Aerospace Industry Reshaping Begins To Deal With COVID-19 Effects

Almost exactly 15 years ago, tens of thousands of spectators positioned themselves around the fences of Toulouse’s Blagnac Airport. On April 27, 2005, the Airbus A380 took off for its very first flight, heralding what many believed was going to be a new era of flight. Fast forward to April 2020: Almost the entire fleet of A380s is grounded, as are tens of thousands of smaller aircraft. And Airbus CEO Guillaume Faury wrote in an internal memo that “the survival of Airbus is in question.”

That such a message would come from Airbus, arguably the soundest commercial aircraft manufacturer in terms of finances and strategic positioning, was unthinkable just two months ago. But similar memos could have been issued by any of his colleagues or competitors as the novel coronavirus wreaks havoc on commercial aviation. Many airlines are on the brink of collapse, as are many suppliers. And the financial pressures on the OEMs and large suppliers are so intense that they have no choice but to focus on their own survival rather than considering customer financing or supplier support at any scale.

• Airbus, Boeing announce deep production cuts
• Boeing terminates Embraer tie-up, open to Mitsubishi partnership
• No recovery to pre-COVID-19 levels expected for several years

The COVID-19 pandemic is reshaping aerospace and, about two months into the sector’s worst crisis ever, its future shape is becoming clearer. The industry is becoming much smaller than it was just a short while ago. Bankruptcies are almost guaranteed and will not be limited to smaller, weaker firms. State bailouts and the rising influence of governments will soon be commonplace. Research and development has slowed or is on hold. And transactions are collapsing, most prominently the planned commercial aircraft joint venture between Boeing and Embraer, Boeing Brasil-Commercial. There will continue to be two major players. A third, Embraer, is trying to compete in its own niche against the giants while new rivals such as Mitsubishi slowly appear on the horizon.

The only bit of good news is that while air transport is about to reach rock bottom in some of the hardest-hit markets, it is on a slow upward slope in others, particularly in Asia where some airlines have cautiously begun to add flights. Unfortunately for the aerospace side of the business, the full effect of the declines is only beginning to filter through and will dominate industry activity for the foreseeable future, with analysts generally not expecting traffic to recover to precrisis levels before 2023.

Airbus had already announced a 30% across-the-board production cut on April 8. Now Boeing, too, is scaling back big-time in various ways: cutting into production rates and curtailing the pace of development programs and future projects.

The combined production rate for the Boeing 777-300ER/F and 777X is set to reduce to three per month in 2021, while the Boeing 787 rate will be cut to 10 per month later this year and shrink to seven per month by 2022.

The 777 slowdown cuts the official production rate in half, to around 2.5 later this year from the current five per month, although the actual rate cut is cushioned because Boeing already accounts for around 1.5 “blank” positions per month in anticipation of the production switch to the 777X. The gradual introduction of the initial 777X model—the 777-9—will also be slowed under the new rate plans and will bring the combined 777/777X production tally to three per month in 2021.

“We will take a measured approach to the 777X rate ramp, as we will look to minimize the amount of change incorporation work by managing the number of aircraft produced prior to entry into service,” says Boeing CEO Dave Calhoun. The reduced rate underlines the drastic change in fortunes for Boeing. which only three years ago provisionally planned to produce seven 777s per month in 2020, almost half of which were to be 777Xs.

The production reduction for the 787 is more precipitous, at least in the midterm, with the rate dropping to 10 per month later this year from 14. The previous plan would have seen a shallower cut, from 12 later this year to 10 in early 2021.

Production of the 737 MAX is to restart this quarter and increase gradually to 31 aircraft per month sometime in 2021, with further increases based on demand. Boeing was producing 52 MAXs monthly and preparing to ramp up to 57 when all MAXs were grounded in March 2019 following two fatal accidents in less than five months. It cut production to 42 in April 2019. In January 2020, it paused production, following months of missed projections about when the FAA would approve changes ordered after the accident probes and related reviews.

The pandemic has also slowed planning for Boeing’s next new aircraft project. In January, the OEM was already transitioning away from the long-running two-family new midmarket airplane (NMA) initiative to a revised 757-size concept. Although Calhoun emphasizes that the company is “not out of the product development business,” he cautions that “it’ll be a little while before we announce a big new airframe.” The advanced engineering and manufacturing lessons learned from the NMA program will be used in whatever program follows. “[But] we will not try to drop a point design on a new airplane now because of all the market and product ramifications associated with this [market] change,” he says. “It is going to take us a while to sort that out.”

Calhoun also indicates the potential shift to smaller-capacity aircraft in a market recovering from the pandemic may have removed some of the urgency to develop a new product family, as well as breathed new life into the 737 MAX sector. “In some ways, if airplane loads want to get smaller as a result of a smaller set of passengers flying on them in the next several years, it might actually play to us,” he says. “We have a robust [737] backlog with it.”

“Robust” could not be used to describe Boeing’s finances, but the picture is beginning to look much less bleak then it did only weeks ago. The OEM was negotiating with the Trump administration about receiving U.S. bailout funds, but company leaders believe they can maintain investor-grade ratings, and they see a sustainable financial path where its commercial aircraft business returns to growth in 3-5 years.

Getting there, however, will require billions of dollars more in debt financing—although no longer from the U.S. government, Boeing said April 30—as well as cutting its workforce at least 10%, or 16,000 employees.

“We are doing everything in the next six months on the liquidity front that we believe is necessary to keep us operating and keep us safe,” Calhoun says. Private-sector financing has opened again, thanks to the new CARES Act in response to COVID-19, as well as the Fed’s separate-but-related corporate-backstop program. Boeing is examining all options and a mix of sources of financing—including Treasury Department funding via CARES that could entail giving the government a stake in the company.

“I think things have changed a bit for the better since maybe a month ago,” Calhoun adds. “But at the same time, we have not yet made choices, and I don’t want to predict outcomes on that front.”

Boeing stunned Wall Street and the aerospace world in March when it openly asked for at least $60 billion in federal aid for itself and its suppliers. Following the latest revelations, though, Boeing’s stock price closed up almost 6%, with analysts and observers noting with relief both that the quarterly results were not worse and that Boeing sees a sustainable path forward. The OEM burned through $4.7 billion in the recent quarter, better than analysts expected, and had $15.5 billion of cash or equivalents available as of March 31.

“Boeing’s . . . first-quarter cash-burn seems to be a relief, and it appears increasingly possible that the company might avoid raising capital from the government, or at least the Treasury,” JP Morgan analysts said. “Nevertheless, the path forward for Boeing remains quite challenging, and while the production rate outlook in today’s release is not a big surprise, it suggests substantially lower activity for some time.”

In turn, Boeing likely will have to rely on layoffs—i.e., involuntary separations—to achieve its 10% workforce cuts, Calhoun says. The company will target white-collar jobs over touch labor and make deeper cuts in Washington state and South Carolina, where Boeing Commercial Aircraft work is centralized, as well as in Dallas-Fort Worth and other Boeing Global Services sites. Cuts should be shallower at Boeing Defense and Space, which is likely to become the dominant division for years to come while commercial and maintenance, repair and overhaul businesses contract, the CEO notes.

Boeing reported first-quarter revenue of $16.9 billion, down 26% from the same quarter of last year. Loss per share was $1.11 on regular accounting rules, compared with a $3.75 gain the first quarter of 2019, and a so-called core business loss per share of $1.70 versus $3.16 gain. Those came from a GAAP (generally accepted accounting principles) loss of $641 million against $2.15 billion in earnings the same period last year.

Total debt was $38.9 billion as of the end of March, up from $27.3 billion at the beginning of the year, primarily due to the drawdown of a new $13.8 billion term loan facility during the quarter.

While Boeing appears to have determined that it can no longer afford the deal to acquire Embraer’s commercial aircraft division, it is already talking about new partnerships. This time it is with Embraer’s (future) rival Mitsubishi. “I’m open to any kind of major partnership. They [Mitsubishi] are in fact incredibly competent, important players in the industry who, if they want to—and if they believe they’ve got some innovative capabilities—[could] move into more of our kind of world,” Calhoun says.

 Potential partnerships with companies such as Mitsubishi would help with the “effect it has on globalizing our company,” Calhoun adds. “Each and every deal has to be struck at the right economic levels and it has to be struck in a fair way,” he says. “And in each of those cases, there’ll be conditions, and both parties will have to meet those conditions.”

One might interpret that as a hint about why Boeing thinks it had the right to terminate the planned Boeing Brasil-Commercial joint venture with Embraer, which began a public fight between the companies.

"[Embraer] believes strongly that Boeing has wrongfully terminated the Master Transaction Agreement (MTA)," the Brazilian company says. "[And] that it has manufactured false claims as a pretext to seek to avoid its commitments to close the transaction and pay Embraer the $4.2 billion purchase price. . . . Boeing has engaged in a systematic pattern of delay and repeated violations of the MTA because of its unwillingness to complete the transaction in light of its own financial condition and 737 MAX and other business and reputational problems."

Boeing, of course, has a different view. “[Boeing] has worked diligently over more than two years to finalize its transaction with Embraer,” says Marc Allen, Boeing’s president of Embraer partnership and group operations. "Over the past several months, we had productive but ultimately unsuccessful negotiations about unsatisfied MTA conditions. We all aimed to resolve those by the initial termination date, but it didn’t happen."

The collapse is a blow for Boeing that may have long-term consequences on its ability to compete against Airbus and reestablish itself as an equally competitive force in the narrowbody and midsize aircraft market. It also means a U-turn for Embraer, which will now have to compete as an independent manufacturer, putting it in an economically much weaker position. Airbus is emerging as the big winner from the breakup.

Regulatory approval for the deal from the European Commission was still pending, which was a key condition for the transaction to be completed. But industry observers say the real reason behind Boeing’s decision is that the current financial pressures are so enormous it did not believe it could afford the transaction. Also, it would have been extremely difficult politically to ask for financial assistance from the U.S. government, cut thousands of jobs and at the same time spend more than $4 billion for an acquisition abroad, as strategically important as it may have been.

Embraer’s value for Boeing was twofold: One, after Airbus had acquired the C Series program from Bombardier and converted it into the A220, Boeing felt pressed to react at the bottom end of the narrowbody market with an aircraft offering the same economics as the A220. Boeing was keen to acquire Embraer’s engineering capabilities, too, which are highly regarded in the industry and would  have been welcome in new aircraft programs such as the NMA.

The lack of a viable product at the bottom end of the narrowbody market that can compete at least in part of the A220 spectrum is now raising even more questions about the timing and design of Boeing’s next new aircraft. The manufacturer not only faces the task of designing an aircraft that eclipses Airbus’ highly successful A321neo/LR/XLR at the top end of the narrowbody market but also faces that gap at the bottom.

Embraer is on its own for now and needs to decide whether it will look for another strong partner, which would likely have to be outside of aerospace, or continue as a broad but small aerospace firm. It also has to decide whether to reintegrate Yabora Industria Aeronautica, the carved-out former commercial aircraft unit, into the group or run it as a separate entity for the time being.

Across the Atlantic, Airbus’ Faury is also preparing his team for tough times. "The aviation industry will emerge into this new world very much weaker and more vulnerable than we went into it," Faury wrote in his memo. While he did not go into potential staff reductions in detail, insiders say Airbus is preparing a major cost-savings program that may be similar to the 2008 "Power 8" project, under which it cut 10,000 jobs. "We may now need to plan for more far-reaching measures," Faury wrote. "That is because of the sheer magnitude of this crisis and its likely duration. . . . We are living through one of the largest economic shocks in history so must consider all options."

Airbus plans to build 40 narrowbodies per month, down from more than 60, along with two A330/A330neos and six A350s per month. Analysts have suggested that Airbus will have to make further cuts of a similar size as customers continue to defer deliveries. However, the OEM will not decide on such changes to its production rates before June. And if they come, they will be “on a smaller scale” than previous cuts, according to Faury.

The airframer plans to spend the next few weeks on an analytical deep dive into the plans and financial performance of its customers, both lessors and airlines, to be able to better assess what their short-term behavior and long-term strategies will look like. The analysis will be “very granular.” Airbus is also trying to assess what the recovery in traffic will look like and is adapting its financial planning accordingly.

Notably, Chief Financial Officer Dominik Asam says, “If we are able to do what we plan, [government aid] should not be necessary, given that at the beginning of April we had about €30 billion [$33 billion] in liquidity resources, which should be ample funding under the circumstances.”

Faury says deliveries will be “very low” in the second quarter, after the manufacturer was able to hand over 122 aircraft in the first quarter, which was only partially affected by the novel coronavirus crisis. Nonetheless, Airbus was unable to deliver 60 completed aircraft in the quarter. “After the summer, we will start delivering aircraft at a better pace,” he expects. Faury says the number of undelivered completed aircraft will peak in the third quarter.

While the short-term focus is on cash conservation and cutting rates, Faury also wants to position Airbus in a way that enables it to resume growth quickly. “The race will start again; we want to be fast and agile,” he says. “There is a threat of being stuck in the crisis and not being able to compete again.” He anticipates that the single-aisle market will recover faster than the widebody one, but he notes the pace of the recovery and the timing “are very difficult to predict.” He indicated that there could be “a very aggressive ramp-up in single-aisle production” after the COVID-19 crisis. The A321XLR development program will continue “at good speed,” he says.

In his discussions with airlines, Faury observes a preference for smaller aircraft compared to pre-COVID-19 planning and asserts that Airbus is well-positioned with its smallest narrowbody, the A220, as well as the A321XLR taking on some former widebody missions and the A350.

Faury expects widebody demand to recover in 2023-25, while the outlook for narrowbodies is “not that gloomy.”

Airbus reported a €481 million net loss for the first quarter on sales of €10.6 billion. That compares to a €40 million net profit on €12.5 billion in sales the same period a year earlier. The adjusted operating profit was down 49% at €281 million for the quarter. Free cash flow was a negative €8 billion in the quarter, almost twice the amount in the first quarter of 2019.