Trump's Tariff Plan: Overblown Consequences For Boeing?

Summary

• Direct impact of tariff on production costs should be negligible for Boeing.
• Bigger problem is the possibility of a trade war.
• Boeing sales could suffer if tariffs were to be imposed as it directly frustrates countries in which Boeing aims to sell its jets.

On the 1st of March, President Trump single-handedly shaved off $10B off Boeing’s (NYSE:BA) market cap after he announced plans to impose tariffs on steel and aluminum imports. In this article, I want to have a look at the possible consequences of such measure for Boeing and whether this is a real reason for concern.

Source: The Post and Courier

I will start off with 3 reasons why there is little to no reason for concern, after which I will zoom out and highlight 3 reasons that could be more problematic to Boeing but also to other industries.

Reason #1 not to worry: Impact Limited

Source: Aviation Stack Exchange

The first reason not to worry about a tariff on steel and aluminum is simply because, waste excluded, the cost component of aluminum and steel are fairly limited. AeroAnalysis ran a quick calculation on the impact of tariffs on the Boeing 787 and Boeing 777-300ER. Given recent changes on Seeking Alpha policies, those calculations will be shared exclusively with premium subscribers.

AeroAnalysis has estimated that the cost components for steel and aluminum alloys are just 1.7% of the total production costs and that is not surprising since engineering and manufacturing to specification are the major drivers of the production costs. Adding tariffs, the 1.7% percentage would increase to 1.9%. So, that is a really small differential. What is important to understand is that a 10% and 25% tariff leads to a 10% increase in material costs and just a 0.2% bump in total production costs for the Boeing 787-9.

Applying the same principle to the Boeing 777-300ER, we found that the cost components of steel and aluminum would increase from .65% to .7%.

Although aluminum alloys are often used, because alloying allows for better material properties when done correctly, aluminum remains roughly 90%-95% of the allow so it is good to look at the aluminum prices and what we see is that aluminum prices have been trending upwards. Obviously, Boeing can arrange long-term contracts at fixed price to somewhat dodge the price increases and it is important to note that since the end of 2015, prices increased by over 50% and we have seen none of that negatively impacting Boeing. The reason obviously is the arrangement of long-term contracts, Boeing’s leverage in the supply chain and again the small cost components of raw materials compared to parts, [sub]assemblies and systems.

The main takeaway here is that a 10% or 25% tariff has almost no impact on production costs. In fact, Boeing would have no problem to feed the impact of the tariffs through in the pricing of the product without creating an unovercomable burden for customers.

Reason #2 not to worry: Not all metals are imported

In the previous paragraph, it was already pointed out that the impact is limited and it also needs to be pointed out that this might be a worst-case scenario, since the calculations are assuming that the tariffs will be applied on the entire aluminum and steel components and especially for the aluminum material component this is not the case.

Boeing has long-term agreements with Alcoa (AA), which provides aluminum plating for all Boeing aircraft. It is unknown how much of the aluminum comes from the US, but if we assume that 25% of the aluminum comes from outside of the US then the tariff impact would only add around 6% to the aluminum and steel costs and we believe it could even be as low as 3%.

So, depending on how much of the raw material already comes from the US and given that Boeing has long-term arrangements with Alcoa, we expect that to be a lot, the actual impact on Boeing should be limited or at least as limited as the fluctuations we are seeing in pricing sparked by raw material price movements.

Reason #3 not to worry: Tariff not in effect

The third reason not to worry is that the tariffs have not taken effect (yet). Tariffs on aluminum and steel will be one of the things that you don’t announce today and it takes effect tomorrow. There needs to be a thorough mapping of the consequences and risks before such tariffs can take effect, and I would expect that currently this rhetoric will serve to force negotiations.

Reason #1 to worry: Trade war

Now obviously, we would be significantly detached from reality if we would mention that there are no negative consequences and as a matter of fact, consequences can be extremely disruptive. This disruption would not be limited to the aerospace industry, but would spread across other industries as well. The majority of this article, was penned early on Friday and since the announcement of plans to instate tariffs there have been some reactions from the EU and China and those reactions give reasons to worry.

The chain of events following a tariff would be complex, but it is not hard to deduce from the reactions of all parties involved that a trade war could be happening and that is something that would know no winners. Tariffs would impact the aerospace industry, but it would possibly spread to car makers and the petroleum industry. So, the consequences could be extremely big and even the possibility of having a trade war could send stock markets down at a moment where there already is significant pressure on market sentiment.

Reason #2 to worry: Supply chain not easily altered

For Boeing, another reason to worry would be the fact that the supply chain is not easily altered. Jet makers and suppliers of key components tend to have multiple contractors to prevent major delays in the supply chain if there are quality escapes. Now, tariffs have nothing to do with quality escapes but as an investor in the aerospace industry, you should be aware that quality requirements are very strict. So, you cannot easily swap one supplier for the other from a quality perspective.

There are only a handful of companies that have the system needed to supply high quality plating and materials and the possibility to scale up if need be. A possibility would be to source more from existing domestic suppliers, which is the ultimate goal, but this would be challenging given contracts that are already signed and the fact that the production capacity needs to be there to meet the needs of jet makers or car makers for that matter. If that is not the case, additional investments would be required which could send prices higher.

Reason #3 to worry: Supply chain is positioned strategically

Another big reason to worry for Boeing is that tariffs could significantly disrupt the strategic positioning of the supply chain. Boeing does not only position the supply chain in a cost-efficient way that meets their current production capacity with possible expansions in the future, but it also places parts of productions in countries where the sales potential for Boeing is significant. By imposing tariffs, Boeing - against its will - is being put directly in a position opposing countries that harbor existing Boeing customers and a significant sales potential.

This means that not only could tariffs affect other industries, it also means that there is reason to worry that with an eye-for-eye approach, which pretty much is a trade war, Boeing sales could be affected as the tariffs also affect suppliers in countries where Boeing wants to give a little to take a big chunk of the sales.

Conclusion

Solely looking at the pricing impact, AeroAnalysis concludes that there is no impact on pricing that can't be overcome. Even in the worst-case scenario where it is assumed that all aluminum and steel will be subject to tariffs, there seems to be no major problem that could not be countered by modest increases in sales prices that would be paid for by the airline… pretty much in the same way a consumer would have to carry the tariff on a can of soda.

The bigger problem is that tariffs should not be considered as an isolated element. Countermeasures can be expected if a tariff would be imposed and Boeing’s business could be affected significantly. In my view, the possibility of a trade war weighs far more than the limited impact (if any) tariffs would have and view any tariffs signed into law even if temporary as a negative to Boeing’s business given the high profile reactions it could spark.

There is no doubt that the US aluminum industry is in a difficult spot, but a tariff would highly likely protect a few jobs in the domestic aluminum industry while having far-stretching consequences for jobs in other industries.

Am I selling my shares in Boeing and General Motors (GM)? No. I would be highly surprised, if we were to see tariffs on aluminum any time soon. However, given the pressure on market sentiment lately, I would understand people trimming their positions in industries that could be affected. These industries would include aerospace, defense, automotive and petroleum amongst others. Industries that are less likely to suffer from tariffs are tech and biotech, so in case a tariff takes effect that is where my money would be flowing.

Analyst’s Disclosure: I am/we are long BA, GM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.