Boeing 737 MAX crashes led to the rare response of a global grounding of the relatively new aircraft, caused uncertainty about how soon corrective action will be taken to allow the planes to be put back in service and heightened risk for investors in the stock.
Two Boeing 737 MAX 8 crashes within five months of each other share dubious similarities as each plane nosedived into the Earth within minutes after takeoff as pilots tried unsuccessfully to counter the autopilot’s ill-fated flight path. The pilots could not control the planes sufficiently to return to the respective airports where they had begun their journeys, causing airline regulators around the world to ban the Boeing 737 MAX jets and driving down the company’s share price.
Once every nation other the United States grounded the Boeing 737 MAX aircraft just days after the second of the two catastrophes, Boeing Co. (NYSE:BA) officials asked the U.S. Federal Aviation Administration (FAA) to follow suit, “out of an abundance of caution.” Roughly 60 percent of Boeing’s annual revenues come from its Commercial Airplanes manufacturing unit, contributing heavily to the stock price’s 11.62 percent slide between March 19 and March 8, the last trading day before March 10, when Ethiopian Airlines flight ET302 plummeted into the ground. That crash killed all 157 people onboard.
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Boeing 737 MAX Crashes Pose Huge Financial Fallout
The financial fallout to Boeing begins with the possible loss of $500 million if a planned software update the company plans to implement leaves the planes grounded for six to eight weeks. A further delay would raise the cost to the manufacturer, especially with aviation regulators in Canada and Europe announcing plans to make their own determinations about when to lift the ban rather than allow the FAA to do so.
“The focus now for the 737 MAX and investors is the potential financial implications for Boeing and the supply chain,” wrote Kenneth Herbert, an analyst and managing director of equity research at Canaccord Genuity, of Toronto. “In spite of the track record of the MAX in the U.S., we are surprised the FAA waited as long as it did to ground the fleet.”
The FAA received information on March 13 from satellite imagery and from the crash wreckage that found similarities between the Lion Air and Ethiopian accidents, justifying the further investigation and grounding, Herbert explained. Potential implications of the software fix for Boeing’s 2019 free cash flow will be a headwind for the stock, added Herbert, who affirmed his “hold” rating and $380 price target on the stock.
Boeing 737 MAX Crashes May Cost Estimated $500 Million to Fix
The total price Boeing will need to pay to fix the problem is roughly $500 million, Herbert projected, if the remedy is successful. There should be “very little long-term impact” on the success of the MAX, he added.
“We see the financial risk for Boeing in three areas,” Herbert wrote in his March 14 research note. “One, there is the direct expense of implementing the software upgrade that has been discussed. Two, there is the near-term risk from delivery delays and progress payments on in-progress aircraft. And three, there is the potential compensation for airlines and leasing companies for service disruptions.”
Additional risk involves longer-term upside from the 737 MAX both from expected delivery rates above 57 per month to cause a potential backlog risk, as well as order activity, including advances and backlog growth, Herbert opined. The time frame for assessing the longer-term impact will take between several months or even years, he added.
Boeing 737 MAX Crashes Spur Software Upgrade
“Boeing has been working on its software upgrade since soon after the Lion Air accident, and once the upgrade is certified by the regulators — expected in April — installation in the global fleet should be relatively easy,” Herbert wrote. “BA estimates that the actual installation takes one hour.”
Boeing’s software fix basically would enhance the Maneuvering Characteristics Augmentation System (MCAS) capability, Herbert advised his clients. This scenario assumes the cause of the two accidents is similar, but the investigation into the Ethiopian Air accident will take several weeks and a final conclusion from the investigation of last October’s Lion Air flight 610 crash that killed all 189 people on the plane remains incomplete.
Boeing is not expected to pull material from the supply chain, Herbert said.
Discussions with 737 MAX suppliers indicate that they have not seen any change to the production rate of the Boeing 737 and it would be surprising if Boeing slowed down the supply chain, he added.
“We are not yet adjusting our 2019 estimates,” Herbert said.
However, Herbert forecast the grounding of the Boeing 737 MAX aircraft could lead to a loss of about $1 billion in free cash flow a month for Boeing from delivery delays and the potential loss of advancements on in-process aircraft. Another possible cost is an additional $1 billion, depending on how much of the airline operating revenues Boeing ultimately reimburses to air carriers, Herbert projected. The amount likely will be “much smaller,” but he predicted Boeing will pay affected airlines for the disruption.
Boeing 737 MAX Crashes Lead to Rare Global Grounding of Aircraft
The grounding of a commercial aircraft is highly unusual but far from unprecedented, especially after the pair of Boeing 737 MAX crashes. The last time a commercial aircraft was grounded due to safety concerns occurred in 2013, when the Boeing 787 Dreamliner, which entered service in 2009, was held back from flying starting January 16, 2013, and ending April 16, 2013. Boeing needed to address the two lithium ion battery failures on Jan. 7 and 16 that year.
Prior to that grounding, the famed Concorde, which began service in 1976, was prevented from flying starting August 16, 2000, through November 2001, amid questions about fuel tank safety following the crash of Air France flight 4590.
In 1982, the Yakovlev Yak-42, which launched service in 1980, became idled due to a design flaw which caused its horizontal stabilizer’s screw jack mechanism to fail in a flight on June 28, 1982, killing 132 people.
Boeing 737 MAX Crashes Do Not Eliminate Need for New Planes
“Do not forget that the airlines need new planes as much as Boeing needs to make them, and [rival] Airbus cannot really pick up all of the slack,” said Hilary Kramer, a Wall Street professional who leads the Value Authority, GameChangers, Turbo Trader and Inner Circle advisory services for individual investors.
It seems increased pilot training and new software could resolve the problem that contributed to the crashes and there may not be “anything intrinsic” to the engineering to change, Kramer said. These Boeing 737 MAX jets have been flying commercially since mid-2017 and racked up more than 100,000 service miles in the first year, she added.
“If the design itself were faulty, we would’ve seen a lot more catastrophic failures,” Kramer said. “Instead, we saw pilots complain about the autopilot and the flight manual, which basically forced them to rely on their own experience during takeoff. Pilots who trust the system haven’t known how to correct and that seems to be the critical factor in these crashes. Getting the programming to reject the bad readings and retraining the pilots should help prevent repeat tragedies.”
Boeing 737 MAX Crashes Should Not Impair Future of Aircraft
“We’ll need to see what happens when the ongoing system update is complete and tested,” Kramer said. “If the problem is fixed, it’s back to business as usual — after all, a lot of airlines around the world have flown plenty of 737 MAX flights with little incident. Otherwise, Boeing truly has a problem. Conservatively, there are 4,600 orders left to fill at a rough cost of $100 million apiece. Cancellations can wipe out the company’s commercial air revenue stream for years to come.”
However, the “immediate threat” is to the carriers that have had to ground flights that would have been fulfilled by Boeing 737 MAX aircraft. U.S. carriers that were using the Boeing MAX 737 include American Airlines (NYSE:AAL), Southwest Airlines Co. (NYSE:LUV) and United Airlines (NYSE:UAL).
Boeing will probably need to pay for that, but the ultimate bill may not be huge as long as the problem is resolved relatively quickly, Kramer said. Every month these aircraft are grounded is a drain of about 0.5 percent on Boeing’s fiscal year 2019 earnings growth, she added.
“While there’s a lot of growth cushion already built into management’s guidance, that’s still an incentive to solve this fast and conclusively,” Kramer said. “Otherwise, they’ll start getting cancellations and the drain will accelerate.
“Right now, I see zero reason Boeing can’t do it. Once the systems are reworked to give pilots the right guidance, the global MAX fleet will be better than ever. And now pilots definitely know what to watch out for… the first crash felt like an isolated glitch but now we can see the pattern and correct it when it occurs.”
Boeing 737 MAX Crashes Should Not Affect Long-Term Profitability
Bob Carlson, who leads the Retirement Watch advisory service, told me Boeing’s stock price probably already reflects all scenarios except the worst event of needing to stop selling 737s.
“More than likely, the result will be that a software upgrade and additional pilot training will be required,” Carlson said. “The real question is whether that resolution will take weeks or months. That should matter only to short-term investors.
“Over the long term, Boeing is likely to finally retire the 737 and put capital into a new design and the regulatory approval process for it. As long as Boeing can continue to sell existing models of the 737 while a new plane is developed, the stock shouldn’t be hurt by the retirement of the 737.”
Aviation regulators around the world will require that Boeing ensure any software or training enhancements are sufficient to protect the safety of the flying public. Boeing has every incentive to implement a successful fix to whatever led to the two MAX aircraft crashes. Investors should not feel rushed to buy the stock now, despite its double-digit-percentage plunge in the past 10 days, since any delays in returning the grounded aircraft into service could hurt Boeing’s share price further.
About Paul Dykewicz:
Paul Dykewicz is an accomplished, award-winning journalist who has written for Dow Jones, the Wall Street Journal, Investor’s Business Daily, USA Today, Seeking Alpha, GuruFocus and other publications and websites. Paul is the editor of StockInvestor.com and dividendinvestor.com, a writer for both websites and a columnist. He further is the editorial director of Eagle Financial Publications in Washington, D.C., where he edits monthly investment newsletters, time-sensitive trading alerts, free e-letters and other investment reports. Paul also is the author of an inspirational book, “Holy Smokes! Golden Guidance from Notre Dame’s Championship Chaplain“, with a foreword by former national championship-winning football coach Lou Holtz. Follow Paul on Twitter @PaulDykewicz. Here is a link to his previous column on Tesla.