The global aviation business is screeching to a halt in the midst of the COVID-19 pandemic. Even airlines that are usually top performers have seen revenue drop toward zero and are on track to burn through cash at an alarming rate over the next few months.
This couldn't have come at a worse time for Boeing (BA -0.14%). The U.S. aerospace giant's top-selling product, the Boeing 737 MAX, has been grounded for more than a year due to safety problems. As a result, the company's debt load was already elevated and cash flow was negative prior to the latest crisis. Several other key products have also encountered technical issues. Not surprisingly, Boeing stock has plunged, recently dipping below $100, down from around $340 just a month ago.
Yet as far as Boeing stock has fallen, investors should still avoid the shares. The government is likely to provide loans and/or loan guarantees to prevent Boeing and its suppliers from collapsing, but that aid will saddle the company with a massive amount of debt. Meanwhile, it could take years for demand for Boeing's commercial jets to recover, leading to an extended period of weak free cash flow.
Boeing was already in bad shape
The 737 MAX grounding, which followed two fatal crashes for that new model, devastated earnings and cash flow last year. For the full year, Boeing posted a core operating loss of $3.4 billion and burned $4.3 billion of cash.
Despite free cash flow turning negative, the aerospace giant continued to pay over $1 billion in dividends each quarter during 2019. This temporarily supported Boeing stock, but it exacerbated the pressure on the company's balance sheet. By the end of the year, it had $27.3 billion in debt, compared with just $10 billion in cash. For comparison, Boeing entered 2019 with only $13.8 billion in debt, offset by $8.6 billion in cash.
Even before the COVID-19 pandemic exploded, Boeing was expecting to burn even more cash in 2020 than it did last year. For one thing, it has had to offer financial support to some suppliers after pausing all 737 MAX production. Additionally, the production halt means that it is no longer receiving much in the way of advance payments from 737 MAX customers. Lastly, Boeing has projected that cash compensation for airlines affected by the 737 MAX grounding would increase this year.
While the 737 MAX represented Boeing's biggest challenge by far in 2019, it wasn't the only problem for the company. The first flight of the 777X was delayed due to engine durability issues; the KC-46 military tanker isn't meeting specifications, driving continued cost overruns; and the Starliner spacecraft's uncrewed test flight went awry, which may force Boeing to operate a second uncrewed test flight at its own expense.
To help navigate all of its cash flow challenges, Boeing arranged a $13.8 billion term loan earlier this year, which it has now drawn down in its entirety. That puts its debt load above $40 billion today.
The outlook just got much worse
Unfortunately, the COVID-19 pandemic has dramatically multiplied Boeing's problems. In the short term, air traffic is plunging, forcing airlines to make unprecedented service cuts. In Europe, Ryanair (incidentally, one of the biggest 737 MAX customers) is slashing flights by more than 80% as of next week. Here in the U.S., Delta Air Lines recently announced that it will park more than half its fleet and reduce capacity by about 70% until demand recovers.
Similar decisions are being made by airlines around the globe. In short, nobody needs new aircraft right now. Airlines are pulling all of the contractual levers they have to cancel or defer aircraft deliveries in order to preserve cash.
That's bad news for both Boeing and its European rival Airbus (EADSY 0.20%). But it's a much bigger problem for Boeing. Many airlines' contracts with Boeing allow them to cancel orders for individual aircraft penalty-free if the deliveries are delayed by more than six months or a year. Many 737 MAX jets have already reached that point or soon will. As a result, Boeing is likely to face a bigger near-term cancellation wave than Airbus.
Looking out a little further, airlines expect the impact of COVID-19 on global air travel to linger beyond 2020. Until the pandemic is definitively stamped out, many would-be travelers will hesitate to fly. Moreover, even if researchers find an effective vaccine, ending the pandemic, the near-term disruption could drive numerous smaller, financially weak airlines out of business.
As passenger traffic returns over time, other airlines will backfill the capacity lost from those that fold. But for the next few years, there could be a glut of cheap used aircraft on the market. Additionally, whereas Airbus previously had few A320neo delivery spots available prior to 2024, order deferrals and cancellations are likely to open up near-term A320neo availability. Both factors will undermine demand for the 737 MAX (and other Boeing models, to a lesser extent).
As bad as the 737 MAX situation was a few months ago, Boeing stock was supported by the fact that Airbus couldn't supply the whole market by itself. That gave airlines with near-term narrow-body aircraft needs no real alternative to the 737 MAX. With global demand for new aircraft plunging and not likely to fully recover for years, Boeing may have to drastically scale back its production plans for the 737 MAX, its key cash cow.
Boeing's main wide-body aircraft families -- the 787 and 777 -- were already struggling with thin order backlogs prior to the COVID-19 pandemic. Sharp production cuts for those models also may be necessary, further eroding Boeing's cash flow potential over the next few years.
Don't buy Boeing stock hoping for a bailout
Boeing is asking the federal government for $60 billion in loans and loan guarantees for the U.S. aerospace industry (including both Boeing and its suppliers). The Trump Administration appears to be supportive of this request, which isn't surprising, given that the aerospace industry supports over 2 million jobs.
But while this bailout may keep Boeing alive, the government isn't likely to give the company free money. The loans will eventually have to be paid back, and its annual free cash flow over the next five years is likely to be a fraction of the $13.6 billion it generated in 2018, due to the glut of used jets and downturn in aircraft demand discussed above.
As a result, I expect Boeing to suspend its dividend imminently, and it could remain suspended (or limited to a token payout) for five years or more. Even if the 737 MAX is recertified later this year and the industry starts to recover in 2021, Boeing will need to devote all of its limited free cash flow to debt reduction for many years to come.
Despite the stock's plunge over the past month, the company still carries a $57 billion market cap. With Boeing likely to exit the COVID-19 crisis with a massive debt load and greatly diminished free cash flow, even this valuation may be too generous. Thus, investors should avoid the stock for the foreseeable future: There's no recovery in sight.