It's been a tough year for Boeing (NYSE:BA), but the aerospace giant and its shareholders should get some much-needed good news before year's end as regulators appear close to allowing the 737 Max to resume flying.
With the stock off nearly 50% year to date and the Max's return a key boost to free cash flow, bargain hunters might be tempted by Boeing shares. But a scathing new report from Congress on the issues that led up to a pair of deadly 737 Max crashes, along with the plane's subsequent March 2019 grounding, is a reminder Boeing's challenges are far greater than just getting the plane airborne again.
"No respect for an expert culture"
Congressional investigators in the report blame the crashes on "a horrific culmination of a series of faulty technical assumptions by Boeing's engineers, a lack of transparency on the part of Boeing's management, and grossly insufficient oversight" by the Federal Aviation Administration. It also put a lot of the blame on Boeing's internal culture.
The 239-page report is focused on a piece of flight control software, called the MCAS, that failed in both crashes. The investigation found that Boeing engineers had identified issues that could cause MCAS to be triggered, perhaps incorrectly, by a single sensor, and worried that repeated MCAS adjustments could make it difficult for pilots to control the airplane. The investigation found that those safety concerns were "either inadequately addressed or simply dismissed by Boeing," and that Boeing failed to advise the FAA.
In fact, Boeing, according to the report, decided against classifying MCAS as a safety-critical system, a move that would have attracted greater FAA scrutiny. Citing company emails, the report said Boeing officials decided against flagging MCAS "in order to avoid increased costs, and greater certification and training impact."
An anonymous whistleblower in 2018 wrote that "there is no respect for an expert culture that has existed through years of experience," in a response to an internal survey. And Ed Pierson, a senior manager at Boeing's 737 MAX final assembly plant, in a 2018 email to the 737 program general manager warned that pressure on workers "is creating a culture where employees are either deliberately or unconsciously circumventing established processes."
"All my internal warning bells are going off," Pierson wrote. "And for the first time in my life, I'm sorry to say that I'm hesitant about putting my family on a Boeing airplane."
What does this mean for investors?
Variants of the 737 make up 78% of Boeing's total backlog, and the 737 Max brand is damaged goods. Boeing seemingly admitted as much by de-emphasizing "Max" from its marketing materials. A Bank of America survey late last year found that nearly 75% of respondents would try to switch flights if booked on a 737 Max.
Despite the issues, Boeing is still going to sell a lot of these airplanes. No high-profile airline customer has signaled plans to abandon the 737, and with delivery contracts in place, Boeing should have no trouble placing the 400-plus Max planes built but not yet delivered.
But there is still risk to overall profitability. The main reason Boeing pushed hard on the 737 Max design was to compete with Airbus' (OTC:EADSY) A320neo aircraft, and the controversy seems to have given the A320 a leg up. Airbus has 262 net orders for the A320 so far in 2020, despite COVID-19 headwinds, compared with 410 net cancellations for the 737 Max.
New airplane designs come with substantial development and tooling costs that take years to be repaid, meaning it is the later deliveries that really drive profitability. At one point, the 737 Max seemed destined to be among the best-selling airplanes of all time, and a major profit driver at Boeing. That no longer seems likely.
Boeing has other issues, too
Boeing's troubles are hardly limited to the 737 Max. Its 787 Dreamliner, which provided much-needed revenue in 2019 while the Max was grounded, is also working through manufacturing quality questions. The space and defense side of the business is facing ethics and culture concerns.
This is all happening as the pandemic eats into airline growth plans, slicing demand for new planes. Boeing cut Dreamliner and other widebody production plans back in April, going from making 14 787s per month to 10 with plans to eventually lower rates to seven. The Max, which at one point Boeing had hoped to be producing at a rate of 57 per month, is now planning a slow ramp to 31 per month in 2021.
In all, it's hard to imagine that airplane deliveries, and with them cash flow, will normalize until 2022 at the earliest. Airlines will emerge from the pandemic with debt-laden balance sheets, meaning the next new order upcycle might take years longer to materialize.
Boeing's a tough business to like right now just based on the numbers. The culture concerns exposed in the Congressional investigation are an added reason for investors to think twice about these shares.
There's great intrinsic value in this company, but Boeing for me has lost the benefit of the doubt. I won't consider buying in until we see concrete evidence that the cultural rot plaguing Boeing has been removed.