Howard Wheeldon - the list of problems is getting bigger for EADS yet so is the share price!
EADS has informed its shareholders that Q3 earnings slumped 77% and has come clean that the A380 programme is now a matter of concern (we reason this more on flagging deliveries as struggling airline customers keep pushing delivery dates back than on the official message of the challenge of meeting customer customizing programmes).
In addition it has warned that even more huge charges are probable on the troubled A400M military airlifter programme which just a week ago lost another big export customer when South Africa pulled out from the programme.
This honesty may be very welcome but will it really be enough to appease EADS’ troubled shareholders? Use the share price as a barometer and amazingly it seems that the answer to that is it does, meaning that for some strange reason the shares actually rose during early morning trade on Monday!
EADS appeared to lay the primary blame for the collapse of Q3 profits (a net loss of EUR87m against Q3 2008 net income of EUR679m) on the still weak US dollar plus the fact that research and development costs on the proposed A350 aircraft, together with customization costs on the A380 super-jumbo programme, continued to rise. To that end EADS management wisely decided against the provision of a Q4 forecast outlook other than saying overall revenue for the whole of 2009 will likely be similar to that of 2008, that it expects to see some kind of unspecified industry improvement in the coming months, and that delayed 2009 A380 deliveries would likely move into 2010. No mention today about order cancellations or deferrals though – thanks for nothing then!
For all that, aircraft deliveries in Q3 were pretty similar to those of a year ago and apparently cash flow consumption (excluding A400M) is no worse than previous expectations. No FY09 earnings guidance then and, one notes, not a word about 2010 expectations either. Not a word on when Europe’s aerospace giant would attempt a first and very long delayed A400M aircraft flight – other than the strangely timed email announcement that appeared late Friday afternoon suggesting that preliminary A400M ground tests were about to start (yuk!) and that subject to these a decision would then be made by the ‘crew’ on when they considered the aircraft fit to fly. The hope is that A400M will get into the air for a quick flip flight around the Spanish countryside before the end of this year. Even so, those of us that have warned right from the very start of this European government partnership programme back in the late 1990’s of what we regarded an exceptional high risk on the parts of the governments of Spain, Germany, France, UK, Belgium and Luxembourg are seriously concerned as to whether this aircraft, with its Europrop International (EPI) TP400-D6 engines that as far as I am aware have been developed exactly as specified within the original command programme, are up to the job.
(Note: Turkey remains an export customer but has already cut its original order from 26 aircraft to just 10 and Malaysia which has had four A400M aircraft on order since 2005 has already been told that the RM600m price per aircraft that is RM43m cheaper than the list price will not be changed.)
During the summer months my understanding is that MTU Aero Engines – one of the EPI partners – delivered a completely new version of the propulsion system’s full-authority digital engine control software and that during testing this has been further up-rated. It is of course the severity of problems on the propulsion system that have been responsible for the near three year delay and huge cost overruns of this programme. Indeed, while we attach no blame whatsoever to any of the engine development programme partners that also include Rolls-Royce we are constantly reminded of the crass nature of the decision EADS took to abandon an actual signed order for an already well proven turbo-prop engine from Pratt & Whitney Canada in order that a completely ‘new’ European designed engine could be developed by the partners at a hugely increased cost. As I have said before when writing on this troubled programme it is my considered view that while the engine has been developed to the absolute specification laid down by EADS it is the specification that was predominantly at fault. Thus, despite enormous work put in by the engine partners and EADS to get the programme right, I am left with concerns that even when it flies this aircraft may not be able to carry weights originally envisaged and marketed to the government partners.
Next on the list of problems yet to be resolved on the troubled A400M is the issue of what further cash the partner governments may be asked to stump up for the aircraft that may eventually be delivered by EADS – assuming the programme continues and that the seven year development phase does after all turn into a full manufacturing programme. Reports circulating today have gone as far as to suggest that to keep the original EUR20bn programme alive it could be split into two tranches – the first deliveries retained on the basis of the original contract price whilst the second tier, say for deliveries planned five years out, would be at a significantly raised price. If the many A400M problems are now close to being resolved and if some of the governments do decide to pay the higher price for a second tranche aircraft (an unlikely prospect in our view for countries such as Britain) we could expect first deliveries of the plane to be made to the French Air Force about three years from now – about three years later than originally expected.
It may be worth noting that the list price of the A400M is still quoted at US$190m per aircraft. Clearly though moves to raise the price have been afoot for the best part of the last year and whilst little actual official detail has emerged we do at least know that before it pulled out last week South Africa, which had intended to buy eight A400M’s, had seen its original price we believe of R17bn rise to R47bn – about EUR4.3bn. My own view is that Britain will not go along with anything that will see the price it would need to pay EADS for the 25 aircraft it has ordered raised. Indeed, while even as late as this past summer I had been convinced that the RAF still wanted the twenty-five A400 planes, I now believe that a view may be growing that there are other ways of skinning the cat and that sticking with A400M is too higher risk. Equally, even if I am unconvinced that the Treasury will play ball choosing to stick with the A400M programme, I am even less convinced that should there be a change of government next May and that David Cameron takes charge that the UK would not then seek to pull out.
Take into account the rest of Airbus’ woes – the impact of the dollar, cash flow, A380 programme concerns, order deferrals, unlikely outlook for airline industry improvement – and there is little if any good news in prospect. We note that Airbus is planning to deliver around 490 aircraft this year compared to approximately 483 last year. In itself this is a reasonable achievement given the difficult circumstances the customer airline industry finds itself in and neither worse nor better than that of Boeing. However, in our view, the disappointing Q3 result and the miserable statement that appears somewhat full of rather forlorn warnings is absolutely no reason for EADS shares to rise!
Howard Wheeldon, senior strategist at BGC Partners