The U.S. Air Force has barred its new KC-46 tankers from carrying cargo or passengers after a new defect was found, a fresh blow to the long-struggling tanker program and a new embarrassment for Boeing (NYSE:BA), the program's lead contractor.
The Air Force said the decision was made following an incident in which the aircraft's cargo fasteners became unlocked during a recent flight, creating concerns that airmen could be injured or killed should heavy equipment get free mid-flight. The Air Force described the problem as a "category 1 deficiency," its designation for a serious issue that needs to be addressed immediately.
In a worst-case scenario, cargo pallets rolling free in the cargo hold could be a danger to crew and could unbalance the aircraft, making it hard to control. It is not yet clear if the issue was limited to one defective latch, or there's a systemic problem that will lead to a comprehensive redesign and retrofit.
"Until we find a viable solution with Boeing to remedy this problem, we can't jeopardize the safety of our aircrew and this aircraft," Air Force spokesman Col. Damien Pickart said in a statement to reporters.
The move creates a new headache for Boeing, and potentially additional expense for the defense titan, and it could open the door for rival tanker builders.
A nightmarish program
The KC-46 is no stranger to setbacks. Initial deliveries were originally set to begin in August 2017, but troubles, including issues with the tanker's remote-visioning system and the high-tech refueling boom, pushed that date back to early 2019. Not long after the initial deliveries took place, the Air Force was forced to ground the fleet after finding tools and other debris left inside aircraft after manufacture.
Boeing's contract with the Air Force capped development spending at $4.9 billion and requires the company to pay for any overruns. The company has already incurred more than $3 billion in out-of-pocket expenses due to problems, and depending on the nature of the fix to this latest issue in the cargo hold, that number could grow in the quarters to come.
Boeing endured a public shaming by Pentagon officials in early 2018 because of the setbacks. Air Force Secretary Heather Wilson complained to Congress that the company appears overly focused on its commercial cash cow at the detriment of defense projects like the tanker. She said, "[W]e 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.
Competition is coming
With each setback for the KC-46, the odds increase that Boeing will eventually have to refight one of the most controversial procurement battles in recent memory. In 2008 Airbus (OTC:EADSY), working with Northrop Grumman, 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. In 2011 Boeing won the recompete, a $49 billion contract to supply 179 tankers based on its 767 design.
Airbus has won high marks for its tanker from other buyers, and the company appears to still be interested in selling the plane to the Pentagon. Last December the company teamed with Lockheed Martin (NYSE:LMT) to jointly pitch its A330-based tanker in Washington. The companies in a statement said they hope to "address any identified capacity shortfall" for the Air Force.
Given the time and capital that has been invested, the KC-46 will be part of the Air Force's arsenal for some time. But even assuming the initial order is completed as planned, it would only represent about half of the tankers the Pentagon wants to buy in the decades to come. Last year the Air Force argued it will need to eventually grow its number of refueling squadron to 54, from 40, potentially requiring it to order upward of 150 additional aircraft, on top of retirements and replacement frames.
The A330 tanker is a proven operator, having secured 60 orders from governments including U.S. allies Australia, the United Kingdom, South Korea, and Saudi Arabia, and the plane has worked well with U.S. fighters operating coalition missions over Iraq and Syria. Given the Pentagon's emphasis on keeping a diverse supply chain intact, and Boeing's troubles delivering the KC-46, it seems likely that the Airbus plane will be a part of any future tanker order.
Boeing can't fly straight
Boeing should be an attractive investment, with a strong and diverse product line, more than $100 billion in annual revenue, and a customer waiting list stretching into the next decade. But the company's fumbling of the KC-46 program alone is enough to raise questions about internal operations, and unfortunately, it is far from an isolated incident.
The company's new 737 MAX remains grounded following two fatal crashes that have raised a number of questions about Boeing's testing and certification processes. More recently, its 777X, Boeing's highly anticipated new long-haul commercial aircraft, failed a safety test after a part of the fuselage depressurized. Through it all, Boeing's shares have held up relatively well and are actually up 17% year to date.
I believe Boeing's engineers will eventually solve the ongoing issues with all of these jets, and given strong demand on the commercial side, Airbus is unlikely to be able to fully take advantage of the issues and gain share. The most likely outcome for Boeing is that, in five years' time, these troubles will be merely footnotes on a long-running growth story.
Yet given all of the setbacks, and the company's inability to manage and control them, I can't recommend buying Boeing shares at this time, especially considering there are much-better opportunities in the defense sector. Until Boeing can demonstrate firm control over its manufacturing processes and quality, investors are advised not to climb on board.