All eyes have been on Boeing (BA -0.76%) in recent weeks, after technical malfunctions have afflicted its flagship 787 Dreamliner, the most advanced passenger jet ever. Problems with the plane's power systems and electronics have led to forced early landings, fires, even an explosion. On Friday, the Federal Aviation Administration launched a full-scale investigation into the safety of the 787, casting doubt on the reliability of the plane and threatening its success. It would be an exaggeration to say that Boeing's future rests solely on the success of the 787, but only barely.
The 787 Dreamliner is Boeing's most technologically advanced commercial plane, made up of lightweight and fuel-efficient carbon composites and using cutting-edge avionics, electronics and power systems, as well as custom-designed engines from industry leaders General Electric (GE 8.28%) and Rolls-Royce. Orders for the futuristic jet make up nearly two-thirds of the dollar value of Boeing's total $378 billion order backlog. Not only that, but the company also plans to adapt systems and components, including the GEnx jet engine, pioneered for the 787, into other jet models, in a bid to leverage the Dreamliner's massive development costs across multiple platforms.
Boeing CEO James McNerney has pointed to the advanced technology of the jet in explaining both the plane's troubled development program -- the first Dreamliner was delivered in 2011, three and a half years late and billions of dollars over budget -- and the recent technical malfunctions, which McNerney has referred to as "squawks." Recently, 787 customers Qatar Air and United Air Lines (UAL 0.17%) both complained of electrical problems in auxiliary flight systems that forced the airlines to ground flights prematurely. Other customers, including the Dreamliner's inaugural customer, All Nippon Airways, have noted more mundane problems such as oil leaks, cracks in a cockpit window, and cracked engine casings over the past several months.
The incident that probably sparked the FAA investigation occurred Monday, when a 787 operated by Japan Airlines reportedly caught fire while on the tarmac at Boston's Logan Airport. The problem was traced to a battery that had exploded, filling the cabin with smoke and causing a fire in the belly of the plane. All passengers and crew were already off the plane when the fire was discovered.
The battery is used only as an auxiliary power source when the jet engines are powered down and therefore presented no known danger to a 787 in flight. Like all the recent problems, therefore, this malfunction didn't seriously endanger passenger safety. However, having the words "smoke," "fire," "explosion," and "787 Dreamliner" all in the same sentence are bad for Boeing.
The FAA investigation is thought to be partially aimed at reassuring the public that the 787 is, in fact, safe, and that no 787s have been grounded from flight. However, if the investigation does turn up serious flaws with the component sourcing or manufacture of the Dreamliner, Boeing will have to rethink how it produces the planes. That would be a very unwelcome hurdle to overcome for a company already struggling to safely ramp up production quickly enough to meet demand. At Boeing's current production rate, it would take the company more than a decade just to deliver the Dreamliners that customers have already ordered. Boeing needs to be figuring out how to produce planes faster, not going back to the drawing board on how to produce them at all.
The news has depressed Boeing's share price, and that leaves investors at a crossroads. For those who believe that Boeing's technical malfunctions are just distracting glitches and don't represent a serious obstacle to the production ramp-up of the 787, this unpleasant news for Boeing creates a nice buying opportunity. Even though Boeing stock is near a three-year high, shares still look cheap, at only 13 times earnings compared with 15 times earnings for the S&P 500. If Boeing can resolve current malfunctions with the 787 and continue to increase production output, the sky's the limit for this planemaker.
As for me? I'm staying away. Boeing's current goal of nearly tripling 787 production from 3.5 per month in 2012 to 10 per month by the end of 2013 is already not ambitious enough to seriously make a dent in the company's 800-plus backlog for the jet. Worse, I'm not optimistic that the current slate of problems will be solved quickly and painlessly. The checkered past of the 787 development program makes me skeptical that these are small, isolated incidents: The test flight program of the 787 was fraught with major events including an engine blowout during ground testing and the emergency landing of a test plane after it caught fire mid-flight, leading to the grounding of the entire test fleet for nearly two months.
Boeing should be commended for blazing a trail in aeronautic innovation, but investors need a lot of faith to buy Boeing today. The FAA investigation will not only cast some short-term doubts about the safety of the program with Boeing's crucial airline customers, but it also may reveal more serious long-term problems in the company's supply chain and manufacturing process, which have long been serious concerns.
