The recent news that Boeing (BA 2.78%) is removing engines from its inventory of 737 MAX aircraft and using them to produce new 737 MAX aircraft demonstrates the supply chain issues in the industry. It also highlights the ongoing issues that engine makers, such as Raytheon Technologies (RTX -0.55%) and General Electric (GE 1.05%) in its joint venture with Safran, CFM International, are facing. Here's the lowdown on what it means to investors.
The report, coming from Leeham News, is a stark reminder of the pressure the aviation industry is under to meet demand levels and execute on its backlog. In a nutshell, Boeing is finding it difficult to increase its production rate in the 737 MAX -- a plane that, along with the Airbus A320 neo family of aircraft, is the workhorse of the skies. The main reason is a lack of engine availability.
On the last earnings call, Boeing CEO David Calhoun dialed back expectations for a production ramp on the 737 MAX. Instead, he aims to stabilize at a production rate of 31 a month, and he needs "confidence that engine suppliers will have their castings in order." In terms of engine suppliers, Calhoun is talking about GE's joint venture, CFM International -- the sole supplier of engines to the 737 MAX. For reference, CFM and Raytheon's Pratt & Whitney offer rival engines on the Airbus A320 neo family of aircraft.
The latest news impacts the investment thesis for Boeing in a few ways:
- Removing engines from its inventory of aircraft (at the end of the quarter, Boeing had 290 of 737 MAX planes in inventory, around half of which are for customers in China) and using them for new production will come at a cost.
- It highlights the difficulty in ramping production -- a significant issue, as increasing aircraft volume is critical to expanding Boeing's profit margin and delivering on its backlog.
What about General Electric and Raytheon Technologies
The stress also highlights engine manufacturers' difficulties in meeting their production plans. GE and Raytheon's Pratt & Whitney are behind their schedule on deliveries. GE CFO Carolina Dybeck Happe said on the last earnings call, "We also expect lower commercial engines revenue, trending below 20% growth year over year due to continued supply chain challenges." Raytheon's CEO Greg Hayes noted that Pratt's geared turbofan (for the Airbus A320 neo and other aircraft) deliveries were "behind schedule" and would not catch up "until the end of the year" due to a "single issue around structural castings." Russia is a major source of the titanium used in structural castings, and the conflict and associated sanctions have negatively impacted aviation suppliers.
Counterintuitively, the fact that GE and Raytheon are behind schedule on engine deliveries can positively impact profit margin. That's because new engines tend to be sold at a loss (the real money is made in the aftermarket). This is something to look out for next year when engine production should ramp and margins will be negatively impacted.
That said, it's in nobody's interest to see production slowed at Boeing, and the engine manufacturers and suppliers will need to increase capacity at some point.
What it all means to investors
It's not good news for Boeing and highlights its bumpy ride ahead as it tries to restore confidence with investors. That said, Airbus is also facing issues ramping production (something that will influence its win rate versus Boeing on aircraft), and it's only a matter of time before the supply chain pressures ease. The most likely scenario is that the industry muddles through a difficult period, backed by strong end demand -- but don't buy any of the stocks mentioned here if you can't tolerate near-term volatility. Unfortunately, there's no quick fix to the supply chain issues hitting the aviation sector right now.
Correction: The original version of this report misattributed who originally reported the Boeing news.