Order Backlogs Are Overrated on Wall Street

by: Chad Brand June 02, 2008 | about stocks: BA / LMT / NOC    
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In the face of oil peaking at $135 per barrel in recent days we have seen many of the airlines cancel planned deliveries of new planes they were going to add to their fleets over the next few years. Those plane orders are now unnecessary as the carriers are cutting capacity.

The big point here is that investors often go gaga over industrial suppliers' backlogs. The longer the backlog the more predictable their revenue stream over the longer term, or so the investors would have you believe. Due to long lead times customers do have to place orders far in advance, often years ahead of time. Hence, the suppliers report their backlogs to investors to give them an idea of future business.

All of this appears to be very important, except for the crucial point that a customer (an airline for instance) can simply cancel their orders whenever they want since they are not binding. A large backlog may look really nice, until customers start canceling orders.

Now, would I prefer a large backlog to a small backlog? Of course. That said, I think backlogs in general are overrated on Wall Street since the orders are not binding. As a result, backlogs don't always translate into revenues.

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This article has 5 comments:

  •  
    Jun 02 08:16 AM
    You need to cover another industry as you really don't understand this one. There are soft orders and then there are firm orders. Soft orders are just that and can be cancelled, whereas firm orders can't be cancelled without penalty. Furthermore, with the airline demand for backlog planes, Boeing and Airbus can shift others without even thinking about it. Watch this summer at the airshow and you will see another record year for the manufactures for more efficient models by the same airlines that are cancelling the existing less efficient models.
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  •  
    Jun 02 10:09 AM
    You need to cover another subject as you don't understand backlogs. Cancellations are not necessarily free. Cancellations can always occur -- large backlogs or small. At times when capacities are tight, there is water in backlogs. Responsible CFO's factor in an estimate of this. In good times division managers tend to underreport backlogs as they create expectations of better performance. In bad times its irrelevant as life stinks anyway.
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  •  
    Jun 02 10:46 AM
    the only way for any airline to remain competitive is to replace their heavy fuel inefficient planes with lighter ones using titanium and carbon fiber...... a twenty percent fuel efficiency gain is a compelling reason for new orders, so I would not worry too much about cancellations of manufacturing backlog.....
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  •  
    Jun 03 01:14 PM
    this is one of the lamest writings I've ever read. fuel hike will only accelerate BA's business, since airlines have to re-fresh their planes sooner than later. Fuel cost and other maint. cost constitute more than 90% of total money spent on the plane, including initial purchase. therefore, if you save 20% in fuel cost, it's like getting an airplane for free.
    also, airline business is cyclical, and will bounce back up some day. only way to survive is to buy fuel efficient planes, rather than keeping old ones, and spend all money on fuel, which would have gone into buying a nice plane and then some.
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  •  
    Jun 05 11:20 AM
    Boeing's 787 Dreamliner can bring twice as many passangers as the 737 and Airbus 320 to the same destination using 20% less fuel so the potential fuel savings per passenger is actually 60% (Do the math). So why would high fuel prices hurt the 787 sales?
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