Developed as a replacement for the aging but popular 737 passenger jetliner, the 737 MAX was supposed to open a new chapter in Boeing (BA, Financial)'s long history of commercial aircraft design and construction. But the company's efforts to conceal software issues, which caused two fatal crashes before the 737 MAX was grounded worldwide, has exposed its management to scrutiny, as well as revealed a concerning level of regulatory capture.
Moreover, Boeing’s current vulnerability has made it a tempting target in the trade war. As the U.S. continues to escalate its disputes with China and other powers, it may find its aerospace industry standard-bearer in the crosshairs of retaliatory action.
Long road back
The grounding of the 737 MAX has unquestionably dented both Boeing’s reputation and its finances. The latter issue may prove pressing in the relative near term since the company has overstretched its balance sheet in recent years.
Yet, clearly, confidence remains high in Boeing’s ability to turn things around. Boeing bulls believe a software fix will be made promptly, with many expecting the 737 MAX back in the air in just a few months.
That confidence may prove to be misplaced, in light of the litany of issues facing the 737 MAX’s path back into service. Indeed, the proposed software fix appears yet to even be submitted to the Federal Aviation Administration, let alone to the host of foreign aviation regulators that will need to be convinced the vehicle is safe to fly.
The elephant in the room
Importantly, numerous major airlines -- both foreign and domestic -- have pushed back their timetables for reintroducing 737 MAX aircraft to active service in their fleets.
Southwest Airlines Co. (LUV, Financial), United Airlines Holdings Inc. (UAL, Financial) and American Airlines Group Inc. (AAL, Financial) have all adjusted their expectations, for example. United and American now expect to bring 737 MAX aircraft online in December, while Southwest no longer anticipates a relaunch this year. A host of smaller providers have taken similar actions, including Canada’s Sunwing.
The elephant in the room for Boeing is that, if it cannot get clearance for the 737 MAX soon, it will see even more order cancelations. The company’s unnecessarily stretched finances may have great difficulty coping with the added expense of a mandated retrofit, let alone a more comprehensive redesign of the 737 MAX.Â
Trade war exposure
Boeing’s problems would be bad enough in good economic conditions. In the current geopolitical climate, they could prove more harmful.
President Trump has taken a bellicose line with America’s trade rivals, especially China. Unsurprisingly, Boeing fears the potential for direct and indirect retaliation, as CEO Dennis Muilenburg acknowledged in an Aug. 9 interview:
“We do have some challenges around tariffs, trade, we have some concerns there, but the fact is that we have a voice at the table, and we see the administration leaning forward to support us as a business while we deal with the realities of the trade war situation.”
A sprawling aerospace business like Boeing is obviously vulnerable to supply chain disruptions, as well as to other economic shocks that may be created by a changing menu of tariffs and barriers. Likewise, the increasing risk of a trade war-induced global recession damage any company working in a highly capital-intensive industry. However, these are issues facing many American and international companies as they attempt to navigate a safe course through the U.S.-China trade conflict.
Sitting duck
Boeing’s idiosyncratic exposure to trade war risks exceeds that of other aerospace giants. First, Boeing’s finances are particularly strained, with the 737 MAX safety revelations and grounding having come at perhaps the worst time. Aggressive share buyback programs have stripped away much of Boeing’s cash reserves, leaving the company comparatively cash-poor with substantial leverage.
Boeing is further uniquely exposed to trade war pressure thanks to regulatory capture. Of course, Boeing’s ability to take an essentially self-regulating position has paid off wonderfully for the company many times. However, in this case, that cozy relationship may prove troublesome. It is now well documented that Boeing’s Muilenburg attempted to convince Trump directly to intervene on its behalf to prevent a grounding. Even after two fatal crashes, the company hoped it could lean on its relationships in Washington to keep the 737 MAX flying. When foreign governments began grounding the aircraft, the U.S. eventually did likewise.
This episode is important because it not only embarrassed the U.S. government and exposed clear failures of regulatory oversight, but also ceded the safety “high ground” to foreign powers. China can keep its 737 MAX aircraft grounded indefinitely, and can deny access to its skies to those airlines that do not do likewise. In other words, Boeing’s plight could easily be weaponized by Beijing. Indeed, portraying such a protracted grounding as occurring “in the interest of safety” could be even easier in light of the clear failures of the FAA and Boeing to manage the regulatory situation in the U.S. market.
Verdict
Investors are simply not appreciating the sheer scale of Boeing’s risk exposure. The grounding of the 737 MAX was a potentially abject disaster in itself. Add to that the mounting economic turmoil and escalating trade war, and the aerospace giant looks vulnerable.
Investors with exposure to Boeing need to appreciate that the real risks are not being adequately priced in. If any of these risks materialize, even in part, it could sink the stock like a lead balloon.
Disclosure: Author is short Boeing.
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