- Boeing stock has been selling off after some analysts fired off a new round of warnings saying that low oil prices would lead to more airlines putting off purchase of new aircraft.
- The analysts have also said that rising interest rates will negatively impact Boeing's business and cash flows.
- How accurate are these comments by the analysts?
Boeing stock has been selling off, falling 6% over the past two days after several analysts fired off a new round of warnings about the company saying that cheap oil and rising interest rates could start weighing on near-term new aircraft sales and also negatively impact Boeing's (NYSE:BA) strong cash generation. The selloff in Boeing stock was initially triggered after Delta (NYSE:DAL) CEO Richard Anderson said during the company’s investor day conference that he had just signed a letter of intent to acquire a used Boeing 777 for just $7.7M.
"I was wrong when I said used 777s were on market for $10M. It was actually $7.7M. We just signed a letter of intent to buy one,"
The implication of Mr. Anderson’s comments is that there is a glut of airplanes in the market which is a bad thing for Boeing. The comments also revived fears that plunging values of wide-body models was a signal that the market was close to a peak. Investors have strangely chosen to focus on the distress sale of a single airplane while choosing to ignore a recent Boeing home run where the company won a deal to supply 110 planes to China Southern Airlines, Asia’s largest carrier, in a deal worth $10.12B.
Note: You might be interested in 'Is Boeing Stock An Ideal Dividend Play In 2016 And Beyond?'
The comments by Delta’s CEO, however, should hardly come as a surprise to anyone seeing that Delta Airlines is a well-known bargain hunter in the airline business. Delta Airlines owns the second oldest fleet of all American Airlines with an average fleet age of 16.9 years. Only Allegiant Airlines has an older fleet with an average age of 22 years. Delta Airlines is a well-known proponent even of duds such as Boeing 717 for which Boeing discontinued production after building just 155 of the 100-seater airplanes.
Can cheap oil depress Boeing sales?
Investors should therefore stop paying too much attention to Delta’s comments and instead focus more on the effect of cheap oil prices and rising interest rates on Boeing’s business. The reasoning by analysts is that low oil prices will reduce the urgency for airlines to purchase more fuel-efficient jets. These comments appear to be quite valid in the context of Boeing. For instance, Boeing designed the 787 Dreamliner with 20% fuel savings in mind, and airline executives have been buying the plane on this premise. Fuel costs account for the largest line item for major airlines, accounting for more than 30% of an airline’s operating expenses. Oil prices have continued to fall, and now it’s beginning to appear feasible that the unthinkable might actually happen and oil might drop to as low as $20/barrel.
But it’s not possible for oil prices to continue falling indefinitely because at some point, most oil companies will simply be pushed out of business and a major rise would then ensue (somewhere in the upper $20s per barrel according to some analysts).
In the final analysis, low oil prices can only act as a short-term headwind for Boeing, but this is something that cannot last. Buying airliners is a long term commitment. With order books sold out, it can take up to eight years to get a new jet from Boeing (the company currently has an order backlog that is enough to take it for 7 years at current production run rates). It's hard to tell what oil prices will be then. Over the long-term, older fleets, including Delta Airlines’ and Allegiant’s, still need to be replaced regardless of whether oil remains cheap or not.
Low oil prices can actually be a boon for Boeing because it will allow more airlines to operate from a net cash positive position thus freeing up more money to be used in buying new airplanes. Most airlines currently are free cash flow negative.
Additionally, if low oil prices persist, airlines will at some point consider passing on the benefits to their customers in the form of cheaper fares. Most airlines have not cut their fares yet despite the prevailing low oil prices, but will almost inevitably do so if oil prices remain depressed for another year or two. Low air fares usually lead to an increase in air travel, which should spur airlines to purchase more aircraft.
Rising interest rates can be a threat not just for Boeing but for most American companies. High interest rates mean airlines have to pay too much in loan interest and consequently have less money to spend on Boeing’s products. The Fed has said that its target inflation rate is 2%, which is where inflation currently sits when you exclude oil. Many analysts have projected that inflation will remain around 2% over the next decade, so large rate hikes by the Fed are not likely to happen soon.
Even though cheap oil might cause some airlines to put off purchase of new planes, this is something that is likely to be temporary. Boeing already has a huge order backlog, and is continuing to win more large deals even as oil prices continue to plunge. There is no good reason why low oil prices should be detrimental to Boeing stock.