July 25, 2019, © Leeham News: Aerospace analysts brushed aside Boeing’s warning yesterday that the possibility exists the 737 MAX production line might be shut down in the airplane doesn’t return to service (RTS) in the fourth quarter.
But analysts shrugged off the news.
Separately, Southwest Airlines today announced it has removed the MAX from its schedule to January.
Below is a synopsis of reactions in notes issued last night and this morning.
Bernstein barely mentioned the issue in its note.
“[A]s long as the grounding does not extend significantly beyond current timelines, there will be no need for Boeing to cut production further. However, if there is a significant further delay (i.e., well into 2020),Boeing could be forced either to reduce the rate further or even shut down production temporarily. Clearly, this would be a material headwind, both in the near-term but also in the longer term as it would make ramping production back to the 57 / month target more challenging.
Bernstein rates Boeing stock an Outperform, with a target price of $442.
There is clearly still some timing risk around the RTS for the MAX, and BA management struck a more cautious tone, in our view. We believe the fact that management highlighted the potential for a temporary shutdown on the 737 line if the grounding moves further to the right spooked investors. While we do not believe the risk to further downside on the MAX has changed, the different tone from management is noteworthy. BA management has also gone out of its way to highlight that the timing is really all regulatory driven (which has always been the case). We believe the best case for BA is a phased approach, with North American regulators lifting the grounding in Q4/19, followed by European and then Chinese regulators in Q1/20. We believe the cost assumptions for BA roughly reflect this timing.
Canaccord rates Boeing a Hold, with a target price of $388.
Investor Reaction To MAX Production Alternatives Looks Excessive.
BA reiterated its assumption that MAX grounding will be lifted with resumption of deliveries early in Q4 and plan to reach 57/month in H2:2020 (likely late Q4). However, in discussing scenarios for MAX production if certification is delayed again, BA suggested possibly choosing a temporary production shutdown over further rate reduction below 42/month. Its reasoning is that a rate reduction causes disruption since jobs on the assembly line change. In contrast, a short production shutdown, like extended summer vacation favored by some manufacturers, allows workers to return to known tasks; and BA would be able to minimize layoff of experienced employees who might be difficult to rehire when production ramps back up. Importantly, BA asserts it brought up the issue of a temporary shutdown in the interest of total transparency regarding all alternatives it might consider, even in less likely scenarios.
Cowen rates the stock Outperform with a target price of $460.
In a note entitled Boeing’s Hedging Spooks Market, Credit Suisse writes:
Candid commentary underscores uncertainty: BA stock closed down 3% and nearly flat on last Thursday’s price, as Q2 earnings call commentary appeared to walked back some of the clarity implied by last Thursday’s press release, which outlined a seemingly confident recertification and recovery timeline. We maintain that the outcome, and the timing, is inherently unknowable, and observers (including ourselves) may have been overly optimistic about management’s level of visibility.
The faint of heart need not apply: Frankly, the recent seesaw in share price is attempting to trade on conjecture. Not even the regulators have a clear view of the outcome, and we recognize that the near-term will continue to yield volatile news flow and equally volatile price action. Instead, we take the long-term view, which is that the aircraft should eventually be deemed safe, and will then return to service. With the tremendous number of moving pieces at play here, we value the stock on the next normal year of full-rate production and deliveries, which is 2022 in our model. We forecast FCF of ~$36 per share in 2022, which informs our target price of $425 (from $427). We reiterate our Outperform rating, but emphasize that we see this name as best suited for longer-term investors who can tolerate interim risk and volatility.
Complete suspension of MAX production a black swan event, in our view: While the suggestion of a potential production suspension proved to be the most newsworthy takeaway from the call, we do not view this outcome as particularly incremental or likely. We always expected management would suspend production in the face of some unforeseen, catastrophic outcome, such as a required hardware fix. If anything, management seemed to take a hardware fix off the table (at least for identified issues).
But maybe it wouldn’t be so bad anyway: While our initial reaction was that a production suspension would indicate a lengthy delay to re-certification, this may not be the case. Taking a closer look at CEO Muilenburg’s explanation indicates that a short term shut down may be preferable (and shorter-lived) compared to another rate reduction. It arrests further storage, cash drain, and inventory build, and likely enables a quicker resumption to the prior, higher rates than would be possible from an incrementally lower rate.
Credit Suisse rates Boeing Outperform with a target price of $427.
In a note entitled, Nothing to Do But Wait, JP Morgan writes:
We assume Boeing’s ~350 bp underperformance yesterday reflects discussion of a potential 737 line shutdown, which management highlighted as one possibility (among many) if current return to service (RTS) assumptions slip.
737 line shutdown is one possibility . . . among many. While last week’s pre-announcement highlighted Boeing’s assumption that it would complete the required 737 MAX modifications in Sep with FAA approval in Oct, these are just best estimates. As a result, management highlighted contingency plans on the call, including a rate cut or a line stoppage. We would note that management did not share the conditions that would trigger either step, but we would guess that a delay of at least one quarter along with a lack of confidence in the new delayed timeline would be required, as neither cash nor space seem to be major constraints for now. Lowering supplier rates is a significant risk with regard to ramping back up, and it is in this context that we view the discussion of a line stoppage, which may be shorter and less disruptive than an extended cut. Boeing would still burn cash—paying employees and some suppliers at various rates—but likely less cash than it is while building inventory. (As background, we estimate that ~65% of Boeing’s 737 costs are in the supply chain and ~35% are internal.)
JP Morgan rates the stock Overweight with a target price of $425.
We thought that last week’s preannouncement took a great deal of uncertainty out of the BA Q2 print. We still had some lingering fears when it came to key Q2 financial metrics (namely FCF) that needed to be addressed with the results themselves. For those items, simply avoiding much weaker outcomes (i.e. significant cash outflows or downside margin surprises) was the necessary hurdle and BA cleared it easily. At least that’s how we saw it. However, based on today’s price action and our conversations, it seems clear that more investors than we appreciated considered last week’s announcement to be an “all clear” of sorts, which caused a negative reaction to some of the call commentary, namely the potential for a 737 line stoppage. We actually believe that nothing has changed this week vs. last week (not even the share price which is now back to preannouncement levels). We also continue to believe that Boeing’s 737 MAX return to service plan represents a reasonable base case, but one that remains out of their control. What we underappreciated is how crowded shares must’ve gotten on the back of last week’s announcement.
The plan remains the plan, for now. While a healthy debate emerged today around whether Boeing’s Q2 call commentary on 737 MAX production scenarios represented some sort of change or reversal, we’d point out that last week’s preannouncement clearly stated that, “This assumption reflects the company’s best estimate at this time, but actual timing of return to service could differ from this estimate.” As such, Boeing’s public statements included the caveat that further schedule delays were possible. It’s not surprising that prudent scenario analysis around a regulator-driven process incorporates a discussion of what would necessitate further changes to 737 MAX production.
Based on the company’s current framework, a production reduction/stoppage is not necessary, but the schedule has never been written in stone. There are multiple ways to lower output if that’s deemed necessary, one being a cut in rate and another being a pause/stoppage of the line (something common among biz jet manufacturers in a downturn – stop for a couple months, furlough employees, resume thereafter). Each has its pros and cons, but both are viable methods. While a temporary line stoppage wasn’t on our radar, we’re not sure it’s more disruptive/costly – in fact it’s unclear why it would be considered if that was so.
We’re not of the view that BA’s assumptions represent an ill-advised guess as media reports suggest. Instead we think they represent a base case that was signed off on by auditors/lawyers and is based on their understanding of the evolving regulatory timeline (a process that we understand they re-calibrate twice daily). In fact, we’re not sure what incentive BA would have to base financial estimates on an overly aggressive return to service assumption. Nonetheless, this is where the investor debate has shifted following the conference call.
Melius rates Boeing a Buy-Accumulate, with a target price of $500.