The nature of Boeing's business—and the company's strong position before two crises hit—give it a better shot at a turnaround than the free-fall in the company's results suggest.
It’s hard to think of any great enterprise that has fallen as far, as fast as the Boeing Company. Just over a year ago, the 104-year-old aircraft and defense manufacturer was ramping up deliveries on its signature product, the super-fuel-efficient 737 Max, a huge hit boasting 5,000 orders, and its earnings, sales, and margins were all headed for records. Wall Street was sold that Boeing had entered a new era of enduring profitability. In just three years, its stock had jumped 300% to over $400 per share. “Over the years, Boeing has established a lead in efficiency and margins over it sole major rival AirbusAirbus,” says Craig Fraser, an analyst for Fitch Ratings. “Then, Boeing went from the best to the worst of times overnight.”
The descent began in March of last year after a Max operated by Ethiopian Airlines crashed because of a software malfunction—the airliner’s second fatal disaster in six months—which brought the death toll to 346. The federal authorities ordered the Max grounded, and revenues from the plane that was supposed to be Boeing’s biggest revenue-and profit-spinner fell to virtually zero. In 2019, as its airline customers were enjoying the best year in their history, Boeing took a $4.9 billion charge for delaying deliveries of the Max and went from generating $8 billion in free cash flow in 2018 to burning $10 billion last year, one of the biggest sudden swings in the annals of manufacturing.
The Max crisis was already certain to undermine Boeing’s profitability and swell its debt at least into 2021 before the second catastrophe struck. Now the COVID-19 pandemic is hammering revenues of its airline customers by as much as 80%, forcing them to postpone, or in some cases cancel, their scheduled Max deliveries. In the best-case scenario, where the Max is ungrounded this summer, Boeing over the next couple of years will ship less than two-thirds of the huge volumes forecast before the onset of the pandemic. An estimated 50% of the world’s 26,000 commercial aircraft are parked out of service, a pullback that has savaged Boeing’s $17 billion services franchise that supplies parts and repairs for carriers. Jonathan Root of Moody’s Investor Service forecasts that Boeing will bleed $30 billion in cash flow in 2020 and end the year with over $60 billion in debt, four times the figure at the close of 2018.
The confluence of two hurricanes, and those scary numbers, have raised doubts about whether Boeing will survive. “Boeing is on the brink,” Bill Ackman, head of Pershing Square Capital, declared in a March TV interview. “Boeing will not survive without a government bailout.” Investors are harboring deep doubts about its future: Boeing’s share price has fallen almost 60% from its February 2019 high to $190, shedding over $130 billion in value. “The airlines are built for 2.5 million passengers a day, and now they’re getting fewer than 500,000,” says Joe Brancatelli, publisher of the business travel website JoeSentMe.com. “Without a profitable airline business, you’ll have no profitable airplane manufacturers.”
Even CEO David Calhoun, recruited as crisis manager in January, is presenting a rather dim view of the market for Boeing’s planes going forward, and by implication, its future. In recent interviews, Calhoun predicted that “most likely” a major airline will go bankrupt this year. He further stated that the carriers and manufacturers face a long, tough task assuring customers that air travel is safe again, and that because traffic will return so slowly, it may take Boeing tree to five years “to return to a growth rate similar to the past.”
It may sound remarkable, then, that fixed-income analysts from both Moody’s and Fitch view far clearer skies ahead than the free-fall in Boeing’s results suggest. That’s significant because fixed-income analysts focus not on stock prices but on a company’s ability to generate cash for servicing and repaying debt. Hence, their analysis is a lot more sober than the often bluebird forecasts from the Wall Street sell-side. To be sure, Fraser of Fitch and Root of Moody’s see significant threats to a Boeing comeback, notably a second wave of COVID-19 that could further delay the Max and wide-body deliveries Boeing needs to produce cash, and still another FAA extension of the ban grounding its most-ordered model. They’re also concerned that the airlines’ first priority even in the recovery will be towards paying down debt, not buying new planes.
Their outlooks rest on their “what if” scenarios incorporating their most likely forecasts of a number of factors, headed by how long it takes for traffic return to 2019 levels. Fraser thinks that air travel gradually climbs back to its pre-COVID levels sometime in 2022, while Root believes the round trip will drag until 2023.
Neither Root nor Fraser think that Boeing can return to its pre-2019 glory for several years to come. But they do predict that a comeback on that scale can happen eventually, and that by 2021, Boeing will be generating sufficient free cash flow to begin trimming its gigantic debt. Both cite a number of factors pointing to a slow recovery: Boeing’s ability to harvest lots of cash in anything approaching normal times; the airlines’ need to replace high numbers of planes, driven by both their fleets’ advancing age and environmental regulations; and the manufacturer’s strong liquidity, reserves built on successful bond offerings displaying investors’ continued willingness to extend it credit.
Most of all, Boeing shares with Airbus a duopoly in a gigantic business that at some point will return to robust growth. Its biggest single advantage: Boeing is still positioned to capture at least half of orders for commercial airplanes for decades to come, and despite today’s freeze, those orders are destined to rise in lock-step with the world’s middle class.
Let’s examine the six strengths that can power Boeing through the storm.
The twin blows wrecked what was looking like a great 2020. “If the pandemic and Max crisis hadn’t happened, Boeing would have posted $112 billion in revenue and $13 billion in free cash flow, meaning $17 billion before paying dividends,” says Root. “The world will not go back to the time before those two events, but where Boeing was headed shows its potential when demand returns and the indigestion from those two events is over.”
Now, Root is predicting sales of $71.2 billion in 2020 and $81 billion in 2021, still 20% below peak 2018 levels. Nevertheless, he sees free cash flow rising to around a total of $10 billion in 2021 and 2022. In 2022, that’s about what Boeing would have generated if the Max meltdown and the pandemic hadn’t struck. Though Boeing won’t be its old self, that would show Boeing’s ability to repay debt, and mark a flight path to recovery.
Here’s why it’s possible. The forecast assumes that the FAA will approve the Max for deliveries in the the third quarter of this year, as Boeing expects. The company has over 450 of the completed jets in inventory. It has already put out all of the cash to make those planes, but collects the vast bulk of the price only when it delivers. Hence, even though those deliveries will be much slower than expected, they’ll be highly lucrative. In addition, Boeing benefits from a stabilizing force: its steady defense and aerospace business that in normally accounts for one-third of its revenues. It is lead contractor on a number of important programs, including the MQ-25 Stingray refueling drones and MH-139 helicopter. The last year contributed $2.6 billion in operating profits and holds a $64 billion backlog, second only to Lockheed Martin.
Fraser notes that Boeing’s cost-efficiency bodes well for its longer-term profitability, citing that it assembles all of its Maxes in a single location, a 1.1-million-square-foot mega-factory in Renton, Wash. “They can dramatically increase production in that facility on that one footprint,” he says. That model contrasts with Airbus’s costlier process of assembling its bestselling A320 at a number of facilities across the world.
In the good times Boeing held only modest amounts of debt, a posture that’s paying off today as it borrows heavily to weather the turbulence. At the close of 2018, its long-term borrowings totaled just $13.8 billion. Fortunately, Boeing’s past prudence has aided in securing lots of emergency cash at reasonable rates. It drew down the full amount of a $13.8 billion, 18-month bank loan in early March and in late April floated a $25 billion bond offering with maturities of up to 40 years; the 10-year tranche carried a rate of 5.15%. Today, its long-term debt stands in the $50 billion range, and according to Fraser, could reach $60 billion by year-end.
The fresh liquidity will easily cover Boeing’s expected cash burn of $30 billion in 2020. At the close of Q4, it should still have a cushion of around $20 billion in cash. Boeing has suspended its regular annual dividend of around $4 billion, and all share repurchases, for “several years.” It plans to deploy the entirety of its free cash flow, once again, expected to hit around $6 billion to $7 billion a year in 2021 and 2022, as well as excess cash, to whittle down that mountain of debt—an essential step to staging a comeback. In 2021, Fraser predicts that if the Max returns to service this year, and without a second wave of COVID-19, Boeing could get off to a fast start by repaying $10 to $15 billion in debt.
In its commercial aviation segment, comprising some 40% of sales in good years, Boeing’s big product is the 737 Max. It accounts for 72% of current orders, versus 16% for its wide-body 767s and 777s. The Max models offer 138 to 204 seats, and the jetliner can fly up to 3,000 miles. Its introduction—first orders came in 2011—fit well with the industry’s shift to narrow-body aircraft serving busy urban routes. But its marquee appeal was energy savings: The Max uses one-fifth less jet fuel per passenger than previous 737 versions. The Max’s sole rival is Airbus’ also super-efficient 320neo family. Boeing’s woes has helped the 320neo surpass it total orders, but that the American manufacturer’s backlog remains so big is a testament to the power of the duopoly.
It’s also shows that despite its tarnished public image, the Max is still popular with customers. “There are a lot of misperceptions about the Max,” says Fraser. “The airlines and lessors have a favorable view compared with the general public.” He notes that the jet was in service for 18 months before the first crash and flew an estimated 200,000 to 250,000 times. “The airlines we spoke to say that it delivers, and that the fuel efficiency lived up to what Boeing promised,” says Fraser.
In fact, the vast majority of customers are convinced the safety issues will be corrected and are sticking with the Max. The overriding problem is deferrals, not cancellations. Here are the numbers. Of the 5,005 orders at the peak, Boeing delivered 387 planes from 2017 to early 2019. Last year, airlines scotched 183 orders, followed by 313 more this year, for a total of 496 airplanes. Cancellations continue, but the rate is falling fast: In May, just 14 Maxes got scratched. All told, Boeing’s retained 90% of the 5,000-plus original orders.
Unless the trend reverses, a real possibility if a second wave hammers air travel, Boeing can count on delivering on the order of 4,000-plus Maxes over the next five to six years. The problem is timing. According to Root of Moody’s, Boeing would most likely have shipped 2,600 Maxes for 2020 through 2023 if COVID-19 and the crashes hadn’t happened. Now, he projects that over those four years, it will deliver 1,400 of the jetliners, 45% fewer. Even that lower number would allow Boeing to meet a target of generating several billion dollars in free cash flow, and repaying around $10 billion in debt, in 2021 and 2022. “What’s overlooked is that they still have a big backlog that should sustain them over the next five to six years,” says Fraser.
Fortunately for Boeing, while the immediate outlook for air travel is horrendous, past trends—and especially the explosion of the middle class in Asia—point to a promising future. “When travel returns to 2019 levels in around three years, the industry will need as many planes as it was flying in 2019,” says Root. From there, the experience following 9/11 suggests the flight time to full recovery. It took until July of 2004, just shy of three years, for traffic to regain the records set just before the terrorist attack.
If that scenario plays out, the drop in air travel will prove temporary, and the trends in place prior to the pandemic will return following two to three year lag. To review those trends, it’s instructive to consult Boeing’s annual surveys forecasting the future course of air travel and demand for new planes, titled Commercial Market Outlook reports. The most recent was published in early 2020 before the COVID-19 outbreak, and the next one will surely downsize forecasts for the next couple of years. But the projections are a guide to what’s the most probable arc when traffic returns to 2019 norms. In other words, imagine that the annual trends forecast from 2020 onward—once again, driven by global demographics—extend instead from 2022 or 2023 into the future.
That most recent CMO projected that air travel would be two-and-a-half times larger in 2038 than in 2019, and that traffic would grow on average 4.1% a year, with Asia setting by far the fastest pace. Though that rise will now start a lot later, the best bet is that it still happens. Push back that timetable by three years. In that case, planes in service would almost double, to 51,000, it would simply take until 18 years instead of 15 years. Of those, only 6,600 would be jets flying today. Airlines and lessors would need to purchase, and the likes of Airbus and Boeing would need to supply, 44,000 new planes. Of those, 12,600 would go to China and Southeast Asia. Even with the three years downdraft, that’s an annual growth rate in deliveries of new planes of over 3% a year.
Of course, with all those thousands of jetliners now parked in the desert and airlines’ capital budgets under stress, it could appear that the airlines would simply keep fixing and flying aging planes. Not so, say Fraser and Root. Keep in mind that over 50% of the new planes will be needed to satisfy growing demand for seats. Plus, airlines need to replace old planes. “The planes typically fly for 20 to 25 years, then have to be retired,” says Root. “Airlines can’t let their fleets keep aging overall,” says Fraser. “They need to spread out maturities. Many of the older planes will be parked permanently.”
A major reason the fleets will be upgraded: The new generations of planes are far more fuel-efficient than the old ones. Jet fuel typically accounts for about one-quarter of airlines’ costs. For the airlines, purchasing new models that shave that burden by 20% per passenger flown is a must in keeping fares competitive.
Fraser and Root note that the airlines have a strong commitment to lowering emissions. “ESG is a really big issue in the aviation sector,” says Fraser. “If coronavirus had not reared its head, it would be a top topic today. And the biggest issue in ESG is protecting the environment.”
As they point out, the industry’s been branded, rightly or wrongly, as a big polluter and wants to fix that perception. All of the U.S. airlines have agreed to accord formed by the United Nation’s International Civil Aviation Organization that caps emissions at 2020 levels even as air travel expands rapidly, and requires 2.5% annual increases in fuel efficiency. If carriers don’t meet the baseline, they’ll have to purchases carbon offsets, equivalent to a tax. “These potential environmental requirements will lever the airlines to operate new planes with higher levels of fuel economy sooner rather than later. The environmental issues will help Boeing sell more planes,” says Root. He adds that they’ll shun the other option: sticking with aging fleets and attempting to pass the penalties on in higher fares that could cost market share.
For years, Boeing and Airbus have been splitting orders for new jets about evenly. Although the Brazilians, Canadians, and Chinese make regional jets, the two titans dominate the narrow and wide-body markets for larger planes required for the busiest routes. That’s unlikely to change. So the big growth that’s probably still in the cards, albeit delayed for a couple of years, will almost all go to the two titans. Despite Boeing’s pressing problems, it co-dominates a huge global business with growth prospects that few manufacturing sectors can match. “Put simply, Boeing’s biggest ticket to a comeback is that it’s one player in a duopoly,” says Root. Its woes are now severe and potentially threatening, and the timing of its revival is uncertain. What Boeing can bank on is the longstanding aircraft duopoly will endure.
