Why The Boeing Scandal Matters to All Investors
Today, I turn my attention to Boeing (NYSE: BA), a mega-cap component of the Dow Jones Industrial Average. The plane maker is a bellwether for not just aerospace/defense but also for the American industrial sector. And Boeing is deeply troubled.
The company’s problems are a reminder that “black swans” can plague a company, sector or market at any time. And by their nature, black swans are complete surprises.
Scandal currently bedevils Boeing’s best-selling product, the 737 MAX airliner. The 737 MAX represents, by far, the single largest U.S. export product. Boeing is the world’s largest maker of planes for the military and commercial sectors and it’s America’s largest manufacturing exporter.
Boeing is a case study of how unfolding trends in the trade, regulatory and economic realms are affecting the financial markets…for the worse. Let’s take a look.
A bygone era…
William Boeing. Jack Northrop. Leroy Grumman. Donald Douglas. Glenn Martin. Howard Hughes. There was a time when the logos of aviation firms boasted a single last name. These individuals were visionaries, typically engineers or pilots, who exerted God-like control over their enterprises.
Sure, they were capitalists and they were out to make money, lots of money, but their true passion was to create aircraft that flew higher, faster, farther, and better. For them, pushing the performance envelope, not fattening the pay envelope, was Job One.
Now that our post-industrial society is in a new century, you won’t find many of the aviation industry’s managerial elite on the shop floor, wielding wrenches and getting their hands dirty. The closest they get to anything aerodynamic is a pair of wingtip shoes. Their main concern: shareholder returns. But ironically, this myopic mindset can eventually hurt the stock, as we’re seeing with Boeing.
Boeing’s 737 MAX airliner is the subject of withering scrutiny. Two separate crashes in 2018 and 2019 of the plane killed hundreds of passengers, which is bad enough, but then revelations surfaced that the aerospace giant knew in advance and lied about safety flaws with the aircraft.
Internal correspondence at Boeing, leaked to the media this month, uncovered a corrosive culture in which executives cruelly mocked customers, passengers and regulators.
The 737 has been a popular workhorse with airline fleets around the world. The aircraft is currently grounded by the U.S. Federal Aviation Administration (FAA) and Boeing has halted production. The FAA is being roundly criticized for taking a hands-off approach to regulating Boeing and letting the company largely police itself.
As the following stock price chart shows, shares of Boeing are on the downward slope and probably have further to fall. Over the past 12 months, the S&P 500 has risen 25.8% whereas Boeing has fallen 13.8% (as of market close Wednesday).
The Dow has surpassed the milestone of 29,000, but weighing on the index has been component Boeing, whose fortunes have gone from bad to worse.
Aviation analysts on Wednesday estimated that the 737’s woes are likely to cost Boeing a whopping $25 billion, in compensation for airline customers and in additional production costs.
Boeing’s new CEO Dave Calhoun told reporters yesterday that the company plans to resume 737 MAX production months before its forecasted mid-year return to service, but industry watchers are skeptical.
If your portfolio doesn’t have exposure to aerospace/defense stocks, why should you care about my topic for today? Because the sector is a multi-trillion-dollar generator of shareholder profits and jobs around the world. As with the energy sector, aerospace/defense exerts an outsized influence on national economies and markets.
The U.S. defense budget represents about 40% of the total global defense budget. The U.S. comes in at number one in defense outlays, exceeding $600 billion last year. Spending is projected to remain on an upward trajectory until at least 2027 (see chart).
Boeing stands to lose a big chunk of the defense pie to competitors. Some analysts think the U.S.-China “phase one” trade deal will save Boeing. I disagree.
The phase one trade deal, signed January 15 by the U.S. and China, does nothing to address structural problems in bilateral trade, especially in aviation.
As part of the deal, China pledges to buy an additional $35 billion in U.S. manufactured products in 2020 and $45 billion next year. Jetliners are the largest U.S. manufactured export to China, so we can expect Boeing to soon announce, with great fanfare, a major Chinese aircraft purchase. But there’s less here than meets the eye.
For starters, when Chinese airlines order jets, they must first obtain final approval from the central government before going public with these orders. By insisting on this process, the Chinese government claims credit for expertly managing the economy. Beijing also gets to use these aircraft orders as bargaining chips in trade negotiations.
Boeing currently has 931 backlogged airliner orders on its books designated for “unidentified customers.” Aviation insiders say that many of these aircraft already are pegged for Chinese customers.
So here’s what I predict will happen: the Chinese government will announce impressive sounding aircraft orders from Boeing, but many (if not all) of them will merely entail formal approvals for orders that were already in the pipeline. In other words, the aviation component of “phase one” is largely smoke-and-mirrors.
Then there’s the dilemma of the 737 MAX. The Chinese aircraft market is largely comprised of single-aisle jets, which represent around 85% of Chinese airline demand. Indeed, of those 931 Boeing orders for undisclosed customers, 867 are for the 737.
However, Boeing’s sole single-aisle product is the 737 MAX, which remains grounded due to the safety scandal. And finally, overall demand for aircraft has slowed in China, as travel in that country enters a slump. China can only use a diminishing number of planes to begin with.
The upshot: Boeing’s problems will only get worse in the coming months, which in turn will plague the DJIA and the overall American manufacturing sector. These interrelated weaknesses represent a crack in the U.S. economy that could widen.
Manufacturing activity has slowed in economies around the world and the trade war really hasn’t ended. The grim situation with Boeing could be a harbinger of what’s to come in the broader stock market.
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John Persinos is the managing editor of Investing Daily. Send questions or comments to: firstname.lastname@example.org