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Morningstar | Abruptness and Deepness of Boeing's 737 Rate Cut Suggests MAX Groundings May Stretch into Summer

Effective mid-April, Boeing plans to reduce its 737 rate to 42 aircraft per month from 52. Given how abrupt and deep the production cut was, we think it signals that the 737 MAX groundings may take longer than our initial 2-3 months view. It’s difficult to provide a point estimate for the duration of the groundings but assuming they last six months and that Boeing produces at 42 aircraft per month over this time period, our 2019 MAX delivery forecast drops about 18% to 485 MAXs. Our total 737 deliveries (NG plus MAX) don’t fall as much since we assume Boeing delivers slightly more NGs than originally planned.

Our 2019 forecast assumes MAXs produced but not immediately delivered will eventually be handed over to customers in 2019 with no impact on our fair value. But our new 2019 forecast for MAX deliveries shaved $1.11 off our 2019 EPS estimate and knocked about $1 billion off cashflow. However, considering our 2019 operating cashflow was $17.5 billion prior to the groundings and since we left our midcycle unchanged, our new 2019 forecast only pushed Boeing's fair value down down $1 to $333. We’re maintaining the $2 billion contingency in our model related to airline compensation and litigation.

Boeing’s major aerostructure supplier, Spirit Aerosystems, announced it will continue producing 737 shipsets at rate 52, placing 10 shipsets a month into inventory. We don’t think that all this inventory will be cleared out in 2019. As a result, we’ve moved down our 2019 revenue, EPS, and cashflow forecast for Spirit, leading to a 1% decrease in our fair value, which now stands at $91. We’d note that LEAP engine manufacturer CFM--GE and Safran JV--announced the same strategy: hold steady at rate 52 despite Boeing’s cut. We believe 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, and to achieve rates well above 52 in 2020 as supplier inventory gets delivered to Boeing's assembly lines.

Unlike smaller suppliers, we think Boeing could continue carry the 737 inventories, but a production cut was necessary primarily due to growing storage constraints. Boeing can’t risk waiting until the storage situation becomes critical since this might involve abruptly halting all production, which would create even disruption across the supply chain.

Boeing continues to deliver 737 NGs (Airfinance Fleet Tracker shows three NGs delivered since the MAX groundings started) but there are fewer than 120 NGs left in the firm backlog (per Airfinance data). While its possible Boeing might convert some MAX orders into NGs and also reshuffle delivery schedules, we don’t think this will amount to a significant number of aircraft. This means most of the aircraft rolling off the Renton production line will still be MAX variants and these will weigh on inventory until the groundings are lifted.

The cash impact from the suspension of MAX deliveries remains a timing issue in our view since Boeing will eventually collect cash from its customers upon delivery of the MAX inventory. In the meantime, we estimate a cash impact for each MAX produced but not delivered of around $15 million per aircraft based on cash COGS less pre delivery payments from customers, which we assume are continuing but this has proved difficult to ascertain. The recently announced production cut will reduce the total cash impact on Boeing since variable costs linked to building 737 MAXs will fall. It’s not clear to us yet if Boeing plans to (or will be asked to) support suppliers carry 737 inventory.

Lastly, we think the MAX groundings may adversely impact Boeing’s possible launch of a next generation midsize aircraft and could potentially lead the company to abandon the program, which already has a weak business case in our view. We’ve previously noted that, due to questions surrounding the adequacy of the MAX certification, a more complex and lengthy aircraft certification process might increase the time required to develop and certify the NMA. Moreover, if the MAX groundings last through majority of 2019, which is a possibility, then we doubt Boeing’s board will grant authority to offer for the NMA program. This is compounded by Boeing’s recently announced move to review its airplane design process in detail. Lengthier certification and/or a delay in authority to offer for the NMA jeopardizes Boeing’s ambitious target of 2025 for EIS. This EIS date is required to respond to a possible A321neoXLR that will be ready in two years or less and to also catch a wave of 767 retirements.