the_guitar_mann
In a recent report, I discussed the delivery flow and pace of The Boeing Company (NYSE:BA) 787. Even at a somewhat moderate delivery rate, it significantly increases revenues and will unlock fresh cash flows. All of those things will gradually become visible on Boeing's balance sheet. One area where Boeing has been lacking pace, though, is the inventory unwind of the Boeing 737 MAX, and the company is now making a big move to change that.
The Boeing 737 MAX Production Rate Hike Fell Through
Boeing 737 assembly line in Renton (The Boeing Company)
For the Boeing 737 MAX, investors and analysts have been watching two items in general. The first one is the ramp-up in production, and the second one is the inventory unwind. Starting with the production rate ramp-up, Boeing already had to tone down expectations. Widely it was anticipated that the U.S. jet maker would announce a step-up in 737 MAX production to 38 or even 42 aircraft per month, up from the current 31 aircraft per month. The move would add $6 billion to $7 billion in annualized revenue. However, as deliveries in China had not commenced, Boeing was forced to postpone its production hike and de-risked China from the production plan.
You can call it the China effect. China is currently holding the Boeing 737 MAX hostage against a backdrop of geopolitical tension with the U.S., first over trade and these days over Taiwan. Boeing initially anticipated deliveries to recommence in the first quarter this year. We are now 6-9 months later and very little has been achieved, apart from a few test flights, and there is no clear reason for MAX deliveries not having recommenced other than tension and concerns on future demand from China.
Boeing To Reassign Chinese MAX Orders To Other Customers
CFM LEAP 1B turbofans (GE Aviation)
Boeing's big move on China is that it will be assigning aircraft once destined for China to new customers. If you think about it, that decision, while not without risk, does make a lot of sense. Demand for new aircraft is there. Fuel prices are high and the newest batch of aircraft burn 15% less fuel than the previous generation aircraft, so renewing the fleet is almost a no-brainer at this point. That is also where Boeing runs into some issues. CFM, a joint venture between General Electric (GE) and Safran SA (OTCPK:SAFRF), is weeks behind on engine deliveries supporting the current rate. So, Boeing cannot just increase the rate to meet demand.
During the second quarter earnings call in July, CEO of The Boeing Company David Calhoun said the following when asked about a rate decision:
If I thought I had an engine supply, I'd do it today.
So, it is really about engines at this point. Airlines buy aircraft with a propulsion system, not gliders. The solution for that problem lies in the unfortunate fact that during the grounding of the Boeing 737 MAX, Boeing built around 450 Boeing 737 MAX aircraft. Leeham recently reported that Boeing would be swapping engines from inventory to newly built jets. It goes to show how big the challenges are to get the CFM LEAP 1B turbofans in Renton in time to be installed under the wings of the MAX. The aircraft that likely would have the engines removed would be the aircraft destined for China.
Boeing 737 MAX 8 (The Boeing Company)
Boeing has been waiting for months to recommence deliveries to the Chinese aviation market without much progress or a definite timeline on recommencing deliveries. So, removing the engines from jets destined for China to apply them to newly built aircraft makes sense. Boeing is now making a pretty bold next step by going ahead and remarketing jets that were built for China. Out of the 450 jets, slightly less than a third was destined for Chinese customers including lessors. The inventory currently is 290 aircraft, and around 120 are likely destined for Chinese airlines.
That also explains why the delivery flow from inventory did not ramp us as fast as hoped. Out of the pool of jets, there were always 120 aircraft that Boeing could not deliver since the MAX was not cleared in China. Interestingly, the 120 jets that are destined for China also match the annualized increase in MAX production had Boeing been able to continue increasing production. So, there is $6 billion to $7 billion locked because the production was not ramped up and another $6 billion to $7 billion in the inventories. Boeing has waited months to be able to deliver those jets to China and they have been patient in the process, but that patience wears out at some point. We are not at that point.
Boeing has tried not to harm the relation with its Chinese customers, but it is definitely fed up with China for slow-balling the MAX return in that country, and to some extent there most likely also exists frustration with the current and previous White House administration.
During the Morgan Stanley 10th Annual Laguna Conference, CFO of Boeing Brian West said the following:
So, right now, we are constantly communicating with our customers and the regulators and we stand ready. When they're ready to pick up where they left off to finish that work, we are ready. I can't dictate the timing from we they take on. But I won't tell you more broadly, we have deferred decisions on those planes for a long time. We can't defer that decision forever. So, we will begin to remarket some of those airplanes. They were otherwise earmarked for our Chinese customers. And we don't do that lightly.
It is pretty clear that Boeing's patience with China has waned significantly. They recognize what the tension between the U.S. and China does to their business and market position and they have been losing out on sales for months waiting for Chinese customers to come pick up the planes. In those months, Boeing has not been able to sell those jets. They are now moving away from that by remarketing a small number of jets to other customers. Without doubt it is a risky move, as it might infuriate China, but Boeing has shown patience. It didn't help them achieve their goal and they are now sending an extremely strong message to China: if you don't take those jets, we will find another customer who will. Initially the remarketing happens on a small number of aircraft to send the message, and if China remains immobile on MAX deliveries, more will follow.
Conclusion: Boeing Is Making The Right Move For Company And BA Stock
Boeing has shown patience for a long time, recognizing the importance of China to its business. However, that patience has brought them nothing, as the company is simply the victim of the current geopolitical landscape and lack of desire for a constructive solution. The U.S. jet maker previously decided to transfer engines from MAX aircraft inventory to newly built aircraft, and it is now going a big step further by remarketing aircraft that were built for China. Not all airlines are fond of taking delivery of aircraft built to the specs of other airlines, so that is why for some customers swapping engines to aircraft built to their standard rather than taking an already built plane makes sense. By now also remarketing a number of aircraft for Chinese customers, Boeing sends a message to the Chinese government while benefiting from demand for these aircraft.
For sure, it is a risky move by Boeing, but they cannot wait indefinitely for China while missing out on sales. While the move will infuriate China, purchase agreements allow Boeing to swap engines and other equipment to smooth their delivery flow and even remarket aircraft. So, this was a move that you could expect at some point.
