On the 8th of March, I wrote a report on Jet Airways grounding several aircraft due to non-payment. Although virtually all media outlets, including aerospace portals, used the term "grounding", which means nothing more than keeping the aircraft on the ground, a tiny fraction of my readers found the wording to be unlucky, as they thought there was some regulatory reason for the ground. I want to make clear that is has never been my intention and it will never be my intention to be suggestive, and I used the wording in the broadest sense of the meaning and in line with how many other media outlets have reported it. To me the word grounding felt a bit more forceful, which I found to be fit given that clauses in lease contracts with lessors forced the airline, Jet Airways, to keep part of its fleet on the ground. I also thoroughly discussed the dynamics involved as well as how this affects lessors and jet maker Boeing (BA), so I found the way the report has been presented not to be close to misleading as a fraction of the readers has suggested, though I agree that using "parked" instead of "grounded" would have been an option. I am always very open and responsive to feedback, and that likely also invites comments - I consider it to be a net positive. My work has always relied on strong content and unique content, and I continue to learn each day.
With that being said, the unfortunate reality is that we have to use the word "grounding" in the sense that some people do expect it just a few days after the Jet Airways report. Following a crash with an Ethiopian Airlines Boeing 737 MAX 8, China has decided to temporarily ground the fleet. In this report, I give some basic information on the fatal flight as well as the consequences of the alleged grounding of the Boeing 737 MAX in China, which also has an additional angle to it when keeping the delivery stream of Boeing’s new single-aisle family in mind.
Ethiopian Airlines Flight ET302
Ethiopian Airlines flight ET302 was a flight from Addis Ababa to Nairobi. The flight is usually carried out by either a Boeing 737-800 or a Boeing 737 MAX 8, and on some occasions, even a Boeing 787. On the 10th of March 2019, shortly after takeoff, the pilot of a Boeing 737 MAX with registration ET-AVJ requested a return to the airport of Addis Ababa due to technical issues. However, six minutes after departure, the airliner - while cleared to return to the airport - crashed, killing all 149 passengers and 8 crew members on board. No adverse weather conditions were reported.
At this stage, there is very little information available that gives an indication of what is a possible cause of the crash, and we don’t want to feed or spark any speculation. The fact, however, is that this crash marks the second crash with a Boeing 737 MAX 8 in 5 months and since commercial service entry. For an industry that can normally pride itself with an impressive safety record, this is reason for concern. Currently, there is no reason to assume that there is a connection between the Lion Air flight that crashed a few months ago and the Ethiopian Airlines flight, other than that both accidents occurred shortly after take-off, both flight crews intended to return to their departure airport and both flights were carried out using brand new Boeing 737 MAX 8 aircraft. As some of you recall, I did an extensive coverage on the crash of the Lion Air flight JT610. I won’t be doing that for Ethiopian Airlines flight ET302 because there is very little insightful information at this time, and I found that the media coverage on the event has been less speculative in nature, which doesn’t require me to add some technical context.
The aircraft, a Boeing 737 MAX with registration ET-AVJ, was delivered to Ethiopian Airlines on the 15th of November, meaning that it was a little over 100 days old at the time of the crash.
While I do find the second crash with the Boeing 737 MAX to be at least concerning, I don’t want to speculate about any cause at this stage.
Boeing support and grounding
In the aftermath of the crash, Boeing has said it will send a technical team to aid the Ethiopian safety board and US NTSB, comprising of members from Boeing, the Federal Aviation Administration and General Electric (GE), as is common during crashes involving Boeing aircraft. A preliminary report should be filed a month after the crash but falls short of a report with conclusions, and it could take an even longer time before final reports with conclusions can be filed.
With the ET302 crash being the second crash in a matter of months, nine parties have decided to ground the Boeing 737 MAX 8 fleet. Keeping the safety of passengers in mind, that shouldn’t really be a surprise, and even as a Boeing investor, I think it is a decision that you should welcome for the sake of safety.
The following parties grounded the Boeing 737 MAX 8 fleet:
- Cayman Airways, which has 2 MAX 8 aircraft in operation and 2 MAX 8 aircraft on order.
- Ethiopian Airlines which grounded its fleet of 4 MAX 8 aircraft. The airline has 25 more MAX 8 aircraft aircraft on order.
- Comair, which has 1 MAX 8 aircraft in operation and 7 MAX 8 aircraft on order.
- Royal Air Maroc, which has 2 MAX 8 aircraft in operation and 2 MAX 8 aircraft on order.
- MIAT Mongolian Airlines, which has 1 MAX 8 aircraft in operation and 3 MAX 8 aircraft on order.
- Aeroméxico, which has 6 MAX 8 aircraft in operation and 54 MAX aircraft on order.
- Aerolíneas Argentinas, which has 5 MAX 8 aircraft in operation and 8 MAX aircraft on order.
- Civil Aviation Administration of China, which grounded the 96 Boeing 737 MAX 8s in China.
- Ministry of Transport of Indonesia, which grounded 11 Boeing 737 MAX 8 aircraft in Indonesia. Both carriers have unfilled orders for a total of 240 MAX jets, according to Boeing's books.
In total, 135 Boeing 737 MAX 8 aircraft are grounded, and the affected customers have over 800 aircraft on order with Boeing.
Obviously, the grounding in China and Indonesia is big news. The Chinese aircraft market is key to Boeing’s success, accounting for 1 out of every 4 aircraft delivered in 2018 and even slightly more when we only consider the single-aisle (Boeing 737 Next Generation and Boeing 737 MAX) deliveries.
The groundings are extremely painful for Boeing, as it has happened in two important markets that drive demand, but it is very understandable. There have been two fatal crashes in a matter of months, and the reality is that even without speculation, crashes for brand new aircraft in such short succession do raise eyebrows. Part of the grounding likely also has to do with trust in the aircraft type. The Boeing 737 MAX is the main future single aisle aircraft for many for many operators, and lost trust in the Boeing 737 almost equates to lost trust in the airline. What holds for China is that they go for a "better safe than sorry" approach. That is also understandable, since the Boeing 737 MAX is key to supporting demand on the domestic market in China. Airbus (OTCPK:EADSF) can’t support growth on its own, and the COMAC C919 is nowhere near service entry. Shortly after two crashes, China would want to ground the aircraft even if it's only for the confidence of passengers in the aircraft type not to be eroded even further.
Grounding in key markets
While the grounding in China is of temporary nature, the signal to Boeing is extremely strong. There is no trade angle to this, it is just a commonsense decision.
China is an extremely important market to all jet makers in the world. Boeing has projected that the country is good for 5,730 deliveries of single-aisle jets in the coming 20 years valued at $630 billion. To date, Boeing has delivered 1,089 Boeing 737 aircraft to the Chinese market, which includes Chinese lessors as well as airlines.
Table 1: Boeing 737 MAX 8 operators and MAX affected regions and airlines
(Author's note: Please follow the comment stream on this article, and my related Twitter Moment, for important updates to this developing story.)
What is important to keep in mind is that the pool of aircraft that is grounded is much lower than the total number of Boeing 737 deliveries, as only the Boeing 737 MAX 8 has been grounded. According to the company’s data, 76 Boeing 737 MAX aircraft have been delivered to Chinese customers. So that is the number of aircraft you’d expect to be grounded. However, western leasing companies also have leased some aircraft in China, and after a deeper dive, we found that currently 96 Boeing 737 MAX aircraft have been delivered in China, 11 in Indonesia and 23 to other airlines that decided to ground the MAX. So, the number of aircraft barred from revenue service is 135 units. To give you an idea, Southwest Airlines (LUV) has a fleet of over 750 aircraft. So the number of unfilled orders these customers have is roughly equal to the fleet size of Southwest Airlines.
Nevertheless, 117 aircraft is a lot, and what should be kept in mind is that Chinese airlines have disclosed unfilled orders for 341 more Boeing 737 MAX aircraft, with a significant portion of unidentified customers to be attributed to Chinese customers. So, Chinese customers account for >7% of the order book, which is significant considering that this percentage can only be higher when unidentified customers as well as aircraft leased to the Chinese airline industry are being considered. Those unfilled orders, according to our estimate, are worth between $15 billion and $20 billion. What can be seen is that all regions and airlines which have grounded the Boeing 737 MAX operate 135 aircraft and have over 600 aircraft on order valued at over $41 billion.
The grounding in two key markets is a significant step, with over 100 aircraft being grounded at present. Currently, it is expected that this is a temporary grounding, so that shouldn’t spell problems for Boeing. What would be more troubling is that if the company can’t convince airlines and regulatory bodies that the Boeing 737 MAX is safe, that these aircraft remain grounded - that could have far reaching implications for the Boeing 737. Admittedly, that is a worst-case scenario. In that scenario, the company wouldn’t be able to answer questions from regulatory administrations and the grounding of the aircraft could spread to other countries and continents. For a jet maker that has 4,661 Boeing 737 MAX aircraft in backlog and no meaningful backlog for the Boeing 737 Next Generation (which is the predecessor to the 737 MAX), a spread of groundings and increased duration of grounding could have far-reaching implications that would cripple the company to an extent that we haven’t seen since the Boeing 737 Next Generation entered service.
Completion center in China
One thing that is likely overlooked at this stage is that in the short term there might be an impact on the delivery stream. The Boeing 737 is assembled in Renton. Part of the aircraft are flown to China to undergo completion work. With the Boeing 737 MAX being grounded, it is unlikely that 737 MAX aircraft will be ferried to China for completion. Currently, I don’t expect the completion center in China to be at full rate for completion and delivery, so that is not a big deal. What is a bigger deal is that the longer the grounding takes, the more it might become visible at the Renton facility. It is likely too late to change the loading sequence for the aircraft, meaning that you might see aircraft destined for Chinese customers parked for the remainder of the grounding.
The grounding of the Boeing 737 MAX in China and Indonesia is a natural consequence of two fatal crashes with the Boeing 737 MAX in months. What is important to keep in mind is that the Boeing 737 MAX grounding only holds for the Boeing 737 MAX 8 - the Boeing 737 MAX 9 has not been in service in China and Indonesia and has also not been grounded, while the MAX 10, MAX 200 and MAX 7 are not yet in service. The Boeing 737-800, the predecessor of the Boeing 737 MAX 8, has not been grounded.
It is to be expected that for the duration of the grounding, no Boeing 737 MAX 8 aircraft will be flown to Boeing’s completion center in China and no aircraft will be delivered to Chinese customers. At present, we are not expecting huge adverse impact, but the longer the duration of the grounding continues, the higher the chance this is going to impact the company’s deliveries and confidence in the Boeing 737 MAX. The jet maker currently is in a spot where it must give convincing answers to the regulator that grounded the aircraft, and it is likely that other regulatory agencies will have questions for Boeing as well. If the company can’t provide timely explanation on the safety of the Boeing 737, it is likely going to increase the chances of other customers or regulators grounding the aircraft with a significant dent to the reputation of the aircraft, which already isn’t good with 2 hull losses on 350 deliveries.
I submitted this report shortly after midnight for publication, sharing my view that I expected Boeing shares to tank significantly in the Monday trading session and added the following:
This is a point where as a shareholder I’m supportive of decisions to ground the aircraft as safety should be of utmost importance and Boeing has some serious explanation to do on the safety record of the Boeing 737 MAX. Failure to provide clear explanation could be the start of a nightmare for Boeing given that the Boeing 737 MAX accounts for 80% of Boeing’s commercial airplanes backlog. We’re currently expecting that the grounding will be temporary, but it is needless to say that Boeing’s shares will tank on Monday and with their index weight it might drag the Dow Jones down as well. Maybe it is time to think about a stock-split and the launch of a new single-aisle aircraft development in favor of a Boeing 797 development.
As more news has been incoming (the grounding in Indonesia), I was requested to update the report. I have done the same for the share price performance. That Boeing was going to tank quite a bit was clear and that also did happen. Shares were trading down 9 to 11 percent in pre-market trading and are at -6% as of this writing. Roughly $25 per share has been wiped off Boeing's price, or $22.5 billion in market cap. Taking into account a ~22 price multiple, it suggests that $1 billion in future profits that had been factored in has dropped out. According to our insights into pricing, we can conclude that Boeing shares are currently valued as if 100 MAX 8 aircraft - roughly the number of the grounded jets in China - will not be delivered. With a backlog of over 4,600 aircraft for the MAX, this is relatively minor. Some investors may view this as a buying opportunity under the assumption that the grounding is temporary.
One thing I'd like to point out is that the initial reaction on aircraft accidents is always negative. As it often turns out that an accident is the result of a combination of factors coming together, share prices do recover. For Boeing, this will be a bit harder, since the Ethiopian accident marks the second fatal crash with the Boeing 737 MAX. While I am concerned about this, I do think the Boeing 737 MAX will return to service with all necessary modifications required, with a key role for the Federal Aviation Administration. At present, the share price has been going down, but the risk has undoubtedly gone up. So, I don't feel like the risk-reward profile has become more attractive versus Boeing trading at $400+ per share. My buying range would be $300-350 and with recovery from -11% to -6% - it remains to be seen whether that price point will be reached. Though not likely, investors should keep in mind that if the absolutely worst-case scenario unfolds, meaning that the Boeing 737 MAX can't return in service, Boeing shares are a strong sell. Why I don't deem this likely is because at the end of the day Boeing is a proven company that has thrived on engineering innovation for over 100 years, and it even managed to turn the Boeing 787 into a success - an aircraft that nobody ever expected to be profitable and that was even ascribed an early termination by some due to battery issues.
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Disclosure: I am/we are long BA, EADSF, GE. 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.