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Morningstar | Allegheny and Carpenter FVEs Unchanged as Production Rates Unaffected by Boeing's Delivery Slowdown

As detailed in an April 8 note, Boeing plans to reduce its 737 production rate to 42 aircraft per month from 52, effective mid-April. Although this significant cut would seem to have a significant impact on the associated supply chain, we believe the  impact will be relatively modest. We do not expect this news to reduce the total number of 737s produced over the next decade. Rather, this simply represents a timing disruption, with more deliveries in the future making up for fewer deliveries in the near term.

Boeing’s major aerostructure supplier, Spirit Aerosystems, announced it will continue producing 737 shipsets at the 52 rate, placing 10 shipsets a month into inventory. Leap engine manufacturer CFM, a joint venture of General Electric and Safran, announced the same strategy. These moves are designed to provide stability to tier 2/3 suppliers, to enable a faster step up back to 52 once the groundings end. Additionally, this will help Boeing achieve rates well above 52 in 2020 as supplier inventory gets delivered to the planemaker's assembly lines.

Consistent with this stated course, Allegheny Technologies issued a press release indicating that it too would maintain current production and shipping schedules for Boeing 737 MAX and CFM Leap 1-B components. We suspect Carpenter Technology will take the same approach, although this remains unconfirmed by the company. Boeing has the financial wherewithal to carry the 737 inventory buildup within its supply chain, and we suspect it will do so, at least in part.

For Allegheny and Carpenter, our forecasts for commercial aerospace product deliveries are tied to our Boeing and Airbus delivery forecasts. However, given that production schedules are unchanged, our volume forecasts also are intact, even as they now diverge from the updated aircraft delivery outlook. Accordingly, our fair value estimates of $33 for Allegheny and $58 for Carpenter are unchanged. We also maintain our narrow moat ratings for both companies.

The aerospace and defense end market accounted for 49% of Allegheny's companywide revenue in 2018, although commercial aerospace accounted for only 42%. For Carpenter Technology, 55% of revenue is derived from aerospace and defense. Carpenter doesn't break out the proportion associated purely with commercial aerospace, although we surmise it would be a proportion modestly above that of Allegheny. These companies' customer bases are far more diversified than those of larger commercial aerospace suppliers like Spirit, a company for which our fair value estimate fell only 1% to $91 per share in light of the Boeing news. Key factors that could inspire a fair value estimate change in the future would be evidence that total 737 deliveries will fall short of our current estimate, a reduction in production rates for Allegheny and Carpenter, or unexpected pricing volatility for affected product lines.