What happened
Shares of Spirit AeroSystems (SPR -0.66%) traded down more than 10% on Tuesday morning after the company said Boeing (BA -0.24%) intends to produce far fewer 737 Max airplanes this year than what had been originally planned. Investors knew this news was coming, but the reduction was greater than many had expected.
So what
Spirit, a onetime subsidiary of Boeing, makes fuselages and other parts for the 737 Max. The plane has been weighing on results at both Boeing and Spirit for a year now following its March 2019 grounding, but the COVID-19 pandemic with its subsequent drop in travel has further eaten into demand.
In a regulatory filing late Monday, Spirit said it received a letter from Boeing telling it to reduce its planned 2020 737 shipsets -- a term for all the parts needed to produce one airplane -- from 125 to 72. That includes the 35 shipsets Spirit has already produced and delivered.
Image source: Boeing.
Spirit had telegraphed that a reduction was likely, saying earlier this month that it had been asked by Boeing to pause additional work on four shipsets and avoid starting production of future sets. But most analysts at the time estimated Boeing's total order for the year would remain around the 100-plane level.
The reduction is likely to have significant consequences for Spirit. The company earlier this month furloughed workers for 21 calendar days based on the halt. Now with so little work for the remainder of the year, it could be forced to do layoffs.
Spirit also said in the filing that, given the reduction, it could end up in breach of financial covenants under its credit agreement in the fourth quarter. The company said it is in communication with its lenders "and intends to work with them expeditiously to obtain appropriate relief from its covenants."
Now what
The grounding of the 737 Max followed by the pandemic has created a perfect storm at Boeing, which has more than 400 737 Max planes in inventory awaiting delivery. With airlines scaling back growth plans, it's not going to be easy to move that inventory once the 737 Max is recertified to fly, something that could happen as soon as the third quarter.
Spirit counts on Boeing for the bulk of its revenue, and while the company prior to the pandemic was taking steps to diversify, there is little it can do in the near term to avoid taking a hit during this downturn.
Boeing can ill afford to see a key cog in its supply chain stumble, and it will likely work with Spirit to make sure it does not run afoul of its lenders. For shareholders, though, it looks like there's nothing but turbulence up ahead.
