Airbus Group SE. Company Valuation. More production, weak competition

Table of Contents

Company overview
CIVIL AIRCRAFTS
DEFENCE & SPACE
HELICOPTERS

Management & Governance
ORGANISATIONAL STRUCTURE
SHAREHOLDERS
GROWTH STRATEGY
RESTRUCTERING PLANS
WTO

Industry overview
MACROECONOMIC CONTEXT
PRODUCT & REGIONAL TRENDS
COMPARABLE COMPANIES

Valuation
MAIN VALUE DRIVERS FORECAST
COST OF CAPITAL
SUM-OF-PARTS VALUATION

Multiple Valuation

Sensitivity Analysis

Annexes

Company overview

The Airbus Group SE consists of three operating business units: Civil Aircrafts, Defence & Space and Helicopters. Each will be presented individually in the following paragraphs:

Civil Aircrafts

The aircrafts produced service the transportation of people, civil aircraft fleet, and goods, cargo fleet. Key revenue driver here is the A320 family. It is by far the most sold product of Airbus, accounting for around 80% of this business line’s

revenues. The base model is the A320, which is 38m long. Three derivatives exist: the 6m shortened A318, the 4m shortened A319 and the 7m stretched A321, which is the longest version with the highest passenger capacity. The

A 320 family was originally introduced in the 80’s but modified several times. A completely new development, also called a clean-sheet design, is not expected until 2025. In 2016, a new engine option (neo) was introduced. It promises to lower the operational costs and increase the competitiveness against its main market rival from Boeing.^[1] Besides a new engine, minor aerodynamic improvements such as winglets were introduced. At the beginning, this project had major roll-out issues, mainly due to the engine manufacturer as Airbus itself does not build the engines. Pratt & Whitney, a unit of United Technologies Corp., builds the plane’s geared turbofan engine for the neo version. Alternatively, CFM International, a venture between General Electric Co. and Safran SA can be chosen as engines manufacturer. CFM hasn’t seen delays. The problem with Pratt & Whitney will be fixed in Q3 2016 and predictably back on track during Q4.

In an analyst call, Airbus Management said that so far they do not intend to sue the OEM for this delay. However, this delay leads potentially to direct costs in two ways. First, some airlines cancelled their orders, such as Qatar Airways. The gulf carrier cancelled its first four deliveries in 2016 and the whole order of 80 aircrafts is at risk. Second, theoretically less revenue is generated. As of 30/11/2016 only 43 neos were delivered. Due to the holidays in the production facilities at the end of the year a total of only 48 are targeted. 12 neo aircrafts less than initially planned are produced at a list price of 107M€ each. However, the impact on the P&L is not significant: those early production aircrafts tend to be sold at a significant discount and the production slots are instead filled with ceo- versions. The current engine option (ceo) is still build and sold as long as the order books allow. Nevertheless, from 2022 a complete shift of production from ceo to neo is expected for the purpose of this analysis.

Thousands of orders from clients lead Airbus’ Management to plan a continuous ramp-up of production until 2019. Besides expanding existing production lines, new plants recently opened in the US and China in order to be closer to the customers and the high-growth markets of the future. For more details on the historical and forecasted balance sheet development see Annex 1 and 2. On the other side of the Atlantic in the USA, main competitor Boeing offers its B737 in this class. A new version called “MAX” is currently developed. Airbus claims to have 14% less fuel consumption per seat (A321neo vs. 737MAX9), a 7’’ wider cabin, a 1’’ wider seat and more total seating capacities.

Second value driver is the A330 which was introduced in 1994. In contrast to the A320, this version offers more seats on a longer range. Offering two aisles classifies it as “wide body”. As with the A320, the A330 is currently updated to A330neo versions called -800 and -900. At the end of 2016, it is expected to be assembled in the final production line (FAL) with extensive flight tests following. At the end of 2017, first deliveries are expected to carriers such as TAP. This aircraft competes with the new B787 Dreamliner from Boeing.

The latest model is the A350. Throughout 2016 & 2017 the ramp-up of production is underway. However, it progresses slower than expected with only 48 models delivered in 2016. A target of 80 deliveries for 2017 was announced. The slightly bigger derivative A350-1000 is currently tested and will be delivered from 2017. It is Airbus’ answer to Boeing’s dominant B777 which is also going to be renewed in the years to come.

The biggest aircraft sold is the A380, which holds up to 853 passengers. It was introduced ten years ago and just hit the break-even point in 2015 due to enormous development costs and a competiveness pricing. Nevertheless, sales are slowing down and production will be decreased to 12 A380s per year by 2018. Those clients nowadays favour more fuel-efficient twin-engine planes. However, congested major hub-airports such as Heathrow or Tokyo and expected air traffic growth of 100% within the next 20 years might support sales of this aircraft in the long-term on specific high traffic routes. Airbus is also pitching ideas about new plane layouts with an increased seat density to costumers. It is in competition with Boeing’s iconic B747 which will go out of production in the near future.

The civil aircraft business line accounts for 70% of the Airbus Group revenues. Those are realized when a plane is handed over to costumers including a risk transfer. Therefore, production rates primarily determine revenues. Besides airlines, also high net worth individuals and governments can order plans. As the numbers of ordered aircraft are by far lower for those VIPs and the mentioned cargo planes, demand will be assumed to be stable in the production forecast. Airbus intends to produce 650 aircrafts in 2016. As a result, a forecast of production rates and corresponding pricing will be the focus of the value analysis. The market is highly cyclical with signs of a weakening at the moment due to low fuel prices and previous years of record sales. However, Airbus still has a backlog for eight full years of production. Besides main rival Boeing, Airbus faces currently new competition from Bombardier and Embraer and in the near future from the Russian company UAC and the Chinese state-owned company COMAC.

Defence & Space

The second line of business is Defence & Space with a 20% contribution to the group revenues. “Airbus Defence and Space is well placed to play a leading role in the markets for future unmanned aerial systems (UAS), as well as combat, transport and intelligence, surveillance and reconnaissance aircraft (ISR). Some of the products armed forces can rely on are the swing-role combat aircraft Eurofighter Typhoon, the multi-role military airlifter A400M and the tanker aircraft A330 MRTT.”^[2] The former is a plane build for refuelling fighter planes in flight. As of year-end 2016, 28 of those are in service with a number of militaries, first and foremost the Australian Air force and European militaries. It is currently updated with high R&D expenditures to achieve a higher thrust in flight and with the military equipment. The A400M also offers a feature to refuel other planes. However, it is mostly used to transport equipment and military personnel. This aircraft is still struggling from quality issues. Some cracks in the fuselage were discovered in 2015 and billions of provision accounted. Meanwhile, additional capabilities are added to the plane. Light military planes such as the C295 are also offered. In the Space business, Airbus is providing space rocket services, in joint venture with other companies. Boeing is already producing a great variety of products in this sector and is more established than Airbus. Moreover, UAC, Embraer, BAE, Raytheon, Leonardo-Finmeccanica, Lockheed, Oboronprom and Northrop play in this market.

Helicopters

Airbus is the biggest producer of helicopters and worldwide market leader here. Three major market competitors can be identified: Bell Helicopters, Augusta Westland and Sikorsky Helicopters. The last two are incorporated within other groups what will be explained later in greater detail. The Airbus revenue is driven by products such as H145 and H175. Furthermore, combat helicopter such as the NH90 are build. In total 10% of the group revenues are generated here. The market is mainly driven by the Oil & Gas sector.

For the consolidated P&L of the Group please see Annex 3.

Management & Governance

Organisational structure

Besides the three previously mentioned business lines, the Airbus Group has a wide portfolio of investments.^[3] The Group is undergoing a strategic review resulting in divestments in the Defence & Space business line. It began in 2013 with the renaming of EADS Astrium into Airbus Defence & Space and the organisational merger of Airbus Military, Astrium and Cassidian. This decision was well received by the markets as the European military budgets were declining and this merger gave possibilities for synergies and job cuts of 5,000 employees. In 2014, it was decided to sell some non-essential business unit of this business line including its communication business, Fairchild Controls (avionics and hydraulic systems for aircraft), Rostock System-Technik (provider of aircraft engineering services and cabin simulators), AvDef (in-house charter airline which also trains French military pilots), ESG (software business) and a fractional sale of its security and Defence electronics businesses. As strategical important are military aircraft, missiles, satellites and rocket launchers. Those disposals were already executed. Those presented a revenue of 2,000M€ out of 14,000M€ of the Defence business at the time.

Airbus Defence Electronics was evaluated as available-for-sale at the beginning of 2016. On 18 March 2016, the Airbus Group reached an agreement with affiliates of KKR & Co. L.P. (the acquirer) to sell its defence electronics business, a leading global provider of sensors, integrated systems and services for premium defence and security applications. The first cash inflow of the total value of 1,100M€ is expected in Q4 2016. Airbus will retain a 25% share for a maximum of three years for the business which generated sales of 1,000M€ in 2015. Reason being, the critics of the German Defence Ministry who is the single biggest client. This sale will terminate the current refocusing of the Defence & Space unit.

Airbus is a truly European project due to its history. It began in the 70’s as reaction to the dominance of US manufacturers. No national supplier in Europe was able to face them with a competitive aircraft product. Therefore, Germany, France and the UK decided to form the “Airbus Industrie” partnership and build its first jointly developed jetliner, the A300. Spain joined the consortium in 1971 with a 4.2% share. The United Kingdom later dropped its strategic involvement but remained important as supplier for wings, as it is still today. Currently, the Airbus Group is headed by Germany and France. Additional factory sides are installed in the UK and Spain. As for the UK, no significant impact is expected regarding the Brexit decision. The details are expected to be an open issue until 2018. Nevertheless, the Management team confirmed that the wing manufacturing in the UK plant is extremely competitive regarding costs and quality. The normal level of investments in order to replace depreciated assets will be maintained and no closure of the plant is considered.

The Group Management team consist of Tom Enders (CEO Airbus Group), Harald Wilhelm (CFO Airbus Group), Marwan Lahoud (Chief Strategy & Marketing Officer Airbus Group), Fabrice Brégier (COO Airbus Group and President Airbus), Guillaume Faury (President Airbus Helicopters) and Dirk Hoke (President Airbus Defence & Space). The relation between Tom Enders, from Germany, and Fabrice Brégier, from France, is reportedly frosty as the recent restructuring programme (see below) sparked tension. For the company it is important that everything is in balance: beginning at the top with a board of directs which has to be adequately mixed by nationalities, down to the burdens of restructuring programmes where job cuts are expected to be shared fairly among member states. Potentially, a non-unified management team could pose a danger to the company’s well-being when fast decisions have to be taken for or against a new airplane design, where to invest in the future or what production output the final assembly lines in the world should produce. Looking into the past it becomes clear that Governance became more and more transparent. Airbus is much more a “normal” company than it was decades ago. If this trend is to be continued than it will become a company which follows entirely the market and where no national stakeholders decide or vote on strategic important decisions in their favours anymore. This will be discussed in detail in the next paragraph.

Shareholders

As of 30.09.2016 two main classes of shareholders can be identified: On the one hand, free floating shares with institutional and retail investors hold 73.6% of the equity. On the other hand, shareholder agreements with SOGEPA (a French holding company owned completely by the government of France), GZBV (German government holding vehicle) and SEPI (Spanish state holding company) account for 26.4% of the equity.

The involvement of Germany and France used to be quite significant. Besides the financial interest also domestic jobs are at risk with every decision taken at the management level so the governments paid close attention. However, that status had to change in order for Airbus to be a flexible market participant: “France is cutting its ownership of Airbus as part of an agreement to reduce the direct influence of the French, German, and Spanish governments over the company. Reached in the wake of a failed merger with defence contractor BAE Systems Plc, the December 2012 shareholder accord is a step toward Airbus becoming a “normal” firm guided by market forces.”^[4] Let alone in 2014 the government sold 451M€ of its stake to institutional investors. After all, any shareholder is prohibited from holding more than 15% of the share capital with the target for France and Germany of 12% and for Spain of 4%. All countries together cannot hold more than 30% of shares. Today, the holding companies of the countries are no longer allowed to influence the daily operations of the company or to designate Members of the Board of Directors or management team. They can, however, propose new members of the board of directors at the Annual General Meeting as long as there is a balance among the nationalities of France, German and Spain in respect of the location of production facilities. The board of directors votes the CEO who proposes the members of the Executive Committee who are thereafter approved by the Board of Directors. A rule specifies that 2/3 of the Executives have to be EU nationals including the CEO and CFO.^[5] Other institutional investors can be seen in the graphic. 772,714,000 shares are issued as of end of 2016.

Growth strategy

Revenue generation in civil aircrafts is mainly determined by production output. In order to grow revenues the increase of yearly deliveries is targeted from two different angles. First, production line capacities in existing factories are increased to take advantage of the full order books which would be enough for eight years of production. Second, international presence is increased. Civil aircrafts already installed two FALs outside of Europe, one in the USA and one in China. The underlining strategies are very different: being closer to the growing demand for single aisle planes in Asia on the one hand. On the other hand, Airbus wants to support local jobs in the US to convince American customers of the political will to invest in the country and get more sales in return. Politics are the main reason for or against an aerospace product.

Defence & Space is specifically targeting the US in order to win US Military Defence contracts. That country accounts for the highest military spending worldwide. However, this strategy is highly complicated. Several political issues rose from US procurement officers giving contracts to non-US companies. The situation could be worsened for Airbus if the newly president-elect puts “America first”, meaning excluding all other contractors. However, Airbus Defence & Space is as of now the prime contractor for the Coast Guard’s procurement of 18 HC- 144A Ocean Sentry maritime patrol aircraft and some other prestigious projects within the American military.

Restructering plans

On 30.09.2016 Airbus publically announced the merger of the Group structure with its Commercial Aircraft entity to form a new company structure. The purpose is to cut costs and to prepare the leaner structure for the digital transformation. Processes that are similar but performed from different teams, such as Technical Research, Strategy, Legal, HR and IT, will be merged and headcounts reduced, thereby eliminating redundancies. It is estimated that around 1164 jobs^[6] will be lost (of which 429 in Germany, 640 in France, 39 in Spain and 54 in UK). The new entity will be led by CEO Tom Enders. Fabrice Brégier will become Chief Operating Officer (COO) and maintain his Presidency of Airbus Commercial Aircraft. Details of the merger and its impacts are now subject to discussions with the social partners on Group, national and divisional level. The risk exists that unions will try to block this decision with defensive measure, such as strikes.

The merger provides the opportunity to introduce a single Airbus brand for the Group and all its entities, effective January 2017. By this analyst´s estimates, which can be seen in Annex 4, cost saving of roughly 220M€ on a yearly basis could be achieved if all jobs were to be cut and not shifted. This includes a country salary adjustment and indirect costs such as IT and HR savings.

The restructuring was already discussed at the Financial Times on the 18/09/2016. The share price reacted with a slight increase. The decision was unexpected by the markets but not received as a great improvement. Compared to the last restructuring with a reduction of 8,000 jobs this announcement seems to be insignificant. Also compared to rival Boeing, which cut 6,115 jobs in 2016 and plans further job reductions in 2017.

WTO

For the last 12 years, Boeing and Airbus are suing each other for unfairly received government subsidies. Boeing is in those cases supported by the US government and Airbus by EU representatives. According to the WTO, Boeing started in 2004 with accusing Airbus of being subsidized by the EU. 2010 was the WTO panel report circulated for the first time and directly appellate by Airbus in 2011.

The schema works as follows: Airbus is getting billions of Euros in low-interest loans for new aircraft developments (“launch aid”). If the commercialisation of this aircraft program is successful, Airbus has to pay back the loan. “In 2010, the WTO ruled those loans illegal because the European governments gave Airbus the money on highly favourable, non-commercial terms.”^[7]

On 22th of September 2016, the WTO ruled in favour of Boeing in recognizing that the EU did not unwind that illegal assistance within the given time frame.^[8] However, the EU is most likely to appeal this verdict again. Other Boeing allegations of an unfairly supported A350 and A380 development were rejected by the WTO. Eventually, the issue could be potentially settled by a compromise between the two companies but this is rather unlikely. At the same time Boeing is facing a 9BN$ tax break investigation over the 777X programme by the WTO, which is to be determined in 2017.

No such results are directly impacting this valuation as the WTO cannot directly impose fines on companies. A verdict might impose additional taxes on EU goods imported to the US if the US should file for this measure with the WTO.^[9] “[…] whatever Boeing will say, nobody will have to go to the bank. There have never been any repayments and there never will be, it is not in the spirit of WTO."^[10]

[...]

^[1] “These improvements will result in 20 per cent fuel savings per seat compared with current engine option (CEO) aircraft by 2020, along with two tonnes more payload, up to 500 nautical miles additional range […] and reductions in engine noise and emissions.“ Source: Airbus

^[2] Source: Airbus

^[3] At year-end 2015, the total portfolio compromised 262 fully consolidate entities, 53 joint ventures and 19 associates which are accounted for using the equity method. Material fully consolidated investments include MBDA S.A.S., Atlas Elektronik GmbH and GIE ATR. Those and all other fully consolidated entities are assumed to be contributing to operating activities with regards to this valuation. The joint venture and associates are non-operating as the merely stand for the portfolio investment strategy of Airbus. Hence, they are excluded from the cash flow valuation and added with fair value to the operating value at the end. Additionally, Dassault Aviation shares are qualified as held-for-sale. Those are being sold over a long time horizon. The latest transaction was executed in June with a capital gain of 528M€. The remaining investment represents 9% of Dassault Aviation’s share capital.

^[4] Source: Bloomberg

^[5] Source: Airbus Report of the Board of Directors, issued as of 26 February 2015

^[6] Source: Handelsblatt

^[7] Source: Seattletimes

^[8] Source: WTO

^[9] Source: Financial Times

^[10] Source: Telegraph