Insight: Wednesday 27 May 2020: Boeing’s 800 Airplane Dilemma

News:

Boeing has a huge dilemma. The company has produced about 820 737 MAX aircraft that are currently on the ground and not flying. About 370 were delivered to customers and paid for, awaiting clearance to re-enter service, and about 450 were built by Boeing during the time the aircraft was grounded, before the COVID-19 crisis that devastated aircraft demand. Boeing would like to deliver and get paid for those aircraft as well, but it is unlikely to happen in the near term.

Today, the industry is well over capacity, with airlines grounding massive numbers of aircraft, and there is virtually no demand for any of the 820 737 MAX aircraft currently sitting on the ground. Most industry crises over the last few decades have been regional in nature, but this one is impacting the entire globe.

The problem is that Boeing has a supply chain it needs to protect, and factories that need to continue to build additional new airplanes. Airbus is planning to cut production by about 1/3rd from 2019 levels. Boeing, with a year’s worth of airplanes in a normal year on the ground, can’t afford to build as many aircraft which will likely be produced at only a small fraction of its capacity when production resumes later this year (hopefully).

Analysis:

Boeing faces a tough decision with respect to the MAX. There are enough MAX airplanes already built to handle the anticipated demand for narrow-body aircraft over the next couple of years sitting on the ground today and selling new MAX orders is virtually impossible in today’s environment.

Since the beginning of the year, Boeing has negative net orders, with 304 aircraft cancellations. The demand for the MAX has been hit hardest, and because the MAX was more than 12 months late for deliveries, customers have the option of walking away from existing orders without penalty. Adding to the MAX backlog in the short-term is unlikely, and as more airlines file for bankruptcy, the likelihood for order cancellations increases.

Unless the MAX orders are replacing very old aircraft, the economics of a ten-year-old aircraft, when capital costs are considered, are better than those of a new aircraft. As a result, some airlines are now in no hurry to take delivery of new MAXs.

Producing new MAX aircraft will be difficult for Boeing, as most of their customers with deliveries on order have asked for deferrals, and since they have the option of walking away, Boeing has no choice but to grant their requests or face a potential reduction in backlog. Getting customers to take aircraft on time may require some additional concessions, whether training, spares provisioning, or extended maintenance or warranties, to enable those deals to be concluded. But concessions can be expensive and erode margins. So, the new aircraft to be produced this year will likely yield very low margins for Boeing.

But the alternative is not to produce new aircraft, in which case Boeing will find that its supply chain will collapse. Boeing would then be forced to orchestrate a consolidation of players, take over key suppliers with proprietary technologies via acquisition, or face potential future gaps in its production rates should a supplier fail. The supply chain, many of whom geared up capacity to meet anticipated higher narrow-body production rates, needs to deliver parts to survive.

The aftermarket, which is an additional source of revenue to suppliers, has also been impacted as excess capacity will result in low-cost serviceable parts cannibalized from grounded aircraft impacting the spares market. This, combined with new production cuts, provides an even more several impact on suppliers. With suppliers in financial difficulty, Boeing needs to maintain its production of new aircraft, even if it cannot sell them.

Insight:

Boeing faces an untenable future. It can either stop production of new aircraft and lose money as it covers the fixed costs of a large factory and workforce and potentially loses a portion of its supply chain. Or it can produce new aircraft into a market with no demand and try to convince customers not to defer their delivery positions. We believe it is quite likely that Boeing will be producing “white tail” aircraft as it resumes production of the 737MAX later this year, pending recertification of the aircraft by the FAA. Neither alternative is a choice Boeing would willingly make, and neither is financially viable. The real question is how long Boeing will need to bleed cash flow irrespective of the choice they make.

If we assume that demand for additional aircraft in 2020 is half of 2019 levels, then Boeing has a 2-year backlog of aircraft already produced awaiting entry or re-entry into the market. There is limited capacity for the industry to take on new 737 MAX airplanes, and by 2021 the excess inventory will still likely be sitting in Boeing parking lots. Demand for the MAX is falling, rather than rising, and Boeing has a huge problem with excess inventory.

The Bottom Line