Boeing MAX production cut signals long grounding – Leeham News and Analysis

  • Airlines seeking interim aircraft leases of six months.
  • At least one sees MAX grounding lasting until November.
  • Impact to Boeing is already significant and growing.
  • Impact on the NMA decision.

April 6, 2019 © Leeham News: Boeing’s decision Friday to reduce the production rate on the 737 MAX was a surprise in timing and scope.

This came so quickly and was steep, cutting production from 52 MAXes per month to 42. It comes on the heals that a second software problem was found, delaying submission of the MCAS software upgrade to the FAA for review and approval.

The production rate cut is effective in mid-April. This is lightning speed in this industry, where rate breaks, as changes are called, typically have 12-18 month lead times.

Boeing hasn’t announced what the second software problem is. LNA is told it is the interface between the MCAS upgrade and the Flight Control System, but specifics are lacking.

LNA interprets these combined events as indicative the MAX will be ground well past the Paris Air Show in June.

The impact to Boeing is going to be huge: customer compensation, deferred revenue, lost revenue, potentially canceled orders and potential lost orders in sales campaigns. The hit to the Boeing brand and impacts of multiple investigations won’t become clear for months to come.

A partial line-up of Boeing 737 MAX aircraft stored at Paine Field, Everett (WA). Photo by Jennifer Schuld.

Lengthy grounding

Even a return to the air by July now may be optimistic, based on LNA’s analysis of events and and emerging information through market intelligence.

This week, the government of Singapore said it now wants in on the international review of the MAX recertification.

It’s already publicly reported that a few airlines scrambled for airplanes to replace the grounded MAXes. LNA now hears that some airlines seek ACMI leases (Aircraft, Crew, Maintenance and Insurance included) in addition to “dry” leases (aircraft only).

This in itself is not unusual under the circumstances. When upwards of 50 Boeing 787s were parked because of problems with the Rolls-Royce Trent engines, airlines across the globe sought ACMI and dry lease airplanes.

What is new with the MAX is that LNA understands some carriers want six month leases. This takes the anticipated grounding to mid-September. At least one wants interim lift to at least November.

A 6-8 month grounding of the 737, Boeing’s cash cow which accounts for about 40% of The Boeing Co’s profits, will be devastating.

Just how bad this could be might be revealed on Boeing’s first quarter earnings call April 24.

Financial impact

The scope of the financial impact won’t be understood fully until a date for return to the air is cleared by international regulators. But here’s what to look for:

  • Customer compensation. Airlines that had the nearly 380 MAXes in service will want compensation for their grounding aircraft. Customers awaiting deliveries that are now deferred will want compensation.
  • Compensation can take many forms: cash, discounts on current orders, deeper discounts on future orders, training and MRO service credits and other discounts and credits.
  • Credits and discounts, while not current cash requirements, nevertheless suppress future revenues.
  • A few airlines threatened to cancel MAX orders, among them the two carriers involved in the crashes, Lion Air (for about 180 MAXes) and Ethiopian (25). Garuda Indonesia says it wants to cancel an order for 49 MAXes. Cancellations are not unknown but neither is it easy to outright do so.
  • The loss of potential orders in sales campaigns could happen. Airbus certainly had, and continues to have, issues with the Pratt & Whitney GTF and CFM LEAP engines on its A320neo family, but these problems are on the decline. Airbus may benefit from the MAX grounding. (On the other hand, Boeing’s need to sharply discount the MAX for compensation may make it difficult for Airbus to match the price.)

We’re talking billions of dollars in financial hit to Boeing that will take years to get out from under this impact.

Long-term outlook

Confining this portion to the assumption the grounding will be no more than 6-8 months, the hit to Boeing’s finances will be significant. But long-term, Boeing will recover and be strong.

Boeing wrote off billions of dollars with the 747-8 and KC-46A programs and it peaked at $32bn in deferred production and tooling costs on the 787.

The fundamental safety of the MAX remains unquestioned. The flaws of the MCAS and now the interface between MCAS and something else in the Flight Control System will be fixed. The airlines and lessors largely remain confident in the airplane, with the understandable exception of Lion Air and Ethiopian. (LNA believes Garuda’s sentiments may revolve more around its own finances, but since it, like Lion Air, is an Indonesian airline, it’s closer to the Lion Air crash than other carriers.)

There likely will be some passenger avoidance after the MAX returns to service, just as there was for the 787 after its three month grounding in 2013. Passengers eventually returned to flying the 787 and to other airplanes that were grounded: the McDonnell Douglas DC-10, the Douglas DC-6, the Lockheed Constellation and even the de Havilland Comet. So they will to the 737 MAX.

NMA decision

What will the impact of the 737 MAX grounding be on Boeing’s decision whether to grant Authority to Offer (ATO) for the NMA this year and potentially launch the program next year?

LNA does not see the Board of Directors approving ATO as long as the MAX is grounded nor until the financial impact is quantified.

With the uncertainties hanging over the MAX now, aggravated by the discovery of a second software issue and now the production rate cutback, the Board Board—which historically is fiscally conservative and risk averse—isn’t likely to green light even a sales campaign, LNA believes.

Furthermore, Boeing CEO Dennis Muilenburg Friday also announced the formation of a Boeing Board of Directors committee “to review our company-wide policies and processes for the design and development of the airplanes we build.  The committee will confirm the effectiveness of our policies and processes for assuring the highest level of safety on the 737-MAX program, as well as our other airplane programs, and recommend improvements to our policies and procedures.”

Until this review is complete and the committee either confirms the effectiveness of policies or identifies flaws and remedies, proceeding with the NMA seems unlikely.

Given the long-term questions, past, present and future over the business case of the NMA, this could even give Boeing the out to decide against proceeding with the NMA at all.

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