In this episode of Industry Focus: Energy, Fool contributors Nick Sciple and Lou Whiteman dive into Boeing's (NYSE:BA) 737 issues -- what we know about what went wrong in the first place, what Boeing is doing to fix it, and what comes next. Tune in to learn what election season could mean for Boeing next year; how the 737 Max groundings are hurting Boeing's relationships with its customers; why those customers can't exactly just take their business elsewhere -- like, say, Airbus -- and why, regardless of Boeing's advantageous market position, investors will probably want to stay away from this stock for the foreseeable future.

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This video was recorded on Dec. 12, 2019.

Nick Sciple: Welcome to Industry Focus, the podcast that dives into a different sector of the stock market every day. Today is Thursday, December 12th, and we're discussing the Boeing 737 Max. I'm your host, Nick Sciple, and today I'm joined by Motley Fool contributor Lou Whiteman via Skype. How's it going, Lou?

Lou Whiteman: I'm good. How are you doing?

Sciple: I'm doing OK. We're headed to the end of the decade, which seems so crazy to talk about. One of the stories that really has defined this past year -- also the end of the year, too, I guess -- has been this Boeing 737 Max story. Remember, October of last year, we had this first plane crash. Maybe folks didn't think about it. This is Lion Air Flight 610. But then, in March, there was a second plane crash. And then this aircraft, the 737 Max, has been grounded ever since then.

Lou, what has happened with this story? What should investors know about the 737 Max today, I guess how we got here?

Whiteman: Well, how we got here... The 737 Max was a reboot on a classic design. We can get into some of the reasons behind it, but, to save money, Boeing felt a need -- they wanted to give the aircraft a longer range, make it a more powerful aircraft, but keep it within the 737 family so they wouldn't have to do a total redesign. That involved putting a new engine on it, a heavier engine, which in turn forced them to move the engine forward. It was a cascading series of modifications that meant that, with how powerful the engine is, and where it was situated, there was some concern that the engine would cause the airplane to drift up. Their answer to this was called MCAS, part of autopilot that was designed to look for this and adjust back so pilots wouldn't have to be retrained -- again, save money on certification costs.

Unfortunately from all the investigations, it looks like MCAS, basically, there are a lot of errors in the readings. There's a lot of false positives. These crashes seem to basically be, MCAS falsely read the engines, forced some planes upwards, and some pointed down to stabilize, which had catastrophic results.

So, that's where we are. We've halted deliveries and they're trying to figure out how to get it right and make sure this won't happen again.

Sciple: It reminds me a little bit of, you think about the space shuttle maybe 30 years ago. You had this super complicated piece of machinery, lots of these moving parts, and it ends up being something no one would ever think of that causes an issue. That's really what's happened here.

Now, just this week, we've had a number of Congressional hearings, folks pointing fingers at the process that was taken to approve this plane. Do we have any look through into how long this could persist, this investigation? I remember when this story first came out, we thought, "Maybe this will be grounded for a few weeks, maybe it'll be a blip on the radar," and here we are six months, nine months later. Do we have any idea how much longer this can persist, and what regulators' main concerns are before this plane can get back off the ground?

Whiteman: The investigation, people will be writing papers about this for a decade. The big thing is, when can these planes get airborne again? The initial target has come and gone. Boeing had hoped to do it by year-end. Now they're saying early 2020. It's definitely going to get into 2020 now for, if no other reason, the European regulators take the holiday season off. What we're going to see is, we need confidence in the software, we need testing of the final package. And then, even after it's all certified again, I think you're going to see a very slow rollout. So, yes, this is going to be a story well into 2020 as these planes, once they're finally airborne. Their return to service is going to be a slow, dragged out process.

Sciple: One thing that comes to mind, too, is we do have an election year coming up this year. Already, we had these hearings this past week. It's a very easy place to score some points; this is a very high-profile investigation. We've also seen relationships with Boeing and their customers -- updated just this week, Boeing reached a settlement with Southwest to handle some of those portions of the grounding.

One other aspect I saw in this deal, talking about pushing out the new 737 Max, part of the pricing they gave to Southwest and others was, they said, "Hey, we'll give you a million-dollar rebate on these airplanes on the condition that you don't have to do any simulation training on these planes." And now, with this investigation, there's going to have to be a lot of that sort of thing. How are suppliers handling this grounding, and the implications of it going forward?

Whiteman: Let's look at suppliers and customers. Boeing made a decision early on. This is a very complex supply chain. The notable supplier Spirit AeroSystems out in the Midwest makes the entire fuselage of the plane. Boeing decided, we're going to continue manufacturing because we want our supply chain to be healthy. The supply chain just can't easily shut down for six months a year and pick up at the drop of a hat. So, Boeing has continued to buy planes. A lot of the suppliers had been investing assuming that production would ramp up, so there have been hits. But the good news is, the supply chain is basically intact, and has weathered it pretty well. The bad news from Boeing on that side is, they've continued to manufacture these planes without delivering them. There's great pictures of Boeing now, they've run out of room to park these planes, so they're parking them in employee parking lots. There's a cost to all that. You can't just park a plane the way you park an old Buick out back and not think about it for six months. All of these are hooked up, their batteries are going to have to be checked out, all the engine work. There's billions in expense just to get things up and running before you get to the customer side.

And, as you say, with the customers, a lot of major airlines, a lot of important customers, a lot of the companies of Boeing needs to keep a good relationship with, they have disrupted their schedules for a year now. There is going to be billions in compensation to these customers, and Boeing really doesn't have a strong negotiating stance there, because they want to keep good relations.

We're talking well into the next few years, and billions and billions of dollars, just in recovery costs from this, even though the supply chain and the production has continued through the grounding.

Sciple: Sure. On the back half of the show, one of the first questions that folks might be thinking about this Boeing relationship is, why don't why don't these suppliers go talk to Airbus, or go talk to another company to go find alternative sources for new airplanes? On the back half of the show, we're going to try to put that into context, why the nature of the airline industry limits that, and how things shape up for Boeing going forward even after this 737 Max issue is resolved.

So, the questions I left off on the first half of the show, that I think a lot of people rightly think about when you think about the 737 Max issue -- these planes are grounded, these customers who would like to grow their business, but don't have access to these planes. Why don't they just go to Airbus? What's the limiting factor of this of this business that limits customers from just jumping to another supplier?

Whiteman: Business has been too good. Boeing and Airbus, A versus B, and it's been that way for a long time. Boeing's got a 5,000-plane backlog, $400 billion. Much of that is 737, upwards of three-quarters of it. But if you go across to Airbus, their backlog is even bigger. And it's dominated by orders for the A320 family, which is the 737 Max's only real competition. An airline right now, if they wanted new from Airbus, those slots are taken well into the next few years. There just isn't an easy, obvious choice where, "To heck with Boeing, we want to go elsewhere." There isn't that sort of supply out there right now.

Sciple: Yeah, get in line is the answer. These are super complicated machines that take years and years to make. You think about the Navy, when you talk about buying new ships, it takes a long period of time to make these new things. Airlines are maybe not quite as large as that, but just as significant when it comes to laying things out. When you talk about demand, too, I pulled some numbers this morning. Their International Air Transport Association reported that you had 4.4 billion passengers that took flight in 2018. They're expecting that to double by 2037. So, over the next 20 years, it's 3.5% growth every single year. Boeing expects, I think it's an $8.7 trillion market opportunity over the next 10 years. So it's really significant. $470 billion backlog, as you mentioned.

So, when it comes to demand going forward in this industry, there's replacement demand here in the U.S., there's also growth overseas. How are the dynamics shaking out there when it comes to demand for these big airlines?

Whiteman: As you say, a lot of it in the developed world, the Western world, is replacement. We're talking to 2%-3% growth a year. China makes up a huge portion of both Boeing's backlog and Airbus as well. I think Boeing expects 44,000 global deliveries in the next 20 years. Says air traffic will, I think, be 2.5X larger in 20 years, and the global fleet will double in size. Most of that is Asia Pacific. Asia Pacific is half of total demand over the next 20 years. We're seeing replacements, we're seeing fuel economy issues in the Western world. But Asia Pacific, China in particular, that is where the growth is, and there is just so much demand. They're going to take whatever orders are available, even if some of these Western companies were to slow their growth.

Sciple: Yeah. When you look at China, I believe, if I'm not mistaken, China has been trying to make some investments in developing their own domestic major airline manufacturers. How does that play into the Boeing-Airbus duopoly, and just demand going forward in the industry?

Whiteman: Comac, they call it. Commercial Aircraft Co. And yes, they are trying to develop a 737, A320 derivative. It's not to say it can't happen, but just to give some context of what this requires. The Boeing 787 Dreamliner, which was a fresh design, $30 billion plus in development costs for that. That includes getting the supply chain up and running, getting the toolings. Even the 737 Max, which, as we said, was a derivative design from a design that's been around for 30 years, was $2-$3 billion in development costs there, including new engines. China, the nature of the government, if they want to swallow, that they can. But it is a slow process. It is an expensive process. There's a reason this duopoly has held up.

And then, if you're talking about China, whatever you want to say about Boeing and the FAA and the way they've handled this, I think there is going to be some skepticism, at least at first, in a lot of the developed world from buying an aircraft from China. There's going to be a credibility ramp there.

There is no overnight solution here. There's plenty of other companies that are trying, especially at the bottom end, to get involved. But most of this capacity, most of this demand, is going to get soaked up by Airbus and Boeing throughout the 2020s into the 2030s.

Sciple: Yeah. To your point, as we mentioned earlier, these are incredibly complicated machines, which requires a huge amount of capital just to get involved. And then, to your point as well, the regulatory landscape these businesses play in is really robust and difficult to navigate. I expect it will become a little bit more difficult to navigate even more so with this latest 737 Max issue. Lots of criticism of the regulatory hoops that folks had to jump through there. So, putting that into context of, this is an issue that's going to weigh on Boeing in the near term, we don't know how long this is going to persist until these planes can start being delivered, but the nature of this industry is such that it's really difficult to foresee a significant challenger to Boeing. What is your view on the stock going forward, and how you need to think about investing in this company today going forward?

Whiteman: I'll admit, I'm of two minds here. I respect the portfolio of Boeing. It is a powerhouse company. I can't imagine, for all of the mistakes they've made -- and they have made a ton of mistakes this year dealing with the 737 Max. There's been a lot of embarrassing ugliness that has come out of the processes that went into it. This has not been a good year for Boeing, for Boeing's management, for the credibility of the company.

That said, this is a massive company. It's a massive order book. I do believe they get this right. They have a defense business that, a couple years ago, was taking a lot of criticism, but seems to be on a rebound. I believe that a current investor now in Boeing will make money over time.

That said, with everything going on, and honestly, with the credibility issues I think that this management team has right now through this handling, management matters to me, and I can't buy into Boeing right now with my money even though I do believe over time, the stock is likely to go up, just because I want to see management get this right. And all over the portfolio, I want to see them restore my belief that they have a handle on this huge portfolio; that they know what's going on in it, and they can manage it well. I would caution others to do the same. I think it's a good company. They've got good products. But I can't buy into a company if I don't trust management, and right now, I don't think management has earned our trust.

Sciple: Yeah. Particularly throughout what we've seen in the last year with the Max, it'd be fair to say that the communication between management and investors, about the true state of what these problems are, has been much less transparent than you would like to see. They do have an incredible hand before them. As we mentioned, it's hard to figure out how you have the hand that this business is dealt and you don't make money over time. But, to your point, I think you're investing in spite of the management team, not because of the management team today.

Whiteman: Right, right. The 737 Max is definitely the most catastrophic issue they've had, but all over the portfolio -- the KC-46 is the refueling tanker for the Air Force. This program dates back 15, 20 years. The bidding was so controversial that Boeing's former CFO ended up in jail over it. But they did win the contract. It's been $2-$3 billion in cost because they haven't been able to stay on schedule. They finally delivered in January, and the Air Force had to ground the planes because Boeing had failed to get the debris and some of the tools out of it before they delivered them. That's just one other example, and there's others. This is a company that, you almost worry it's too big to manage. It is right now, or at least, it hasn't been managed correctly. It's a powerful company. It's a great portfolio. But investors beware, when things like this happen, they happen for a reason. You need that on your radar along with the potential, I think.

Sciple: Yeah, something to definitely be mindful of going forward. Lou, thanks so much for sharing your thoughts on Boeing. I do want to get one thought from you going away. This is probably the last time you'll be on the show here in 2019. We're going into 2020. We mentioned it's the end of the decade. As we go into 2020, what company are you most excited about? What story are you most excited to follow here in this next year?

Whiteman: I spend a lot of time looking at the defense industry. Election years are always interesting for the defense industry. We've had a good run the last few years, and I don't think we'll, hopefully, go back to sequestration on some of the issues from the early part of this current, almost-over decade. But I do wonder if some of these traditional defense firms, if this is the best it's going to be, and how we're going to sort between companies in the next few years. They've had a really good run, and it feels like, depending on how this election goes, the times could be changing for the Pentagon and for the contractors. I'll be watching that close and see how that plays out.

Sciple: I'm sure we'll have you on sometime in the next year or so to discuss that as we get more information. Thanks for coming on, Lou, as always!

Whiteman: Thank you! It's a pleasure.

Sciple: As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against the stocks discussed, so don't buy or sell anything based solely on what you hear. Thanks to Dan Boyd for his work behind the glass. For Lou Whiteman, I'm Nick Sciple, thanks for listening and Fool on!