October 23, 2019 - Boeing's Challenges and Future Outlook

We continue the analysis from our Monday insight to work through our views on the 37 questions that were raised about the MAX program last week: BOEING FINANCIAL IMPACTS If full recertification is required, how long can Boeing afford to keep the plant open and building aircraft to be delivered at a later date? With the credibility of Boeing now in question, will the certification process for the 777-X extend the already late entry into service schedule further, and how much more will it cost? Will this impact the planned merger with Embraer? Would Boeing be able to deliver Embraer E195-E2 models to customers as an interim aircraft? Will the Boeing/Embraer merger be canceled? Recent comments from EASA indicate that a full re-certification of the MAX will be unlikely, and their review focused on the flight control issues. That means the aircraft will likely return to service with airlines in the 2nd quarter of 2020 at the earliest, given requirements for bringing aircraft back into service. Boeing has the capability to keep the Renton plant open and producing indefinitely given its large backlog. While it is running out of parking spaces for newly built MAX aircraft, it could continue to produce aircraft at a lower rate. The key question becomes layoffs, and in today’s economy in Renton, this would mean losing key experienced personnel. Training new personnel after a restart would entail some productivity difficulties and likely impact quality, with rework required. A continued delay of another 3-4 months will likely not bring layoffs, as Boeing understands the trade-offs. Ideally, being able to maintain production would be the best possible solution for Boeing, as the supply chain is also constrained at the moment. But paying employees during a downturn in production would result in too many cooks in the kitchen, so to speak. Boeing will need employees to help maintain and deliver the new aircraft, so rather than hire new employees, Boeing could temporarily re-assign experienced personnel to Moses Lake, San Antonio, and other Boeing sites where aircraft are stored once FAA approval is received. Before that point, however, Boeing has to deal with another. Boeing’s supply chain is also struggling with the same issue and needs advanced notice of a reduction in components being supplied. After gearing up for record production increases, and having expended the capital to do so, many suppliers are caught in the vise of lower revenues and higher costs from the capacity expansions that currently are not needed. A number of smaller suppliers are facing potential bankruptcy, which could be quite disruptive to the restart of the program. Boeing will find that it's Partnering for Success program will need to be a two-way rather than a one-way street in the near future, or that its restart of the MAX could face disruption due to the financial straits the MAX grounding has put onto the supply chain. While Boeing is still diligently working on the 777-X and NMA aircraft, the clear priority is getting the MAX back into the air. When the 787 had issues, people were borrowed from other programs, causing a cascading effect of delays, as with the 747-8. Similar delays could happen in this case for the already delayed 777-X (GE engines the latest delay) and NMA development. The merger with Embraer will likely move forward as planned, albeit Boeing’s reputation has taken a major hit worldwide, particularly with the latest revelations regarding the company’s lack of transparency with the FAA. While some in Brazil are having second thoughts, they realize that competing against Airbus, which acquired the competing program from Bombardier, will require someone with the size and sophistication of Boeing to effectively compete. Embraer will be a key asset to Boeing, having developed 14 new programs in the last 14 years between commercial, business jets, and military operations. They have been consistently on-time and on-budget, and that expertise in program management is something that Boeing needs to capitalize on. The E195-E2 can certainly compete well with the smaller Airbus A220-100, but cannot be a full-sized replacement for the MAX7, which is larger. However, until the merger is cleared by European anti-competitive regulators, Boeing can’t immediately take advantage of the E2-Jets for its existing customers who need lift. STRATEGY AND LEGAL IMPACTS Does this further delay the NMA program at Boeing? Will this force a move-up in the schedule for the Future Small Aircraft? What will this do for earnings, particularly since lawyers now have new ammunition that Boeing lied to the FAA? Will out of court settlements be much higher than anticipated? Will the 737MAX supply chain survive an extended grounding, and will Boeing need to “bailout” smaller suppliers by continuing to take on inventory for future production? How low will the Boeing share price drop, knowing that the company now faces tens of billions in potential costs from the MAX program failures and apparent cover-up? The rumor mill is rampant with discussions of the NMA and a potential 767-X re-engining program that would be less expensive in the short term. We don’t believe the NMA should be dropped, as there is a market and a ready customer in Delta who could likely order 200 aircraft. But the Board has been reluctant to give a go ahead and Boeing’s CFO has been rumored not to favor the project from an economic standpoint. We believe the NMA, and the new materials and manufacturing technologies and processes it would introduce, are vital as they will also be needed for the future small aircraft. The NMA provides a way to work out any kinks associated with the new technologies without the risk of introducing them into a high volume situation. We fully expect out of autoclave composites, advanced robotics and additive manufacturing to each have stronger roles in the next generation of aircraft. It would be sound business practice to work out issues on the NMA rather than the FSA future small aircraft that would require high volume production rates. The reputation of the MAX, once back in service, will likely determine whether the FSA needs to move up in its timetable for entry into service. We believe Boeing will need to accelerate the FSA by a couple of years, as the MAX will not be popular. From a legal standpoint, the revelations of the last week have plaintiffs attorneys smiling around the world, as it now appears that there is some culpability at Boeing. The flight test pilot pleading the fifth amendment doesn’t help the company’s public image and implies that certain individuals know that they broke the law. As a result, we expect legal settlements to grow substantially and have increased our estimate of legal liability substantially to several billion dollars. That adds another major cash flow hit to Boeing just when it doesn’t need one. The impact on Boeing’s share prices is just beginning with last week’s revelations. We believe it is headed for the $200s rather than $400s, as tens of billions in losses and liabilities will drive the price down substantially. Had Boeing not artificially propped up the stock price with $37 billion in stock buybacks and $13 billion in dividends over the last five years, they would have a war chest to easily survive this crisis and still invest in new programs. Unfortunately, the stock buybacks now constrain the company’s strategic options with respect to new programs. LEGAL ISSUES Will there be criminal indictments of Boeing executives who may have known about the potential problems with the aircraft and hid MCAS problems from the FAA, airline customers, pilots, and Boeing’s airline customers? How will customers react to the realization that Boeing apparently lied to the FAA? Will the old saying “if it isn’t Boeing, I’m not going” be reversed in the near future? Will there be customer boycotts of the 737 MAX on social media? Could those boycotts extend to other Boeing aircraft? If boycotts cripple profitability for Boeing aircraft, could this reduce orders for non-MAX Boeing aircraft as well? Is Boeing “too big to fail” and could a government bailout result? Can Boeing’s board survive this crisis? With multiple investigations underway and ex-employees already pleading the fifth amendment to avoid self-incrimination, it is clear that indictments are likely. The question is whether they will remain at lower levels or rise to include senior management. This will be the decision for the Department of Justice to make based on the facts they uncover. Boeing’s lack of transparency with the FAA is not helpful in convincing people that there was no cover-up of information known before the two crashes and that Boeing did not favor expediency and cost over safety. Initial customer reactions to our survey are not favorable to Boeing, and we believe customers will choose not to fly on the MAX for a longer period than the DC-10 or historic circumstances because of social media and the Internet. The MAX will continue to be news on social media, even if it is no longer news in the mainstream media. This will be an interesting test of consumer sentiment, and today, that sentiment is not with the MAX nor trusts the FAA. We expect consumer sentiment to be slow to change, forcing airlines to re-evaluate their fleet plans and the productivity of the MAX in their route systems. If MAX load factors are lower than those of other airplanes, Boeing may need to pull the FSA forward more quickly. Our survey data indicates that customers are not in a forgiving mood. Is Boeing too big to fail and the next General Motors? Will a federal bailout be necessary? We don’t believe this will cripple the company, as Boeing remains one of the world’s largest defense contractors. Nonetheless, everyone from suppliers to airlines to the attorneys representing passenger families will be attempting to get the maximum possible settlements from Boeing as this crisis continues and creates additional economic harm. A total bill in the $20 billion range is not out of the question when all costs are added up. But Boeing, which has used $50 billion to repurchase shares over the last five years, is not in financial jeopardy. With respect to leadership, we don’t believe Dennis Muilenburg will survive this crisis as CEO, and we don’t believe the departure of Kevin McAllister, CEO of BCA, the first sacrificial lamb, will be the last. Muilenburg chose to be the company’s single public voice on the crisis, and the image of Boeing is clearly in his lap. So far, he hasn’t come across as credible to the traveling public, and is unlikely to shine before Congressional hearings that will be aggressive in asking why the MAX was certified with fundamental flaws? The Board may be waiting for an event that doesn’t place the company in a good light to provide the right excuse for his departure. That could also come once the federal investigation issues indictments, which the industry rumor mill indicates can be expected, for certification omissions with the MAX. Ralph Nader and others believe that a wholesale change of the Board and senior management may also be necessary to return Boeing to what it once was - an innovative company that puts safety first and took risks, like the 747, that bet the company’s future. Today, management and the Board have taken three years to decide whether they should build the NMA and still haven’t reached a conclusion. While they may be gun-shy after the 787 debacle, they are still in competition with Airbus, which has the capital and opportunity to renew its product line.

US Flight Planner	Airbus vs Boeing
US Airline Schedule Performance	Daily Production & Deliveries

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