Boeing (NYSE:BA) expected to deliver 500 737s in 2022. This was cut to 440. With the lack of engines, it will probably be in the mid-300s. The loss of profit from this approximately 150 737 aircraft makes Boeing a sell.
CFM, a 50-50 joint venture owned by GE (GE) and Safran (OTCPK:SAFRF) (OTCPK:SAFRY), a French aerospace company, builds the LEAP engine. Jet engines are sold at a loss, with the knowledge that as the airliners age, the engine manufacturer can sell parts at high margins. Pratt & Whitney planned to reestablish itself in the single-aisle airliner market. It made a huge investment turn bring out its new geared turbofan engines. CFM responded with the Leap engine. CFM also slashed the prices on these engines to discourage Pratt & Whitney. It was a foolish move because Pratt & Whitney had made a massive investment and it was not going to be deterred. The LEAP engine entered the market in 2008; it has yet to become profitable because of the low prices. Between 2016 and 2022 CFM cut 44% of the cost out of LEAP. The current plan is a cost reduction of more than 15% in variable costs by 2025. CFM is tired of losing money on this engine and it is willing to take the risk of production disruption. They changed the manufacturing process and their design with the objectives of achieving breakeven and the capability of making more than 2000 engines per year in 2025.
In 2019, CFM produced more than 2100 single-aisle engines, 1736 of which were LEAPs. In the first six months of 2022, it produced only 465 engines - 44% of the production of 2019. Neither Boeing nor Airbus (OTCPK:EADSY) is getting an adequate supply of engines. Production delays can be caused by the manufacturer, redesigned parts, or by the disruption of the workforce laid off during the pandemic, or a combination of the above. There is black art to making many of the exotic engine parts. Neither the engine nor aircraft manufacturers have given a public schedule for fixing these issues. It is unlikely that the disruptions will be fixed until sometime in 2023.
Boeing has begun removing engines from inventory aircraft and moving them to the production line. This is quite expensive. Boeing has produced about thirty sets of counterweights to replace the engines of the inventory aircraft. The concept is they will replace the engines at a later date. If Boeing could bring the inventory up to specification that would obviously be the cheapest solution. But they can't convert inventory planes to meet specifications in a reasonable time frame.
If the inventory awaiting conversion to the current specifications is so slow and expensive to upgrade, then what is the real value of these aircraft? It was expected that today's aircraft could be converted quickly and provide money to pay down debt. The slow conversion raises questions about the value of that inventory and the need to write down this inventory.
The table below contains the deliveries made in July and August. I assumed that 737 deliveries in September would be equal to those in August. This would require taking engines from inventoried aircraft. The total aircraft delivered in September would be 35 aircraft. This puts the quarterly deliveries at the same level as the weak first quarter.
The three quarters illustrate the low level of 737 deliveries. Total deliveries of the 737 were 266 aircraft.
|September Year to Date Production|
Total deliveries for the year would be about 420 which is a very big disappointment. Boeing CFO Brian West in June said that supply chain issues would cut the expected 500 737 delivers to the low 400s. In three quarters, deliveries are only 266. Boeing plans to produce detailed financial plans for the remainder of 2022 and 2023 in November. Hopefully, management will address these issues.
In the partial month of August, Boeing delivered two airplanes and took two aircraft that could have been delivered to make customer-requested changes. The production rate is planned to go from one per month before deliveries resumed to 5 a month by the end of 2023. Boeing believes that the bulk of the 118 inventoried 787s will be delivered by year-end 2023. However, some planes are going to be more difficult to upgrade so there could be a large number of 787s undelivered until 2024. Assuming that 20 787s are delivered this year, revenue would be $2.8 billion. Delivering 70 planes in 2023 would produce $10 billion of revenue. The 787 will provide a cushion for recovery issues.
Boeing is working on the certification of 737 dash 7 and dash 10. Changes are required by law to both models if they are not certified by year-end. This would mean that these models will not be directly compatible to the rest of the product line requiring additional pilot training. Both models have been delayed in working on FAA certification far longer than the law anticipated. Boeing's approach is to continue certification and, if it is not available by year-end, to require a change to the law, or more likely, FAA ruling that year-end is not required.
The fixed price contracts that Boeing entered before the pandemic have resulted in large overruns. Boeing is taking the position that a long-term future justifies continuing with these contracts. It is possible that there will be further write-offs on these contracts.
737 engine delays could be fixed earlier than 2023 which would improve profitability.
Boeing lost $1.73 per share in the first half of 2022, so a P/E ratio doesn't make sense. The value of the business is currently the expectation that it will return to its prior profitability in the future. This makes uncertainty a destroyer of stock price. The 737 normally makes up about 80% of deliveries. The inability to upgrade inventory 737 is a major problem. The lack of engines for the newbuild 737 is another unknown. Disappointing results may bring it back to where it was before the resumption of 787 deliveries. This is a price 30% below the S&P 500 index. This is a 10% drop, but this is uncertain because Boeing's prospects are so uncertain. There could be more downside.
These issues and other problems lower the value of Boeing stock. The company still expects to be cash positive for 2022. This should give the ability to avoid additional long-term loans or equity. The engine problems will make 2022 less profitable than they anticipated at the present time. The company's valuation will be impacted by the engine problem uncertainty. I would anticipate that Boeing stock will go from 20% below the S&P 500 back to 30% below. Should they have a strong 2023, the stock will be worth far more. At present, it is a sell.
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