Boeing (NYSE:BA), the world’s largest plane-maker, is reeling from one of the worst crises of its history, triggered by two fatal crashes involving its most promising plane, 737 Max. This narrow-body aircraft was the aerospace giant’s safest bet to grow in a tightly fought battle with its competitors.
But after the two crashes during the past five months that led to a global grounding of the plane and initiation of many inquiries against the Boeing’s safety practices, this growth journey has come to a screeching halt. Boeing’s long-term investors are trying to figure out the extent of the damage to the company’s reputation and its financial outlook.
The stakes are too high for both Boeing and for the U.S. economy. The 737, which first entered service in the late 1960s, is the aviation industry’s best-selling model and Boeing’s top earner. The re-engineered Max version was so successful that it brought more than 5,000 orders worth more than $600 billion, including planes that have already been delivered, according to Bloomberg data.
Deposits from 737 MAX orders helped boost Boeing’s revenue above $100 billion for the first time last year. That drove the Chicago-based company’s market cap over $250 billion before the Ethiopian Airline crash on March 10, the second after October’s fatal incident that also involved Max 737, operated by Indonesia’s Lion Air.
The 737 Max is Boeing's largest contributor of product revenue and earnings before interest and taxes (EBIT), according to Goldman Sachs estimates, with a potential to make up for 45% of Boeing’s EBIT over the next five years.
Boeing’s China Risk
China, which made up about 20% of Max deliveries worldwide through January, is considering excluding the Max jet from a list of American exports it would buy as part of a trade deal with the U.S., according to a report by Bloomberg. If this move materializes, followed by other countries and airlines, it might hurt Boeing's cash flows and push back its growth plan for years.
Though analysts are divided over the short and long-term impact that Boeing will face due to the Max crisis, it’s not hard to see that 2019 will be a tough year for Boeing and that most of it will be consumed by damage control. According to Credit Suisse, a combination of negative developments may hurt Boeing’s cash flows by $3.7 billion this year, or about a quarter of the cash flow forecast by the bank.
Analysts at Edward Jones, while downgrading Boeing stock, said in a note that the two accidents may result in additional costs and some delays in Max orders, pushing Boeing earnings lower.
“Longer-term, we believe the outlook is balanced by the backlog of other planes (such as the 787), recent defense program wins, and the expansion of the services business... Overall, we believe shares are appropriately valued for long-term investors,” Edward Jones analyst Jeff Windau said in a note to investors.
Boeing shares, which were up 33% in 2019 before the March 10 crash, have lost about 11% since then, reflecting the investors’ nervousness and uncertainty about the potential revenue impact of these two incidents. The shares have risen 1% over the past two sessions to close yesterday at $376.16.
In our view, there is no way Boeing can escape the short-term damage to its business in the shape of cancelled orders, production disruptions and the cost associated with the fixing of software problems. This human tragedy struck Boeing at a time when its stock wasn’t cheap. The company saw its market cap surging from under $100 billion in 2016 to $211 billion today. Its stock still trades at about 21 times earnings after the recent pullback. That valuation is in line with its average forward P/E ratio over the past five years.
Going forward, we expect Boeing shares will remain under pressure as more information becomes available about the extent of the financial cost to the company, as well as the potential negative outcome of the many regulatory probes now being conducted.
Bottom Line
There is no doubt that Boeing stock will recover from this crisis over the long run. Airlines have no alternative but to pick one from the Boeing-Airbus plane-maker duopoly. That’s the reason that Boeing stock is still up more than 18% this year, showing Wall Street's strong faith in the company’s long-term competitive advantage. This bearish spell, however, won’t end anytime soon for Boeing. The time to take advantage of its share weakness has not yet arrived.