Sept. 6, 2018, © Leeham News: Boeing officials say the parked inventory of 737s has peaked at around 50 aircraft and should come down slowly as traveled work is performed.
Officials made the comments yesterday at its annual Investors Day for aerospace analysts.
The first two research notes LNC received last night reflected skepticism by Canaccord Genuity and JP Morgan that Boeing will successfully meet its recovery plan by year end.
As more notes were received today, these analysts generally were more receptive to Boeing’s upbeat message.
We see [the 737] as the most critical issue for investors after the increase in parked airplanes and the shortfall of deliveries in July. Management said that roughly 50 airplanes are parked at this stage and expects this to be the peak level. At a 52/month rate (current rate), a normal number of parked airplanes would be 25 (roughly half a month of production).
Our understanding is that the number of parked airplanes had been running higher than a normal number because of the delivery buffer that Boeing has built in to cover the risk of late LEAP deliveries (we believe this buffer has been about six weeks).
Our understanding is that LEAP deliveries (from CFM) to Boeing have been running 4-5 weeks late for nearly two years. Management said that LEAP delivery timing has been improving. But, as the MAX becomes a larger portion of the production mix, the number of airplanes awaiting engines due to late deliveries has grown. The main issue for late 737 deliveries, however, was said to be the late delivery of fuselages from Spirit Aerosystems.
Even though fuselage deliveries may only be one or two days late, the fact that the fuselage is the starting point for final assembly has created disruptions and out-of-sequence work across final assembly operations.
Management said that Spirit and CFM are each on track for a recovery plan, so that the company stands behind its guidance for deliveries for the year, although deliveries are likely to be back-end loaded into Q4. Management also expects it will stay on track for a 737 rate increase to 57/month in 2019. Our view is that these delivery delays should not have a material impact on the value of the company. These delays should be simply a timing issue, as the problems are not related to any technical or design problems.
The delays do, however, raise the likelihood of a weak Q3 and a greater possibility that Boeing might not meet its year end delivery goal. On the other side, Boeing is planning to move to 57/month in 2019 with minimal additional investment.
Many eggs in Q4 basket: While Boeing did a good job of showcasing the bullish outlook for the long term, we remain mindful of the company’s optimism around 737 production recovery and further ramp. Investors and analysts pressed management throughout the day on the issues behind the recent 737 delays. Boeing explained that the situation is improving and reiterated the following: 1) deliveries in Q3 will be a little light; 2) the company expects to fully catch up in Q4; and 3) the delays will have no material impact on the 2018 results. If there was one fly in the ointment, it was reconciling the 50+ gliders parked at the facility to Spirit’s assertion that it has been executing on the recovery plan. While CFM engines are also somewhat at fault from a dearth of certain specialty metal components, fuselages remain the long pole in the tent, and we see this as the key risk to BA’s 2018 targets.
However, our investment thesis takes a somewhat longer view, and we remain enthusiastic about the overall macro and micro story for Boeing.
The key delays are in fuselages and engines (specialty metal components), though there is progress. That said, we still sense that Boeing and fuselage-supplier Spirit are not fully on the same page quite yet. Clearly, let fuselages are among the hardest delays to overcome because they are the starting point for final assembly, and traveled work is exacerbated compared to delays to most later-stage components.
Boeing has brought extra labor into Renton from other facilities, which mitigates incremental labor costs, but also has some 82 people at Spirit to help move things along. BA will then use this extra labor to help ensure a smooth transition to rate 57, which still appears on target for mid-2019, though we can’t help but expect some minor risk to that timing. Any further rate hikes seem to be on the back burner for now.
Boeing stated it is executing on a recovery plan to resolve the unfinished 737 build-up by year end. There are currently slightly more than 50 unfinished 737s parked outside the factory at Renton, twice the normal number. While work is not fully back in position, Boeing believes the inventory build is at peak and will decline as catch-up work is performed. Boeing has moved about 600 additional personnel to Renton to help finish aircraft, compared to 10,000 total employees at that factory. Boeing teams remain deployed at Spirit, and management noted that both fuselage delays and engine shortages from CFM are improving; interiors were not mentioned as an issue.
Boeing remains confident in its ability to step up to rate 57 next year despite supply chain challenges. Some of the loaned labor at Renton will stay on to support the rate step-up. Boeing notes Spirit has hired in advance of rate 57, which gives them confidence in their ability to execute on the step-up.
Boeing continues to assess higher rates on the 737. They believe the market can support that level of supply, given they are currently selling slots in 2023 and beyond. But Boeing aims to remain disciplined on supply and will assess what the market can absorb and what is sustainable.
According to management, 737 work-in-process inventory peaked last week, and while it can apparently fluctuate day-to-day and week-to-week, the clear message from multiple execs is that they think the bleeding has stopped in terms of incremental open jobs on planes entering the production line.
We gathered that problems stemming from parts delivered late or incomplete (Spirit fuselages referenced most often as they are important at the first position in the final assembly line) are on the decline. Incoming units aren’t completely without flaws just yet, but incremental progress is being made on a key item for a sustainable recovery. The planned recovery will see baseline production/deliveries return to normal in (hopefully) short order, but it will take several months to work off the backlog of unfinished aircraft. However, if the baseline flow looks repaired we think the Street should eventually be willing to look past excess planes on the ramp awaiting their finishing work.
The Biggest Question Mark We Still Have: Embedded in the current recovery plans for Boeing is an assumption that engines will arrive on a schedule provided by GE/SAF. Based on public disclosures, LEAP engine deliveries have been running “four weeks late” essentially since the beginning of the year, but the looming ramp requirements will be unrelenting in the coming quarters as 737MAX production more than doubles and 737NG production subsides (737NG engines are apparently on time at present).
As we’ve mentioned in prior reports, it seems that shortfalls are primarily related to Arconic and Precision Castparts parts (castings/forgings/machined parts) whose ramp-up plans are based on improved manufacturing yields that have yet to materialize. Given the need to dramatically increase production rates on new engine platforms and what we assume is still an implied improvement in manufacturing yields, we’re still somewhat cautious that engines could present a problem for Boeing’s recovery plans.