Below are excerpt of some of the research notes received by LNA:
FAA officials testified to Congress that Boeing’s software fix and proposed training approach should resolve MAX issues, but milestones remain to be done. Despite positive messages, certification now appears to be dragging well into January. With more than 400 parked airplanes in inventory, it has become impractical for Boeing to keep adding planes to storage.
It is unclear how long the production halt will last. We have no clarity from the FAA on timing. Boeing, after being admonished, will not speculate on timing. The halt, we believe, could continue through January – or longer if the certification and JOEB approval go more slowly than recent statements suggest. Rate 57 in 2020 appears impractical at this stage and likely shifts to 2021. Boeing plans to redeploy employees to other programs and keep the supply chain ready to restart. The supply chain plan will be tailored by supplier, depending on operational and financial strength. There should be added costs related to operations and customer compensation, but an impact well below yesterday’s $7bn fall in Boeing market cap.
Considering the anticipated two-week December shutdown at the Boeing Renton 737 factory, the MAX production suspension is effectively starting the end of this week. With almost 400 MAX in inventory (basically 9 months at 42/month) and continued uncertainty on the exact timing of the MAX return to service (RTS), it is not surprising Boeing has taken the steps to suspend its production. However, negotiations with suppliers are ongoing, and it is not yet determined at which level key suppliers, such as Spirit AeroSystems, will continue to produce 737 MAX aircraft (note that SPR had been maintaining its production at 52/month). The expected impact on Boeing and its suppliers is significant, but the exact financial details are still to be worked out, and we expect the supply chain to maintain some MAX production, but likely at a lower level than the current production rates.
Boeing indicated that it views a temporary pause as the least disruptive to its supply chain. Boeing in fact indicated that it is not expecting any layoffs or furloughs as a result of the production pause. We believe Boeing will do all possible to ensure that its suppliers are able to maintain their 737 employees to ensure that once Boeing is able to start deliveries of the 737 again, it has the ability to ramp production as quickly as possible. We estimate that the MAX, at 42/month, is a $1.4B monthly cash burn for Boeing. Boeing did maintain its current dividend, and we believe Boeing has sufficient financing capacity to weather an extended pause. However, we also believe part of the decision by Boeing to pause its MAX production is to lessen the perceived pressure on the FAA and other regulators.
We now view an RTS for the MAX in February as a best-case scenario. It is clear that the FAA has been frustrated with Boeing’s pressure and public statements regarding the MAX. Boeing is still looking to complete several of its key milestones soon, but this has taken longer than expected. While Boeing has not indicated that the pause will be in place until the successful RTS, at a minimum Boeing will want better visibility on the key milestones, including the JOEB training requirements. Moreover, it is likely Boeing will gradually “wake-up” the factory after the pause, and it could take several months to get rate back to the 42/month level.
With uncertain duration and uncertain supply chain treatment, an uncertain impact: In sum, we think Boeing had to take at least one of the options noted above as continuing apace seemed untenable given the unknowable timing of recertification. However, without more detail on the duration of the suspension and the supplier terms, it is difficult to gauge the economic impact of this decision to Boeing and its suppliers. Regarding liquidity, it is also unclear how much cash this decision will actually save given the unclear treatment of the supply chain as well as the fact that Boeing is undertaking no actions to produce labor cost savings. Boeing stated that it would provide financial information regarding the production suspension in connection with its Q4’19 earnings release in late January. We reiterate our Neutral rating and $324 TP. Risks: regulatory and execution.
Boeing’s MAX announcement leaves many questions unanswered but that was probably inevitable, given the difficulty of forecasting how the aircraft will return. Some of these questions include 1) the duration of the halt, 2) the production pace post-halt, 3) the timing of re-certification, 4) the delivery pace after reaching that milestone, and 5) how Boeing will support the supply chain during the halt, with uncertainty on these topics leaving a broad range of outcomes for modeling. We sense that investors are still looking to a “clean year” in 2022-23 for a sense of how to think about the stock and on this basis, our estimates are little changed today at ~$16bn of FCF, though this is based on several important unknowns. In addition, the path between today and a “clean year” contains risks, such as we saw with today’s production halt, which had seemed far less likely several weeks ago. The focus of the halt appears to be inventory management and while the duration is TBD, the release states that it is the least bad option for preserving supply chain health, suggesting to us that it should be fairly short term—perhaps a few months. We cut our PT to $370.
Suspension creates execution challenges. The short-term disruption from the halt will be a challenge for suppliers and we have concerns about the subsequent ramp for both Boeing and suppliers as well. Prior rate changes (i.e. from 47 to 52/mo last year) caused disruptions for suppliers and so we think that going from zero to 30-40/mo and then eventually to > 50/mo will be very challenging. A mitigating factor might be that all these aircraft will be MAXs vs a combination of NGs and MAXs previously; in addition, Boeing and suppliers should be staffed for higher rates, even if this is inefficient near term. However, if some suppliers do not follow Boeing all the way to zero, they will end up with more inventory that will take time to unwind. Note that key supplier SPR has been producing at 52/mo, vs Boeing’s 42/mo, and will need to spend a meaningful amount of time below Boeing’s production rate on the other side of the suspension/grounding to work through this balance. We expect some impact on all 737 suppliers.