April 4, 2018, © Leeham News: The Trump Administration’s ill-conceived proposed tariffs on aircraft parts made and imported from China prompted what on the surface appears to be a hit back at Boeing, but which in reality seems more fluff than substance.
Jon Ostrower broke the news yesterday about the list of aircraft components Trump proposes tariffs on. Since Boeing uses China for some of its aircraft components, the tariffs would hurt Boeing.
China today proposed 25% tariffs on Boeing airplanes—but excludes the MAX 8 by weight. (The MAX 7 may be included, with between 10-20 announced ordered by two Chinese airlines).
According to Airfinance Journal Fleet Tracker, there are only 19 737-800s remaining on order for delivery this year through 2021. This doesn’t include any Unidentified orders.
Eight -800s are scheduled for delivery this year, six in 2019, two in 2020 and three in 2021.
US aerospace analysts are unimpressed. The following is a synopsis of their reaction.
China proposed a 25% tariff on aircraft weighing between 15,000 and 45,000 kgs in response to US trade actions against the country. As of this writing, aero stocks in our coverage are trading lower by 1-3% due to concerns that Boeing (and the supply chain) will not be spared from the escalating trade war. We understand some big picture concern but it appears to us that the specific proposals from China this morning are calibrated carefully to avoid a major impact on Boeing and are therefore intended more as a message to the US administration that additional trade barriers will be met with an escalating response. In other words, this looks like a shot across the bow with regard to Boeing and our base case remains that we will see little change in Boeing aircraft deliveries into China.
The proposed weight limits on commercial aircraft look to purposely single out the 737NG. The NG is Boeing’s current narrowbody offering that is transitioning to the new MAX variant over the next few years. This appears to limit the fundamental impact on earnings and cash and we think signals a purposeful intent on the part of the Chinese government to maximize headlines, while simultaneously leaving natural room open for negotiation.
This implied “room for negotiation” also signals an expectation by the Chinese that Boeing can and will exert influence on the USG. This is a subtle point, but we think an important one as there must be an angle for the Chinese to selectively carve out only one subset (but an important subset) of BA’s business. However, whether Boeing can help deliver a more palatable solution is up for debate. With BA appearing closer to the White House than we can recall in many years, this is a dynamic that should be on investor’s radars.
We see a ~5% impact to BA’s cumulative earnings through 2021, based on our read on current tariff proposals. There’s a natural desire to calculate what the maximum earnings impact may be. We currently see the fundamental impact as modest and that’s before considering that narrowbodies at both Boeing and Airbus are sold out into the early 2020s, making switching difficult for Chinese airlines that need the planes. However, given the fluid nature of this situation and the myriad of unknowns, we’re not sure exactly how helpful this analysis is; at this stage multiple contraction appears to be the bigger risk. In Aerospace, our general rule of thumb over the years is that a 10% free cash flow yield (or $300 for BA based on our 2020E FCF/share forecast of $30) is where you buy a stock aggressively if you believe the underlying cash flow forecast is largely intact. Boeing’s fundamentals and operational execution remain very strong – a 10% yield would be a steal based on what we know right now. If tariffs are limited to 737NGs, we’re getting very close to the level where sidelined investors will need to take a much closer look and we are not recommending that holders sell into this weakness. We’ll be monitoring for second and third derivative impacts on global growth and air travel. Although these do not appear material yet, they would be more fundamentally impactful over time than a loss of some % of last-of-line 737NGs.