Analyst shrug off possible 737 production shut down

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.

Boeing’s statement, on its 2Q2019 earnings call, created headlines in the press coverage, including on LNA.

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 Research

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.

Canaccord Genuity

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.

Cowen & Co.

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.

Credit Suisse

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.

JP Morgan

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.

Melius Research

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.



22 Comments on “Analyst shrug off possible 737 production shut down

  1. In my opinion these analysts
    – have institutional investors as customers
    – know more about stockmarkets than about aerospace
    – are in denial because Boeing stock has been so strong for so long
    – might have more direct interest & are buying time

    Maybe a GE stock value scenario should be referenced. Boeing said drastic actions could be taken if the MAX grounding moves into 2020. #1 customers SouthWest just moved back their Return To Service to 2020. So, 3,2,1… denial.

    • It is amazing how fast a bad CEO can destroy a company – GE as an example.

      • While a bad CEO can destroy a company I think that in most cases the origin of the problems lie a long way back.

        GE is the perfect example of that. The problems there, in my view, started with Jack Welch. Any company that can produce perfect results with never a blip, quarter by quarter, is obviously manipulating the numbers. The fact that industrial production was hardly moving, but the credit arm was rapidly expanding made that pretty easy.

        Sadly there are many assets in a company that are never recorded on the balance sheet, such as the expertise of the staff, the strength of the research, and the number of new products which can later produce the growth. The only thing worse would be if these were allowed on the balance sheet ! What tricks creative accountants could make with that, and auditors would be lost.

        What Jack Welch did was to liquidate those assets, and now we see the long term results as successive CEOs dispose of their industrial holdings which are no longer competitive.

        I suspect the same thing has been going on at Boeing, and the evidence is in the amount of technical expertise that was outsourced.

        • Agree, Jack set it up for failure because he got his and does not care.

          That is all too typical of management these day.

          The rot goes way down, I quit my job because they sucked up all the money and none went to the people who were making it.

          • As pointed out, Boeing has had a management vacuum for decades (and so too – the board of directors.) Funny thing, is a lot of American industrial companies decided to follow the Jack Welsh Business School. Like the New England Patriots spawned coaches for other NFL teams, GE executives infected a great many manufacturers in this country whose emphasis was on outsourcing and political influence and great trade pacts.

        • It is these aggressive share buybacks, which concern me. I worked half of my career at a US company, and it was the same stuff. Every Dollar was squeezed out of the business to buy back shares, made the shareholders happy, but we lost our technological edge and the downward spiral of restructuring, lower revenue, restructuring seems to never stop

      • Muilenburg formall took control as CEO on 1st March 2016, the MAX had flown about 6 weeks previous and had been launched in 2011.

    • Agreed. There’s a lot of denial going on. In effect, if Boeing did collapse, shareholders would have brought it on themselves for not prying into the company’s internal affairs, just accepting the board’s multiple reassurances, had they sought them at all, without question. And they’re still doing it.

      An assurance a shareholder might have sought prior to the tragedies is, “Are you running the company along proper, careful engineering principals?”. Had anyone asked the board that question, I’m sure the answer given would have been “Yes”. My point is that the impact of the company’s own recent admissions of failures (i.e the answer is “not really”) is diluted for not having asked such a question before the crashes happened. This has “normalised” the company’s problems, because the markets have not established what “normal” actually could, and should, be.

      Yet there’s many engineers who do know what “normal” is, and they know that the gap between “normal” and where Boeing is right now (and has been for 15, 20 years) is a vast yawning chasm. The shareholders and analysts seem to think that the company can bridge it pretty easily; I think the reality is that this is going to be very difficult indeed.

      Question for analysts; care to model what happens if the 737MAX has to be scrapped altogether?

      • ” An assurance a shareholder might have sought prior to the tragedies is, “Are you running the company along proper, careful engineering principals?”.

        That’s an interesting 100,000 foot view based on some sort of theoretical concept that any shareholder can ask the board such a question and get other than a non definitive real answer which has been well scrubbed by legal and PR and several others.

        Such a question needs to be VERY specific on a specific point-issue

        Yes it CAN be done, and in SOME very rare cases one can get a one on one answer from a responsible executive. But such a theoretical question will at best get a theoretical non significant answer…

  2. keesje:

    I would flip that around.

    The investment community has a lot of history to work with. Blips out 9of the ;norm revert to the norm (be the blip be high or low)

    The first year I was with our investment broker we got 17%. He called me and told me don’t get excited, that not the norm. Nice yest but don’t expect it. I know enough about it to know he is right and its aggregated 7% which is not bad at all.

    But he was not crowing he was someone special. He had all that data saying it would revert.

    It does not mean there will not be a failure. RR had to come out with an all new engine to replace the Trent 1000. I know of a lot of engine that never made it into production, I cna’t think of a one that failed once it was and fully tested.

    In this case I think the Investment community is right.

    They displace the emotions and hot button aspect to trends.

    Years back we had the .COM era, yep it came crashing down.

    I think Aircraft orders are doing the same, lot of indicators they are coming down.

    Betting against the investors is like thinking you can beat the table at Veges.

  3. ‘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).’

    ‘Complete suspension of MAX production a black swan event, in our view’

    ‘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’

    ‘737 line shutdown is one possibility . . . among many.’

    All these quotes are at odds with the briefing that we are being presented with and all of them are skewed towards a far more optimistic viewpoint. I find this strange.

    This suggests to me that the announcement we have been fed is not really for the financial community (who have been given a further hidden briefing to the contrary), instead they are there to ‘ensure’ that RTS will occur in qtr 4 by putting pressure on the regulator. I am not normally one for conspiracy theories but in this case I see the senior management team being too clever for their own good. No statement seems to pass their lips without some Machiavellian aim or underlying bias.

  4. Credit Suisse seems to have a realistic assessment
    – all going well 2022 is the first “normal” year
    – a shutdown is not the “probably” outcome
    – but nobody knows how this will end, not the regulators, not Boeing
    – as for investing in Boeing, “The faint of heart need not apply”

  5. Jbeeko summary of Credit Suisse is prophetic.

    Everything I’ve been reading and listening to makes clear there isn’t an agreement between the regulators and Boeing with regard to return to service.

    That means the regulators are still in the process of finding out. In other words, the regulators are still performing due diligence.

    Only when the regulators understand will they then set the conditions for a return to service. That will take weeks.

    Then Boeing must do it. That will take months, a lot of months if a software fix isn’t acceptable.

    Then the regulators must verify Boeing have met the conditions for a return to service. That will take months.

    To quote jbeeko’s post:

    “but nobody knows how this will end, not the regulators, not Boeing”

    Prophetic words – in other words, as it stands, an accurate prediction of the future is nobody knows.

    Nobody knows. Not looking good, though.

  6. Melius was if the opinion that Boeing’s statement was signed off by auditors/lawyers. Well, there’s the problem right there!

  7. FlightGlobal made clear that SouthWest, as stated by it’s CEO, is in the dark on technical matters with regard to the 737 MAX grounding

  8. FWIW from this long retired Boeing engine- ear who spent most of his time in Manufacturing areas.
    1)Current mess is result of MDC buyout in areas of aerodynamics, profit motive, engineering excellence, etc. Books have been witten on subject.

    2) Boeing is still hiding just how bad things ARE and WILL be regarding RTS of MAX and probable rework and costs of Trim System of most 737-xxx in service on some sort of schedule basis

    3) The net result will be goodbye to any profit on 737 series in real $$$$

    4) A hard hard hard look at just what 737 replacement needs to be. Possible resurection of 767 twin isle sized twin engine airplane. (IMO ) This would help to reduce sardine class seating with short and medium body length versions.

    Just my .00000000003

    • @Bubba: “Books have been written on subject.”

      Are there any references that you could give us?

      • Of course Norm- I can list three that together tell the real story of the MDC ” buyout” and miss- management ( not the hydroplane )

        Suggest you look them up on amazon and definitely read the reviews – not in order of preference. I’ve read at least one and may still have my copy

        1) Boeing Versus Airbus
        by John Newhouse

        2) Turbulence: Boeing and the State of American Workers and Managers
        by Edward S. Greenberg, Leon Grunberg , et al. | Oct 12, 2010

        I’ve read this one and personally know the ‘ union’ reviewers-There is a lot ofa well done survey described and results are well prresented- part of the desciption follows

        ” This timely book investigates the experiences of employees at all levels of Boeing Commercial Airplanes (BCA) during a ten-year period of dramatic organizational change. As Boeing transformed itself, workers and managers contended with repeated downsizing, shifting corporate culture, new roles for women, outsourcing, mergers, lean production, and rampant technological change. Drawing on a unique blend of quantitative and qualitative research, the authors consider how management strategies affected the well-being of Boeing employees, as well as their attitudes toward their jobs and their company. Boeing employees’ experience holds vital lessons for other employees, the leaders of other firms determined to thrive in today’s era of inescapable and growing global competition, as well as public officials concerned about the well-being of American workers and companies.”

        3) Emerging from Turbulence: Boeing and Stories of the American Workplace Today
        by Leon Grunberg and Sarah Moore

        This is a later follow up – again read the reviews

        IMHO- both 2 and 3 paint a reasonable picture of Boeing at the times indicaed- but even so, there is a lot more egregious issues not mentioned simply because of room/space/time and reluntance/fear- even though the company gave relatively unfetterd access.

        I can personally cite some very positive things done by management at the top levels, and some absolutely horrible- unprincipled things done by ‘ middle ‘ management.

        But none that I know of or have heard about come close to the current mess causing the carnage of MCAS-737- and its related issues, including the ‘ response’ of top management.

        I’m sure a book about this mess is already in work- but it will be two or three years before publication.

  9. If Boeing was still run by engineers, what would happen right now?
    1. They wouldn’t be in this mess
    2 They wouldn’t be wasting time & money trying to keep on with a mistake
    3. That means all existing Max stock should be removed from certification issues, by re modeling them to freighter only, and possibly pilot-less.
    4. All the money going on trying to re certify be diverted into getting the NMA over the line and onto the market.
    5. The NMA has been touted as scaleable. Read that to mean it can be downsized to current 737 size. So it’s feasible under these extraordinary circumstances to actually launch TWO new aircraft at once – the NMA AND the Max replacement.
    Call this half baked and crazy, but they are in a half baked and crazy hole and appear to be digging it deeper

    • There is an old saying of “don’t throw good money after bad money”. Also, there is an good Aussie saying, “Fix it or ……. it”

  10. Thank you very much @Bubba for the references. It so happens that I have read the first two books: the first one in 2008 and the second one in 2011. Perhaps it’s now time for me to read the third one which is a follow-up of the second. For the latter I have actually written a review on Amazon after reading it in 2011 and here is what I had to say then:

    This book is about the state of American workers and managers in the new economic reality of globalization, as seen through the transformations that took place at Boeing in the late nineties.

    The basis of the book is a study carried out over a period of ten years, between 1996 and 2006. The authors “surveyed, interviewed, analyzed, and wrote about the employee experience at Boeing”. The key point, which is made clear throughout the book, is that what happened at Boeing is not different than what happened at many other large corporations in America. You don’t necessarily have to be a Boeing employee to recognize your own experience here. The organizational changes that have transformed Boeing are part of a large trend which redefines the way large companies are dealing with their employees in order to remain competitive in the context of globalization. The impact this transformation had on employees is analyzed here in details, and subjectives interpretations are given to make sense of the enormous amount of data accumulated in the four surveys that were carried out over the ten year study.

    You don’t have to be a Boeing employee, or ex-employee, to appreciate this book. What is discussed here is now a universal theme. It’s about the new paradigm that has started to replace the one that was established after the war in 1945. The relationship that the employers had with their employees had not changed much in the first 50 post-war years. But the mounting pressures of globalization forced Corporate America to take drastic measures to remain competitive, and this had a devastating impact on the morale of the workforce. Compared to other books on globalization, the main difference is the importance given here to the impact of globalization on the employees themselves rather than the corporations, in this particular case Boeing.

    The last survey was carried out in 2006, but the latest developments up to 2010, the time of publication, are largely discussed. The title of the book “Turbulence” suggests that it has not been an easy ride for Boeing employees. The transformations had started a year or so before the first survey had begun and it’s still an unfinished business. The tensions between Boeing and its employees remain high, and since increasing competition is threatening Boeing’s share of the market we can expect the conflict to linger for sometime. Eventually a new rapport will have to be developed between Boeing and its workers. They have to, for the future of Boeing depends on it.

  11. Just how bad could this get for the B737?
    The Max is the Joan Rivers of aeroplanes — one facelift too many.

    Consequently anyone following BA has to get ready for complete emltdown and the potential failure of the MAX programme — possible and not probable from the information available but the number id getting bigger by the week.

    Even if all goes well the (re) EIS date is now heading f0r 2020 and the supply chain is being bent double to try and minimise the cost a disruption.

    Everything points to BA’s financials being a fairy story of hope, bluster and financial engineering to keep the stock price going up and the bonuses flowing. They are just too good to be true — and yet everything is done in plain sight with accounting blocks and deferred efficiency gains.

    Worst case scenario is the failure of the MAX programme, the NG series rising from ashes and the “B757” making a comeback or at least its wingbox flying again.

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