Military

After 737 MAX Production Cuts Confirmed, Assessing Boeing's Financial Fallout for 2019 and Beyond

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Boeing Co. (NYSE: BA) announced on Friday afternoon what investors should have already been expecting. After showing that its flight control issues were the result of the two 737 MAX airplane crashes in recent months, Boeing is lowering production of its 737 MAX planes. The company is also in the process of remedying the issue, but there is going to be a financial impact for longer than just a few weeks.

Boeing is cutting 737 MAX plane production by almost 20% (to 42 from 52) over the next several weeks. The company also has appointed a special board committee to examine its new-airplane development. As noted in our prior observation Friday morning, Boeing cannot deliver the new planes, which are rolling off its assembly line at the rate of nearly 50 a month, while the 737 MAX is grounded. Boeing also does not generally get paid until it delivers the planes.

Boeing has proposed a software fix and additional pilot training to avoid the Maneuvering Characteristics Augmentation System (MCAS) flight control problems. At issue now is the timing of production, deliveries and collecting payments. After considering a return to flight and resumption of deliveries, the reality is that Boeing is now likely looking at months rather than weeks before these 737 MAX deliveries can resume.

One issue that will continue to be an overhang, perhaps until the company’s earnings report in late April, is that Boeing did not offer financial guidance ahead of the earnings report. This means that analysts and investors are going to have to put pen to paper to figure out what lower production means with zero 737 MAX plane deliveries.

On the expense side of the equation, Boeing said that 737 program and related production teams will maintain their current employment levels. Also on the expense side, Boeing noted that it would work directly with its suppliers on their production plans to minimize operational disruption and financial impact of the production rate change.

While production cuts should have been assumed after the company’s admissions, this move to lower production overrides Boeing’s previous plan to boost monthly output of its best-selling plane to 57 by this summer. Analysts previously expected that higher production would allow Boeing to make almost 600 deliveries of the 737 this year, roughly 90% of them being the MAX model.

CEO Dennis Muilenburg already issued a statement accepting responsibility for the two 737 MAX 8 crashes. The incidents killed 346 people in total, and the Ethiopian government’s 33-page report on the Ethiopian Air crash was after 157 people lost their lives and the previous crash in Indonesia killed 189 people. Muilenburg said:

It’s apparent that in both flights the Maneuvering Characteristics Augmentation System, known as MCAS, activated in response to erroneous angle of attack information. It’s Boeing’s responsibility to eliminate this risk. We own it and we know how to do it.

Boeing also noted that the software update that Boeing is working on “will eliminate the possibility of unintended MCAS activation and prevent an MCAS-related accident from ever happening again.”

The more recent statement after Boeing announced production cuts on Friday afternoon said:

We now know that the recent Lion Air Flight 610 and Ethiopian Airlines Flight 302 accidents were caused by a chain of events, with a common chain link being erroneous activation of the aircraft’s MCAS function. We have the responsibility to eliminate this risk, and we know how to do it. As part of this effort, we’re making progress on the 737 MAX software update that will prevent accidents like these from ever happening again. Teams are working tirelessly, advancing and testing the software, conducting non-advocate reviews, and engaging regulators and customers worldwide as we proceed to final certification. I recently had the opportunity to experience the software update performing safely in action during a 737 MAX 7 demo flight. We’re also finalizing new pilot training courses and supplementary educational material for our global MAX customers. This progress is the result of our comprehensive, disciplined approach and taking the time necessary to get it right.

It will be Monday morning before investors can see the full impact of Friday’s production cuts. This has been assumed to be coming if the grounding and fixes were not going to be just a few weeks. That said, now it is formal, and that means a financial impact for missing production, deliveries and revenues on dozens and dozens of planes. And the harder issue to assess will be how many 737 MAX orders, likely international orders, will be canceled as a result.

As 24/7 Wall St. noted last year, Boeing’s The 737-8 had a list price of $112.4 million. The plane was the replacement for the good old 737, which Boeing had produced nearly 10,000 of since its introduction. Even lopping off 10 planes per month would represent $1 billion in monthly sales, but taking out revenues for closer to 50 planes might chop off $5 billion in revenues.

Analysts had been slow to downgrade Boeing, but more recent cuts have been seen on its price targets and estimates. Still, downgrades an estimate cuts have been seen for some of Boeing’s top suppliers for the 737 MAX planes.

For a reference here, Boeing generated $101 billion in revenue for 2018, and the Refinitiv consensus revenue estimates were last seen at $111 billion for 2019 and more than $118 billion for 2019. Obviously, this is going to result in lower revenue expectations for 2019, but is it possible that all those delays could create a cramming event in which 2020 revenues could be better. A lot of things will have to go smoothly (beyond just an FAA clearance) for that to occur, but it does remain a possibility.

Boeing shares lost about 1% on Friday to close at $391.93, but the shares already were down from its all-time and recent high of $446.01. Clearly, some of this carnage and lower revenues were being priced in as many analysts have lowered their targets and expectations. That said, the after-hours indications pointed to active trading on Friday, with Boeing shares more than 2% lower to about $383.50.

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