When it comes to plane manufacturers, two companies come to mind:Boeing(NYSE: BA) and Airbus. But which one is a better buy?
In this week's episode of Industry Focus: Industrials, Sean O'Reilly has special guest host Adam Levine-Weinberg on to answer that question. Find out which company sells more planes, which comes out on top for customer comfort, which has the lead in fuel efficiency, which are the most important models for each company and what they specialize in, how the companies strategies have started to drift and what that means for the future, which makes a better buy for investors, and more.
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A full transcript follows the video.
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This podcast was recorded on Jan. 26, 2017.
Sean O'Reilly:Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today isThursday, January 26th, 2017, sowe're talking about energy,materials and industrials. I'm your host, Sean O'Reilly, and joining me todayin studio is Motley Fool contributor Mr. Adam Levine-Weinberg. Good morning, Adam. How are you?
Adam Levine-Weinberg:I'm great. Good morning, Sean. How are you?
O'Reilly: Nottoo bad. I got my coffee, got agood podcast companion -- we're good to go here.
O'Reilly: So it's been a little while since I've had you on the show, a month or two. You weregood enough to join me, we talked about Buffett's investmentsin the airline industry for the first timesince the '80s, when he did the preferred stock investment inUS Airways. Anyway,I wanted to get you in here andanswer the eternal question:who makes a better plane,BoeingorAirbus?
Levine-Weinberg:It'sa great question. We're going to slice this afew different ways.
O'Reilly: Iremember when I first posted this to you, and you were like, "Oh,that's a good one." Anyway,go ahead.
Levine-Weinberg:To start off,I wanted to say, safety-wise,both of these companies make very safe airplanes these days. There's really no difference. Both of them haveincredible safety records. Obviously, there are accidents sometimes. Most of the time,it's pilot error or some kind of human error. So, safety-wise,both of these companies knowwhat they're doing; they make very reliable planes. Whenyou getbeyond that, there's some really interesting comparisonsbetween the planes of both companies. We'llstart off with what'sprobably the most important for a lot of the Fools listening to thisshow out there, which is passenger comfort. Howdo you feel when you're on the plane? Is there space? Do you feel like you're cramped inlike a sardine? A lot of thatactually doesn't depend so much on the airplaneas much as it does on the airline itself,because the airlines have a lot of leeway to set up the plane the way they like.
O'Reilly: So they can move the seats,is what you're saying?
Levine-Weinberg:They canmove the seats aroundin their own configuration. There are some limits to that, butnot a lot. What's interesting is that, in general, Airbus planestend to have wider seats thanBoeing. And there's a few reasons for that. On the narrow-body side,these are the single-aisle planesthat you see flying all around the United Statesand on some of the shorter international flights,the Boeing 737is the best-selling planein history. The runner-up is Airbus'A320,which is their competitor. Andit just happens thatthe Boeing 737has been around since the 1960s,and Boeing keeps just redesigning it and redesigning it.
O'Reilly: Wow. Sothis is a 50-some-year-old plane now?
Levine-Weinberg:Whenit was originally designed, it was a small plane meant to carry about 100 passengers. And now it's gotten up to 150and even 200 passengersin many configurations. They made it longer; they have obviously upgraded of the engines several times; they'veupgraded all of the interiorsand the cockpits. But what they haven't done --
O'Reilly: Theydowngraded leg room --I'm kidding.
Levine-Weinberg:That's true,but again, that's up to the airlines. But what hasn't changed is the width. This was a plane that wasoriginally meant forrelatively short flights,so it's a little narrower than the Airbus A320, which was designed about 20 years later, in the '80s. The result is, generally speaking, the seats on a Boeing 737 are about a half inch to an inch narrower than the seats you'd see on an A320, and the aisle is often usually narrower, about a 7- or 8-inch difference.
O'Reilly: Whichdoesn't sound like a lot, but you're talking aboutthat on every seat. It adds up.
Levine-Weinberg:Yeah. Critics of the industry have said thatthe average weight is going up,especially in the United States --
O'Reilly: I was going to make a joke, like,it's interesting that the European plane has the wider seats; what's up with that?
Levine-Weinberg:Yeah, it's justfrom when it was designed and what it was designed for. The 737 grew into its current mission. Five or 10 years ago, Boeing was reallystrongly considering sunsetting the 737,getting a completely new design. But the problem is,when you think about the cost of a completely new planecompared to what it costs to upgrade onewhen it's already selling --
O'Reilly: There's no incentive, yeah.
Levine-Weinberg:They've sold thousands of these, looking out five and even 10 years. So there's just no reason right now.
O'Reilly: That'sso funny, becausethe joke is obviously, oh,you Americans and your big cars, andEurope makes the slightly bigger plane.
Levine-Weinberg:Yeah. You'veseen the same thing on the widebody side. These are the planes with two aisles that youtypically see on the longer haul international routes. The Airbus A330 and A350 were designed with 18-inch seats. Ifyou talk to Airbus, they'lltalk to you about how they love passenger comfortand they have decided that18 inches is the correct width,and the seat can't be any less than that or you're going to be uncomfortable,especially when you're trying to sleep, or juststuck in your seat for a 12-hour flight. Thefunny thing is that Boeing didn't intend to have narrower seats on its widebody planes, which are the 777 and the 787, which isalso popularly known as the Dreamliner. Those wereactually designed with wider seats. The planes areactually so wide thatairlines realized they could fit an extra seat in each row --
O'Reilly: Oh,here we go.
Levine-Weinberg:-- so that's what they did. So, originally, these were meant to have 18-and-a-half-inch or 19-inch seats,even wider than the Airbus ones,and now virtually every airline,especially the ones that are taking the airplanes nowas opposed to the ones that got them 15 or 20 years ago, in the case of the 777, they're allconfiguring them with an extra seat in each row. So, now, they have 17 inches of seat width, which is OK for a while, buta lot of passengers find thatuncomfortableif you're traveling for a really long time.
Otheraspects of travel, the newest planes from both Boeing and Airbus, sothis is the 787 from Boeingand the Airbus A350,they have some really innovative changesbecause of the new materials they're working with,they can keep the cabin a lot more humid than it used to be possible to do. They'vealso increased the air pressureso it's closer to the ground level pressure. Usually, it's pressurized now at about 6,000 feet instead of 8,000 feet. They've said that itgreatly increases passenger comfort,and can also help a lot with reducing jet lag. So,those are two big improvements that bothmanufacturers have made. But just based on the seat width alone,Airbus has a bit of an edge over Boeingin terms of passenger comfort.
O'Reilly: Got it. So I just took over an airline. I'm an executiveat an airline. I was completely sold by Buffett'sextremely modest investment in the sector. AndI am coming to you and I am talking to Boeing and Airbus,and I'm like, "So,guys, biggest cost is fuel,it's oil, it's gasoline. Oil prices are cheap right now,gasoline, too, it's actually been a huge boon for the industry, butthat might not last forever. Which of you guys is more fuel efficient?"
Levine-Weinberg:Yeah,this is another big point where the two manufacturersdisagree with each other andput out all kinds of statistics that are usually doctored in one way or anotherto show why their planes are so much more fuel efficient. The best people to talk to on this areactually the airlines,because they don't have a dog in the fight. Generally, when you talk toeither the airlines or the aircraft leasing companies,historically, Boeing has had asmall advantage in terms of fuel efficiency. It's not a lot --
O'Reilly: What do you mean by small?
Levine-Weinberg:We'retalking about maybe 2% or 3%,for a comparable generation of planes. So, obviously, a 20-year-oldAirbus plane is going to be way behind a Boeing plane thatjust rolled off the assembly line today. But for what they're building at the same time, they've beenpretty similar. On the narrowbody side, so, this is the 737 and the A320,historically, Boeing has had anadvantage, and that may have disappeared just now. One of the problems withBoeing having this really old design that it keeps reusing for the 737 is that it can't use the same type of engines as Airbus has beenable to use because the plane is very short. It'snot very high off the ground. So without making really big changes to the landing gearto prop up the plane higher, they can't use bigger engines. And those bigger enginestend to have better fuel efficiency.
O'Reilly: Yeah,just because of more surface area on the blades and stuff.
Levine-Weinberg:It'svery complicated science. The bigger enginecreates more drag,which reduces the fuel efficiency,but the engine itself tends to be more efficient, and thatusually more than balances it out. Boeing has found someworkarounds. It got pretty close. But Boeing has typically talked about itsnext-generation plane, the 737MAX,which is going to be available to the first airlines this year, asbeing about 13% better than theprevious generation, whereas the new A320neo, which is the version of the A320 withupgraded engines, that's about a 15%-16%advantage in terms of fuel consumption. So that alone probably closed the 2%-3% advantage that Boeing hadpreviously held over Airbus. So now, they're pretty much neck-and-neck on that.
On the widebody side, the Boeing planes arealso probably a little bit better, butit's pretty close,especially with the new A350,which is a new Airbus plane that came outa couple years ago. Then there's anupgraded engine version of the A330that will be availableearly next year. With those coming from Airbus,it's pretty much neck-and-neck. Andthat's really not that surprising,because these two companies are using the same enginesuppliers. And the engine,obviously, is the most important part of the planein terms of determining how much fuel it uses.
O'Reilly: Got it.Adam,fuel efficiency is a bit of a tie. Airbus has a modest advantagein terms of seat size,and again, that's up to the airline. Talk to me about the market. Boeing has long been known --if you think of the quintessential example of anAmerican manufacturing firm, it's either Boeing or [General Electric]. And GE sells the engines to Boeing, so it is what it is. What's the marketplace look like right now? What's Boeing's backlog? It's some enormous number, in the hundreds of billions or trillions or something.
Levine-Weinberg:Yeah,it's been hovering for the last few years in the $450 [billion] to $500 billion range.
O'Reilly: Ofall the future orders, they may or may not happen, butbottom line, they have this backlog of future orders. You hear, like,Qatar bought like $50 billion worth of planes from Airbus. So what does it look like today with the market in terms of market share and all that stuff?
Levine-Weinberg:In terms ofoverall market share, Airbus isa little bit higher in terms of the orders for the future. Butin terms of annual sales -- that'swhat's being delivered in each year right now -- Boeingstill has a little bit of an advantage. That willprobably, at least, it might flip at some point. Obviously, if Airbus continues to have more orders thanBoeing, then eventually it will be building more planes than Boeing.
O'Reilly: So future orders are higher for Airbus.
Levine-Weinberg:Exactly.O'Reilly: Was thereever a time where Airbus was way in the lead, or has Boeing been it for ...
Levine-Weinberg:This beingover the past five years,particularly since the A320neo went on sale, that's really whereAirbus has built up this advantage. For a long time,the A320s and 737s were splitting that single-aisle market prettyevenly, but Airbus was at a big disadvantage on the wide bodies. Now, they're even split or thereabouts on the widebodies, and the single-aisle planesAirbus is starting to gain an advantage. So, basically,when we look at the market,Boeing has really done some pretty innovative things in the way that the Dreamliner -- this is the 787 -- hasopened up a lot of new markets for airlines. Theybasically created a plane that is small on the widebody scale; it can seat,typically, 200 to 250 people in a three-class layout where you havelie flat, first class, and that kind of stuff. And it can still fly8,000 miles around the world,whereas usually only the biggestjets in the past were able to do that.
O'Reilly: Andthose are hard to fill up. That's the trick, right?
Levine-Weinberg:Right. What happened was,either you had to put all your flights throughone or two very big hubsto generate the traffic, or you had to sella lot of faresat really low prices thatweren't profitable. Great fortravelers; not great for the airlines,typically. So basically, Boeing has created this plane that hasopened up new markets -- 6,000- to 7,000-mile flightswhere it was never possible before toprofitably fly that on a nonstop basis.
O'Reilly: So that was a bit of a brilliant move on their part.
Levine-Weinberg:It really was.Boeing and Airbus had different philosophies.Airbus developed the A380, which is this enormous plane, two decks alongthe entire length of it, can seat 500-600 people. Their idea was,air traffic keeps growing at a really quick rate,it's doubling every 15-20 years,so we just need bigger planes. And that's true,except that Boeing said, "Wait,rather than having everybody continue to go through these hubs and justmake them bigger and bigger, why don't we let people go nonstop on routes where you couldn't go nonstop until there wasenough of a critical mass of traffic?" And so they had different philosophies.
The result is that,right now, Boeing has better coverage of the full market. They have their narrowbodies, which are the shorter-haul flights,usually less than 3,000 miles, and between 120 to 200 seatsat the most at the high end of the range. Then they have the small widebody with the 787, and they also have the 777, which is asomewhat larger widebody, which is more in the 250- to 350-seat range. Thatactually has a new version coming out that'sgoing to make it even bigger and stretch that range up to as many as 400 seats. Airbus, by contrast, they also are very strong, even stronger, in fact,on the narrowbody side,where they have, especially, the largest variant of the A320, which is called the A321, whichhas really taken off, seena lot of interest from airlines,because it reduces the cost per seatthe more seats you can put on the same version of a plane. The A321 is justbetter suited to that market than Boeing's largest narrowbody is right now. So Boeing kind of needs to respond to that,and they're very close, potentially, to announcing an even larger version of the 737 that would get itcloser in size to the A321. But, after the A321, there's a big gap in Airbus' lineup, where theydon't have a lot in the 200- to 250-seat range like Boeing does.
O'Reilly: Yeah. It'sprobably 20/20 in hindsight, but that seems like they dropped the ball there.
Levine-Weinberg:Yeah. They've talked about how they'vecome up with new cabin configurations for the A321, where you can cram more seats on it, but then that starts togive up their advantage in terms of comfort, because some of that comes from actuallycoming up with a better way of organizing the plane. But for the most part, it's shrinking seats, it'sshrinking in the bathroom, it's doing all kinds of stuff,shrinking the galleys, so that they can't serve food out of them anymore. It's really not as easy as Airbus' management has made it seem. So as a practical matter, most airlinesaren't going to take them up on the possibility of putting 220 seats onto an A321. It'sonly going to be the ultra-budget airlines that are going to do that.
O'Reilly: Let'stalk some numbers before we head out of here. Who sells more planes?
Levine-Weinberg:AsI said before,Airbus definitely has a lead right now in terms of the orders. Every yearfor the last few years, they have pretty reliablycome in ahead of Boeingin terms of orders. On the widebody side, both companies had about 1,200 or 1,300 orders in backlog,and those planes tend to go for $100 million or more. So,between the two of them, that's several hundred billion dollars of planes. On the narrowbody side,the numbers are actually even bigger.Boeing has over 4,400 planes that are in backlog just with the 737 and the upcoming 737MAX. Airbus has over 5,600. That's quite a bit ahead.
O'Reilly: This is a lot of planes we're talking here.
Levine-Weinberg:So there's definitely an advantage for Airbus,but the fact remains thatit's going to take Boeing seven years just to build all the planes that it has.Airbus, it's kind of overkill. It's great to have that many orders in backlog; it means that you can survive a recession where you might have orders dry up suddenlyfor a couple years at a time. Butunless that happens,it's not going to really matter so much,because Airbus doesn't have the capacity to build planesmuch faster than it's already planning to build them, which is less than 700 a year. So it has eight or nine years ofproduction already locked in. As a result,it's just not going to sell as many planes in the future, orit's going to have to figure out some way to build new factories or squeeze more planes out of theexisting factories it has.
O'Reilly: So, obviously, this is The Motley Fool; we'reinvestors. What do you see coming around the bend forthese guys, and what do you think of the valuationsof these companies? I have looked, Boeing is long --I cannot believe this company's return on capital and equity. It's like in the '90s, some years, 90% return on equity in a year. It's a funbalance sheet, and we can talk about that a little bit more another time. But it's got a 12, 13 multiple P/E. Airbus, it's a good business, but it's inferior by every measure. They're not free cash flow-positive most years. Boeing just throws off money like it's its job. Which stock do you like? What do you see coming around the bend for these guys?
Levine-Weinberg:I still like Boeing's stock. It has run upquite a bit in the last few months. Early last year, about a year ago, it had diveddown to the low hundreds,and it's risen about 15% since then. But I still think that Boeingcould continue to gain groundover the next few years. Right now, they have alittle bit of a transitional periodwhere a couple of their models,particularly their 777, which has been a big cash cow for them inthe past few years,demand is really falling off. But the reason whyis that you have a new version of that planewhich is coming out in 2020 --
O'Reilly: And they all know it,so they're not ordering it.
Levine-Weinberg:Everyone knows; they announced it several years ago. It'sreally hard to keep selling an old plane when everybody knows that a new, better model, more fuel efficient, more range, is coming out not that far inthe future. And it's also true thatright now, a lot of the developing world inparticular has been having troubleboth with a strong dollar,which makes it more expensive to buy these planes, and also just unsteadydemand, especially in places like Russia and Brazil, where you've had big drops off in GDP recently. So that'sdefinitely cut into the demand for these planes. But if you look out to 2020 and beyond, once that new version of 777 ramps up, Boeing is going to be, I think,in pretty good shape to continue growing its free cash flow.
O'Reilly: Awesome! All right, Adam.Thank you so much for your time!
Levine-Weinberg:Thanks for having me, Sean!
O'Reilly: Cannot wait tohave you on the show again. That is it for us, folks. Be sure to tune intomorrow for the Technology show with Dylan Lewis. If you're a loyal listenerand have questions or comments, we would love to hear from you. Just email us at firstname.lastname@example.org. As always,people on this program may have interestsin the stocks that they talk about,and The Motley Fool may have formal recommendations for or against those stocks, so don't buy or sell anything basedsolely on what you hear on this program. For AdamLevine-Weinberg,I am Sean O'Reilly. Thanks for listening, and Fool on!