Boeing's 737 MAX Problems Are Far From Over

On June 29, Boeing Co. (BA, Financial) took a major step toward the recertification of its troubled 737 MAX 8 aircraft. Under the watchful eye of the Federal Aviation Administration, the aerospace giant conducted its first test flight of the aircraft equipped with an updated version of the Maneuvering Characteristics Augmentation System, or MCAS.

A lot was riding on Boeing’s first test flight, which News Break described as “a crucial moment in its worst-ever crisis.” However, a clean bill of health for MCAS will not be enough to get the 737 MAX back in the air.

Issues run deeper than MCAS

Boeing has persisted in its insistence that the 737 MAX’s faults, which resulted in two fatal plane crashes and the indefinite grounding of the aircraft, were attributable to its MCAS alone. According to Boeing, a software fix was all that was needed to make the aircraft fit to fly.

However, in the months following the 737 MAX’s second fatal crash in March 2019, more evidence has come to light suggesting that the next-generation passenger aircraft’s design pathologies run much deeper, as Michael Allen of Business Traveller reported in January:

“At the request of the U.S. Federal Aviation Administration (FAA), Boeing conducted an internal audit in December to determine whether it had accurately assessed the dangers of key systems given new assumptions about how long it might take pilots to respond to emergencies, the newspaper said, citing a senior engineer at Boeing and three people familiar with the matter. Among the most pressing issues discovered were previously unreported concerns with the wiring that helps control the tail of the MAX, the report added. The company is looking at whether two bundles of critical wiring are too close together and could cause a short circuit.”

Boeing has claimed that the various emergent issues can all be resolved expeditiously; the company has continued to say that MCAS is the only real problem.

International regulators remain skeptical

As the Seattle Times reported on June 24, aviation industry regulators in Canada and the European Union have insisted that Boeing integrate substantial changes to the 737 MAX’s avionics beyond fixing MCAS. Without these broader fixes, they will not consider recertifying the aircraft on anything but a provisional basis:

“Aviation safety regulators in Europe and Canada have demanded design changes to the flight control systems on Boeing’s 737 MAX that go beyond fixing the flawed system that ultimately brought down the aircraft in two fatal crashes...The required changes to the flight control systems highlight weaknesses in the 737’s inherited avionics systems. The fixes could add substantial cost to the MAX program and might slow the ramp-up of deliveries Boeing needs to recover its cash flow. Boeing has already developed a fix for the new MAX flight control system that was the main cause of the two crashes: the Maneuvering Characteristics Augmentation System (MCAS). Janet Northcote, head of communications at the European Aviation Safety Agency (EASA), said while MCAS ‘absolutely needs to be fixed for the plane to be recertified as airworthy...there are other issues in some way related to the sensor problem’ that triggered MCAS and these also require correction.”

Even if the FAA were inclined to agree with Boeing’s managers, foreign regulators have been less inclined to give the beleaguered aerospace company the benefit of the doubt. Moreover, even if Boeing manages to alter the 737 MAX’s avionics to the satisfaction of aviation regulators, both foreign and domestic, it must still contend with another challege: an increasingly ugly aircraft market environment.

Demand is becoming a serious problem

The passenger airline industry has been decimated by the Covid-19 pandemic, as I have discussed previously, and aircraft operators are already facing an overcapacity problem. With passenger demand not expected to return to 2019 levels until 2023, Boeing may have trouble finding a market for its embattled aircraft. These headwinds led Berenberg to downgrade Boeing to a sell rating on June 25.

Boeing has already reacted by cutting its production forecast. Before its grounding, the company had planned to produce 216 737 MAX aircraft in 2020. By the start of 2020, the company had reduced its forecast to 125. On June 22, Boeing cut its projection to just 72.

Airline overcapacity, cost overruns due to avionics redesigns and a severe loss of trust in Boeing’s engineering and operational integrity have all contributed to the production cuts. Demand has certainly dried up over the past year. Indeed, mere hours after the June 29 test flight, Norwegian Air (OSL:NAS, Financial) canceled an order for 97 Boeing planes, including 92 737 MAX aircraft.

My verdict

While Boeing’s test flight buoyed investors’ spirits, it represents only the first step on a lengthy path to recertification. Even if it manages to get recertified, the 737 MAX has been tainted by two high-profile crashes, while the company’s reputation for engineering excellence has been severely tarnished, and that has had a tangible impact on Boeing’s order book. As CVC Research observed on June 29, Boeing’s 737 MAX order backlog has already fallen below 3,900 units – a more than 17% drop from its pre-grounding height.

My recommendation to investors is to follow the recertification story with great care. If Boeing can get the 737 MAX flying again, it should be enough to restore a degree of confidence in the embattled company. However, it will take a lot more to convince airlines, who are already reconsidering aircraft purchase plans, to stick with such a troubled model.

If Boeing cannot win back the confidence of aircraft operators and consumers, it will struggle to maintain even its current, already diminished, valuation.

Disclosure: No positions.

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