China May Use Boeing In Its Asymmetrical Trade Warfare

About: The Boeing Company (BA)
by: Markos Kaminis

The trade war between the United States and China has recently expanded to include asymmetric weaponry, including penalizing companies.

Boeing carries risk exposure to China trade policy in my view.

I expect the stock to continue to have a cap on its upside potential while facing significant further downside risk near-term.

The trade war between the United States and China has taken an ugly turn to include the blacklisting of companies with significant sovereign exposure. I believe Boeing (BA) could be on China's short list of target companies. I expect any disruption of Boeing's business in China would significantly impact the stock. Boeing shares have underperformed the market since my late-March sell recommendation. The stock has been weighed down by the ongoing probe into its 737 Max aircraft troubles and global economic concerns. The company's China-specific exposure is an additional concern adding to risk near-term.

Chart Data by YCharts

Boeing shares are down roughly 4%, including adjustment for dividends, since my "Sell" recommendation on March 26, 2019 and through June 7, 2019. That compares to the 2.1% increase in the Vanguard Total Stock Market ETF (VTI) through the same holding period. But I still see further downside risk for Boeing shares because of risks outlined in my prior report and because of special exposure to China trade policy.

Asymmetric Trade Warfare Includes the Targeting of Companies

The United States has condemned Huawei Technologies, banning U.S. firms from sharing technologies with the China-based company. The argument against working with Huawei is that it is a national security threat to the United States, but the firm's executives think it is being targeted because of the trade war between the U.S. and China.

Whatever the case, a second salvo has been cast back in the direction of the U.S. China just labeled FedEx (FDX) as an "unreliable" operator within its borders because of suspect redirected deliveries of certain packages. FedEx is under investigation, and I think it is simply part of the escalation of the trade war between the two countries. Last Wednesday, China fined a Ford (F) venture a small sum for an antitrust violation. This asymmetrical trade warfare is something I have warned about before, but it only recently became a viable factor and active threat to specific stocks. So where else might this lead and what other companies' shares might be in the line of fire?

Boeing's China Exposure is on Multiple Fronts

Boeing has multiple risks because of its important dealings with China and the rest of the world. Within Boeing's annual report for 2018 you'll find its risk factors, or those most foreseeable. Among the pitfalls, we find Boeing's significant international business risk. The report states:

"We derive a significant portion of our revenues from non-U.S. sales and are subject to the risks of doing business in other countries."

Boeing's total risk exposure to China is significant. However, the relationship between Boeing and China is mutually beneficial. One-fourth of Boeing's production line is delivered to Chinese customers. More than 50% of the Chinese fleet is comprised of Boeing airplanes. Boeing estimates China needs $1.2 trillion worth of new airplanes over the next 20 years. China plays a component role in in every current Boeing aircraft model. But, China also has a budding aircraft maker, the Commercial Aircraft Corporation of China, Ltd. (Comac), so perhaps reason enough for the communist country to opportunely penalize Comac's American competitor and industry leader now and blame it on the trade war. China may already be doing as much.

Last Wednesday, we learned that the largest aircraft order in Boeing's history may be held up because of soured trade negotiations between the U.S. and China. Bloomberg reported that Boeing is in negotiations with Chinese airlines for the order of some 100 large wide-bodied jets including Boeing's 787 Dreamliner and its latest aircraft, the 777X (and 777-9). However, the completion of the deal is apparently awaiting the approval of the Chinese government.

Unfortunately for Boeing holders, I think this may be indicative of something more. If China were preparing some sort of punitive action or restriction against Boeing, it would not likely approve such a large order simultaneously. Or perhaps China is simply teasing us with the carrot of a large order that the company will only benefit from if a trade deal is struck between the two countries. This opinion of mine is based on my mosaic analysis of currently available information, but it is just a theory on my part. I believe it serves China's trade interests to let it be known that the American manufacturer is at risk of losing a significant order to a foreign competitor because of the trade war.

Another Sour Scenario for Boeing and China

I do not expect China regulators to approve the Boeing 737 Max aircraft for flight when the U.S. Federal Aviation Administration (FAA) does. In fact, I would go so far as to say that I expect many of the world's regulators to lag the FAA in the clearing of the 737 Max for flight again. Or perhaps a coordinated global clearance of the aircraft for its return to flight will be delayed. Some of the reasoning for this may be because of the FAA's prior delay in grounding the aircraft after two similar crashes within months of one another. But some of the reasoning may simply be to penalize the United States for the aggressive trade dealings of its President. Boeing derived 56% of its revenues in 2018 from non-U.S. customers, so the company's shares should factor risk relative to souring sovereign relationships.

Risk of Permanent Damage to Relationships

Furthermore, the long-term operations of Boeing and other American multinationals may face permanent damage because of the protectionist policy, or at least protectionist posturing, of the American president. I am all for stopping some of our clever adversaries from breaking rules and forming a better moral code, but sometimes it makes sense to make a less than best deal for the sake of amicable long-term relations with our global neighbors. And when we get the great deals the President expects it would serve us well to show some cordiality while putting the pen to paper.

Viable Event Risk to Boeing

If Boeing is singled out by China as an "unreliable operator" within its borders and penalized in some significant manner, which is perfectly possible considering recent events, then the stock could see an abrupt drop. China might do this because of Boeing's significant weighting in the Dow Jones Industrials Average, and so, its ability to possibly impact the broader stock market. Given the importance of stock market performance to the president, and to the economy, it's a relevant possibility. Otherwise, recent economic data softening and economic uncertainty continue to weigh against the stock, as does the yet unresolved 737 Max situation. Risks to this thesis exist, given the likelihood of an eventual clearing of the aircraft for a return to flight, and with trade policy being so fluid. However, given recent escalation in the trade conflict and the inclusion of asymmetric warfare in trade negotiations, with the targeting of specific company operations, I see the risks to the downside weightier for Boeing shares.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.