ownership structure needs to be resolved as soon as possible.
Until EADS sorts its way through its problems, investors need to define their investment horizons and see if they have the stomach to stay in the game.
Disclaimer
James Smith is an independent columnist for this web site. James Smith may hold long or short positions in any of the stocks mentioned in this article and those positions can change at any moment.
InvestorIdeas.com Disclaimer:
www.InvestorIdeas.com/About/Disclaimer.asp, InvestorIdeas is not affiliated or compensated by the companies mentioned in this article. James Smith is a freelance writer. Nothing in the articles should be construed as an offer or solicitation or recommendation to buy or sell any specific products or securities. Past performance does not guarantee future results.
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