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Morningstar | Entire MAX Fleet on the Ground; Cost to Boeing Could Reach Into the Billions

The Federal Aviation Administration has grounded the Boeing 737 MAX, which means the entire fleet of MAX 8 and 9 aircraft isn't flying. After assessing the potential costs to the firm, we are placing a $2 billion contingency in our model, but we are not changing our 2019 forecast. However, this results in only a 1% decrease in our fair value estimate, which is now $334 per share.

Assuming initial findings from the Ethiopian Airlines investigation into the March 10 crash point to aircraft issues, we think the groundings will last at least three months, due to the time required to review the accident and roll out a fix on the MCAS software. Boeing faces four costs linked to recent MAX accidents, including one in Indonesia in October: an already ongoing technical fix of the MCAS on all MAX aircraft; airline compensation; suspension of 737 MAX deliveries; and potential order cancellations.

The cost of the MCAS fix is a moving target, since Boeing must still test and certify it and then retrofit existing aircraft. Nonetheless, we think an MCAS update could cost  $180 million to $375 million, depending on the cost to retrofit each of the 376 MAXs in service. We estimate that, on average, carriers are losing $75,000 per day in revenue on each grounded MAX. Assuming the groundings last 90 days and continue to affect the entire MAX fleet, airlines might claim $2.5 billion in compensation via cash payments, discounts on aircraft sales, or covering the cost of leased aircraft. The impact from the suspension of MAX deliveries is more of a timing issue. That said, we calculate that Boeing’s first-quarter operating profit could take a $133 million hit. We also think Boeing may now delay its planned 737 production rate increase from 52 to 57 aircraft per month. Turning to the backlog, we continue to believe that the vast majority of customers will maintain their orders and that the 4,659 MAX backlog (according to the Airfinance Fleet Tracker database) will convert to revenue.

Gauging the total cost to Boeing is challenging, but we think the MCAS software update could cost between $180 million and $375 million, depending on the cost to retrofit each plane. For example, if it costs $500,000 to fix each of the 376 aircraft in operation, the total will come in at $188 million. In addition, Boeing will enter into compensation negotiations with the airlines that operate the MAX. This compensation often consists of discounts and concessions on aircraft sales, as opposed to cash. However, Boeing will probably have to write checks to some of the affected airlines.

We estimate that carriers are losing, on average, about $75,000 per day on each MAX they were operating. Assuming the groundings last 90 days and continue to affect the entire MAX fleet, airlines could look to Boeing for $2.5 billion in compensation via cash payments or discounts on aircraft sales. Another way of looking at the potential cost would be to take the monthly lease rate for a narrow-body aircraft (around $250,000) and multiply that by the MAX aircraft in service. This yields a cost of approximately $95 million per month to lease replacements for all of the grounded MAX aircraft globally.

MAX deliveries are effectively halted now, and even if an airline wanted to take delivery, Boeing couldn't fly the aircraft from its facility in Renton, Washington, given the FAA grounding. Although Boeing doesn't disclose profitability per program, we estimate that the 737 will account for around $6 billion of operating profit in 2019 (about 40% of consolidated full-year operating profit for Boeing). Boeing delivered 66 737s through end February 2019 (46 MAX variants), which implies a production rate of around 1.5 deliveries per workday. Assuming this pace would have continued through March, Boeing will likely miss about 17-18 737 deliveries during the first quarter of 2019. Using our per-plane profit estimate of $9.5 million and assuming 14 of the deliveries were MAX variants, we calculate a possible impact of $133 million to Boeing’s first-quarter operating profit. Going forward, Boeing may be able to begin to backfill some missed MAX deliveries with older 737 variants, but there are only 86 of these on order currently, according to Boeing's own backlog statistics, which represents less than two months of production.

The pileup of 737 inventory at Boeing's final assembly lines will weigh on cash flow. More importantly, though, Boeing's 737 supply chain had been gearing up for another rate break (rate 57 per month) around mid-2019. Trying to manage both growing 737 inventories at its final assembly lines as well as a supply base ramping up production will stress Boeing's production system (not to mention the potential lack of space at the Renton facility). As a result, we think the company may delay the 737 rate increase. A delay in production ramp on the 737 line could further stress an already fragile supply chain via inventory buildup or unplanned decreases in production. If a rate increase is pushed into late 2019 or early 2020, such a move would also dent Boeing's full-year 2019 results.

Unless there is a critical flaw found in the 737 MAX (something we don't envision), we believe customers will maintain their MAX orders and that the 4,659 aircraft backlog for the MAX will convert to profitable revenue for Boeing. Customers may be tempted to cancel orders on the MAX but they would most likely forfeit the cash advances they already made to Boeing. More importantly, Airbus cannot accommodate any additional customers on its competing A320neo because its manufacturing lines are already running flat out to meet demand and the line is sold out through the middle of the next decade.