David Nolletti: The Boeing Debacle – ABL Advisor
David Nolletti wrote an article for ABL Advisor titled “The Boeing Debacle.”
The Boeing 737 Max. It is a story of devastating tragedy that has claimed 348 lives in two separate crashes. It is still unfolding and impacting a commercial aviation industry that has heretofore grown and thrived for more than a decade. Boeing, our nation’s largest exporter by dollar value, has stumbled and questions remain on how their steps and missteps will affect the industry, economy, workers and investors in the days to come.
From the early days of this crisis through the end of 2019, with planes grounded and orders at a standstill, Boeing continued building aircraft at a rate of 42 a month. At the same time, the supply chain was manufacturing componentry at a rate of 52 a month. Why? Boeing was trying to keep people employed and the supply chain up and running, recognizing how much damage even a temporary shutdown would cause to the massive supply chain. Stopping it is a very difficult task but starting the supply chain back up again is even harder. Boeing’s supply chain has within it well over a thousand suppliers, ranging in size from a company like Spirit Aerosystems in Wichita, Kansas that builds all of the 737 fuselages, to the mom and pop machine shops with 25 employees that make a couple of part numbers. It is an enormous chain with suppliers in every single state in the U.S. The fallout of the recent shutdown has already begun. Spirit has announced the layoff of 2,800 employees, or, roughly 20% of the workforce at their Wichita facility. Media out of Wichita has subsequently reported that another 2,800 to 3,000 employees at various Spirit suppliers will be similarly laid off. That’s 6,000 jobs in one metro area alone.
If you’re a small supplier, privately held company or family business and 50 percent of your revenue comes from the 737, this is a significant emotional and financial event. Many suppliers will find themselves unable to pay their bills. Moreover, the Boeing debacle is going to have a huge ripple effect on not only the aerospace industry, but the country as a whole. Some analysts estimate a negative 0.5% impact on GDP for 2020 – all because of one line shutdown. The effects will also be felt globally, in particular in China and Asia where a plurality of Boeing’s 737 MAX production is slated to be delivered over the next five years. As of this writing, most 737 Max operators have canceled flights through early June. New reports predict the plane may not be back in operation before Q3 or Q4, 2020.
Traditionally, from a lender’s perspective, the aerospace industry has been a safe haven, although there have been exceptions. After 9/11 and especially in 2008-2009, the business jet community experienced a significant disruption with the Great Recession and production cut by 80 percent. It has yet to fully recover. Aircraft and manufacturing capital items (equipment) are no longer safe harbors. Before, asset-based loans covering machining, forging or casting equipment for making Boeing parts were viable, because there was perhaps seven years of backlog and that equipment was going to continue to run. Now, manufacturers that have taken on substantial debt to buy equipment are idling it for an indeterminate period of time.
If I’m a lender, I’m sweating a bit because even if I repossess the equipment, I can’t put it back to work and suddenly my collateral seems much less safe. The same goes for the plane itself. Commercial lenders have always felt comfortable lending against aircraft because, globally, air travel has typically grown at rate of 5 percent annually, making for a very safe asset. Now, you have aircraft sitting on the ground that can’t fly and no one knows when they’re going back into service. That has a chilling effect on a bank’s willingness to lend as aggressively against such a product.
The MAX is essentially the fourth derivative of the original 737. As the 737’s engines have become larger and larger in diameter, engineers have had to continue to raise them higher off the ground in order to deliver maximum power and greater fuel economy while maintaining adequate ground clearance. With engines forced to be placed above the level of the wing, the potential for the nose of the aircraft to pitch upward developed, with Boeing, in turn, designing the maneuvering characteristics augmentation system (MCAS) to counteract these forces. The MCAS was designed as a fail-safe for enhancing and ensuring the pitch stability of the aircraft. Tragically, system malfunctions, including a faulty, contradictory and non-redundant warning system, and lack of adequate pilot training conspired to deliver disaster.
If and when Boeing can provide some indication as to an aircraft recertification date, reticence will remain across the board. Will air carriers feel comfortable that previous safety concerns have adequately been addressed? Will the general public want to board these planes? How do you even begin to reinstate customer confidence? For the supply chain, what indicators will dictate whether to maintain workforce or lay people off? For lenders, how safe are their notes? Do I continue lending into the aerospace market, or do I take a step back and continue to evaluate? For all parties and the industry itself, the return to service date is the single biggest key.
Industry regulators will play a determining factor – not just here but the world over. In the past all the global regulatory agencies have largely followed the FAA’s lead. I believe that each of the major regulatory agencies, including EASA and CAAC, which are the European and Chinese safety agencies, respectively, are going to want to have their own say. They are all going to have different questions that need to be answered by Boeing.
Is there any relief for the supply base? What about their ability to sign on for work with other airline manufacturers? Perhaps in the long-term, but certainly not in the near term. In the corporate jet world things are still tight. Last year, Dessault Aviation sold the majority of that business to Airbus after selling the lowest number of jets in that space since 2009. Airbus, meanwhile, is ramping up production in Mobile, Alabama, with plans to add 300 to 500 jobs this year. Nothing in the aerospace industry happens quickly and opportunities for suppliers are slim. Those looking to or actually making moves to diversify now could see some positive returns later in 2020. But it is not going to help them in the first two or three quarters of this year.
In the case of Boeing, certainly no one could have predicted what has occurred. Yet, could those who work within this industry have been better prepared? It’s an interesting question both now and for the future. The aerospace industry, from a supply chain standpoint, is extremely deficient in data. I came to this industry in 2002 from the consumer products sector where data was readily available and was shocked at how little useful data on the supply chain existed for the aerospace industry. We know all about how many people are flying and what kinds of airplanes are out there, but deep and insightful information about who is making the parts and where they are geographically located is not widely available. This, in turn, makes predictive analytics and forecasting incredibly challenging.
That said, as with virtually any industry, contingency planning can be crucial in working to minimize future operational bumps in the road. The aerospace industry is so heavily concentrated in just a couple of end customers that if one of them has a disruption or if there’s another recessionary event, you need to be prepared to act quickly – whether it’s an upside case or a downside case – to maintain the business. There is really no way to avoid customer concentration unless you’re a multi-billion-dollar company. If you are a $50 or $100 million supplier, you’re going to have a concentration issue. You must have contingency plans in place to deal with such realities.
Ideally, for those affected by Boeing, contingency plans are in place and have been enacted. If not, with a shutdown that has only been in place for a few weeks as of this writing, it is still not too late to take action steps. It is imperative for suppliers to work to maximize cash flow and preserve liquidity in the interim. Here, you want to do everything you can to keep the business running. If you’re a lender with a troubled credit out there, the last thing you want to do is sit tight and wait for a recovery. You need to get resources in there that can help the supplier preserve credit and the very company itself.
Certainly, this will be a pivotal year for the aerospace industry. Reacting to it with foresight and aplomb, rather than with a “fight or flight” mentality, will make a difference in navigating challenges and identifying the paths best traveled.