Boeing (NYSE:BA) passed a major milestone in January when the first planes from its long-delayed refueling tanker program were finally delivered to the Air Force. Barely a month later, the government has grounded the fleet. The Defense Contract Management Agency and the Air Force required Boeing to ground the planes and make a series of procedural changes after inspectors found tools and other debris left inside aircraft that were already completed.
The grounding was first reported by the Seattle Times, which quoted a memo from Boeing factory management saying that Air Force pilots were not flying the planes due to debris issues and "the current confidence they have in our product," adding "this is a big deal."
The specific issues will likely be resolved fairly quickly, but execs are correct in calling the grounding a big deal. The lingering impact on Boeing's tanker business could last decades.
A long-running drag
This is far from the first issue Boeing has faced with the KC-46 fueling tanker. The initial deliveries that finally happened in early 2019 were originally slated for August 2017, but troubles, including issues with the tanker's remote-vision system and the high-tech refueling boom, have been tough to resolve. Boeing's contract with the Air Force capped development spending at $4.9 billion and requires the company to pay for any overruns.
As of last year, the Air Force expects the development to cost more than $6 billion.
Boeing has taken more than $2 billion in charges due to fines and cost overruns on the KC-46 and has been forced to endure a public shaming by Pentagon officials. Air Force Secretary Heather Wilson last spring complained to Congress that Boeing appears overly focused on its commercial cash cow at the detriment of defense projects like the tanker. She said, "we have asked them to put their A-team on this to get the problems fixed."
Not long after her comments, Boeing announced a major overhaul of its defense business.
The competition is watching
Boeing's KC-46 tanker win is one of the most controversial procurement battles in recent memory. Airbus (NASDAQOTH:EADSY), working with Northrop Grumman, in 2008 won a $35 billion deal to build tankers based on the company's A330 commercial design, but that deal was eventually overturned after political pressure. Boeing in 2011 won the re-compete, a $49 billion contract to supply 179 tankers based on its 767 design.
Airbus has been sending signals that it's looking for a rematch. The company in December teamed with Lockheed Martin (NYSE: LMT) to jointly pitch the tanker variant of the A330 to the Pentagon. The two companies said they hope to "address any identified capacity shortfall" for the Air Force, without mentioning the KC-46 or its troubles specifically.
The Boeing KC-46 order is almost certainly not going to be scrapped, but even if it proceeds as planned, it would represent only about half of the tankers the Pentagon wants to buy in the decades to come. The Air Force in September argued that it needs to eventually grow from 40 refueling squadrons to 54, potentially requiring upwards of 150 additional aircraft on top of retirements and replacement frames.
The A330 tanker, despite losing in the United States, has secured 60 orders from governments including Australia, the United Kingdom, South Korea, and Saudi Arabia, and the plane has already proven itself in the field. Airbus tankers flown by U.S. allies have performed refueling missions involving American coalition aircraft fighting militants in Iraq and Syria.
With each setback for the KC-46, the odds increase that the Air Force will diversify its tanker fleet with any future order and the monopoly Boeing won in 2011 will be short-lived.
Boeing works even if the tanker doesn't
The news isn't all bad for Boeing Defense, which in the past six months has scored major wins including defeating Lockheed Martin in a $9 billion Air Force trainer jet competition and in a $2.4 billion Air Force helicopter competition. Boeing also late last year won a significant U.S. Navy carrier-based drone contract, and recently won a deal to construct four large unmanned submarines.
In fact, outside of the KC-46 headlines, I'd argue that Boeing's defense business is enjoying its best run in recent memory, and the company's commercial business remains strong. There's a lot for investors to like about Boeing.
This is all the more reason to hope Boeing Defense can soon work through its tanker troubles and focus on its future.