Aviation Week Network's Joe Anselmo sits down with AeroDynamic Advisory's Richard Aboulafia, Aviation Week's Michael Bruno and Bank of America's Ron Epstein to discuss aerospace suppliers and investors—and what the new MAX woes could mean for their businesses.

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Transcript

Joe Anselmo:

Welcome to Aviation Week's Check 6 Podcast, coming to you this week from our A&D Supply Chain Conference in Los Angeles, California. I'm Joe Anselmo, Editorial Director, and I have here three of our regulars at this event on Check 6. Michael Bruno, our Executive Editor for Business, Ron Epstein from Bank of America, and Richard Aboulafia from Aerodynamic Advisory. Michael, let's jump right into this. Set the stage, what is everyone talking about here this year?

Michael Bruno:

Whenever we do conferences, there's always a fear we're not going to have enough to talk about and we have the exact opposite problem this year at the Aviation Week Supply Chain Conference. We started the day talking about Boeing, and we ended today talking about Boeing, and we're going to be talking about Boeing tomorrow. We, of course, will be talking about the ramifications and the consequences for the supply chain and a lot to unpack there.

But if I would have to sum up what we're hearing so far in the conference, I think it's Boeing, especially with the new FAA announcement about rates getting frozen, Boeing's in a pickle, and that pickle involves everybody else in the supply chain and nobody's quite sure how to get out of this pickle. It's a culture thing, it's a leadership thing, it's a quality control thing, it's a supplier management thing. The list goes on and on. So a lot there to unpack.

The other thing to talk about are what's happening in the supply chain, not just the ramifications for Boeing itself, but we have a supply chain that's still really struggling, especially with the labor, to try to recover from the effects of the pandemic. We had a whole lot of people leave the supplier base labor force and replacing them and getting that workforce up to the skill level that maybe we once enjoyed last decade looks to be like it's going to be an out year project and there's problems in the meantime. And you see it everywhere from problems at Spirit AeroSystems last year to just people continuing to talk about problems at other little suppliers around the supply chain. So whole lot to unpack still.

Joe Anselmo:

And as Michael said, we had a bombshell drop this afternoon back in Washington, DC. The FAA has said Boeing cannot increase MAZ production rates, they put a lid on that. Ron, what are the financial ramifications of that?

Ron Epstein:

Yeah, I think they said it's not going to be business as usual, right? They're pretty strong in their statement. So when you think about production rates, they essentially have two factories going, right? And there's aircraft coming out of inventory, and then there's aircraft coming off the line. They're at 32 per month today. If we understand what the FAA has said, they'll be stuck at that level for a while. And the FAA also said they can't start any new production lines, that means the facility up in Everett won't open and that was key to getting to higher rates. So that just suggests everything gets pushed to the right. When we model 737s, nominally a $50 million airplane with 20% cash margins, that's ballpark $10 million an airplane. And then on top of it, those delays will have penalties associated with them. We haven't worked through that math yet, but that's probably a number that's going to be bigger than just the impact of the slipped deliveries. And then finally, what's this all mean for Boeing's customers? Yet another hit to their reputation. And then what happens? Do you start to see some airlines doing other things to get lift because they need the lift?

Joe Anselmo:

And Michael, we were talking just before this podcast about their rates. They were aiming to go to 50 by 2025, but it wasn't clear yet what they wanted to do this year, is that correct?

Michael Bruno:

Yeah, we were waiting for the big announcement. January 31st is when Boeing is scheduled to have its quarterly update, and of course, look ahead to any kind of forecast projections they would offer. And we were waiting to hear whatever forecast they would give for 2024. We knew they said 50 MAXs by 2025 was the goal. There had been some leaked news last fall that perhaps they were going to try to get to 45 as soon as the middle of this year if possible, but that was never confirmed from Boeing, so we didn't know that officially. Now all we know is that rates have been frozen.

Joe Anselmo:

Richard, you were pretty unsparing on the opening panel today about Boeing, and you think there needs to be a change in Boeing's leadership ranks.

Richard Aboulafia:

I'm shocked if there's any debate in anyone's mind at this point. I mean, it's been years of this, it's an extraordinary low level of performance. And the only questions I'm getting from people is, "Well, do you think there's anything that Dave Calhoun can say with earnings and results in a few days that'll change that?" It's extraordinary that we're only thinking of him in terms of somebody who presents financial abstractions. At the end of the day, the only thing that would change my mind, and I think anyone's mind is if you were to say, "What am I doing talking about financial abstractions? Why am I not talking to the people who are building the planes? Why am I not visiting the factories both in our company and in our suppliers and getting out there and saying, "Hey, are you getting what you need? Do you have the resources? Are the expectations reasonable here?" This is a management team that is as removed from industrial reality as can be conceived. So unless they change that, unless they magically have this epiphany that they have to actually go and visit people who work on planes for a living and design planes for a living, whatever they do, then yes, they need to be replaced by people who will do that.

Joe Anselmo:

So guys, I wanted to ask you about the broader audience here. I mean, our audience is suppliers and investors who invest in suppliers, and the one thing they really crave is certainty, certainty to make their investment decisions. And boy, it seemed like at the end of last year we seem to be getting into a more certain environment, now that's all upended, isn't it?

Richard Aboulafia:

Yeah, that's exactly right. But how long has it been like this? You had this terrible decade. My colleague, Kevin Michaels, wrote a column for you folks about the failed market that is aerostructures, describing what happened under the [Boeing] Partnering for Success, the wonderful Orwellian term up there with quality escapes, followed by of course the MAX shutdown, which led to them to have a massive inventory problem, and then of course, the pandemic. I mean, it's been nothing but chaos and pain. And finally when they were asked to find their own working capital to dig into the most ambitious production ramp we've seen in years, now this. So this is just poison icing on a terrible cake.

Michael Bruno:

I do want to point out something we talked about a couple of years ago, which is the fact that there's probably three or four different rates plans out there. There's the stated goal that a company like Boeing will say, where we are trying to be at rate 38 on the MAX right now, and they say they want to get to 50 by 2025. Okay, so that's a stated goal. That goal used to be what the target was, that's what everybody moved to. Now it's a goal. Then you've got what the tier ones are actually building at and what the Tier Four, the forgings and castings are supplying to. You've got everybody with their own plan and the other plan that they think everybody else is following.

You add up all these plans, it's like three or four different rate plans out there. Who are you going to believe? Nobody's really going to believe the OEM, and they really don't want to believe their own forecast because they need to show growth to their investors and their stakeholders. And if they're not really showing growth, that's not good either. So this is absolutely the worst thing that could happen because you need more stability and you need a plan to get to higher growth in rates, but we're just not seeing it.

Joe Anselmo:

Ron, beyond all the headlines though, isn't it true that Boeing is still somewhat protected just by the fact that this is a duopoly and if you want to go buy an airplane, if you don't want to buy a Boeing, you're going to wait a long time to get an Airbus, right? So Boeing's market share just can't slip to zero, can it?

Ron Epstein:

No, it can't, and that's, I guess, sort of the magic of a duopoly. That begs a question we can talk about a little bit if you want, does this open a door for a third player? That's an evolved conversation. But that's just a fact, if you want to get an airplane, there's only two guys you can get an airplane that's, call it 150 seat size or greater, and that's part of the investment thesis that's been on Boeing. You're in a civil upcycle, you've got two ways to play it, one's Airbus, one's Boeing, and that's where it is. So yeah, the duopoly does save them. Now, that said, there are capable other players in the world, the third-largest airplane manufacturer is Embraer. Is this a moment that they can seize upon that's sort of once in a generation where, hey, they can knock on the doors to some airlines and say, "Do you want a third producer?"

Richard Aboulafia:

Yeah, I completely agree. You've also got RTX and maybe GE out there as spoilers too, because of course they've bulked up on capabilities and are likely to continue to do so. So the prospect of them allying with RTX or even JetZero, as we saw with the announcement of the Air Force prototype effort, is very exciting. The problem, of course, is that whether it's Embraer or JetZero or somebody else, we haven't thought about, this is a decade, probably a multi-decade effort, which means, gee, you've got this dysfunctional duopoly with high switching costs, high barriers to entry. It's a recipe for frankly someone with not very good intent to seize control of a protected revenue stream and muck things up but good, which I think is our base case scenario for the next, well, five to 10 years at least.

Joe Anselmo:

And Ron, I thought it was really interesting on the opening panel at the conference this morning, you, the Wall Street guy, sort of chastised Boeing for being too focused on Wall Street. You said they should focus on producing the best commercial and defense products possible, and then the dividends and the share buybacks and the cash will follow. It's reversed, hasn't it?

Ron Epstein:

Yeah. I mean, I don't think anybody wakes up and wants to start a company with the vision of generating cash to buy back shares and pay a dividend, right? They're a byproduct of generating good products. So Boeing should be and should aspire to be the best aerospace and defense company in the world, part of that, part and parcel is airplane products, new products, and everything else will follow. If you bring good products to the market in both markets, you'll make money, you'll generate cash, you can pay a dividend and buy back shares, but it can't be the other way around.

Joe Anselmo:

Michael, anything else you're hearing here from suppliers?

Michael Bruno:

I would just add a couple of things about suppliers in particular. I think many of them are starting to feel really, truly like they need greater relief from someone, whether it's more are kind of a price leeway from the OEM on down, whether it's some kind of government assistance to some degree, whether it's the contracts they're signing where the payment terms are sooner rather than later. So instead of 90 to 180 days, it's 15 to 30 like in the military. So, there's really an increasing call from the supply base that terms have got to change for them on a national level. If you want a healthy supply chain for the American aerospace sector, you're going to have to do something a little more to actually help suppliers rather than just kind of rely on current market conditions, or at least that's what I'm increasingly hearing here.

Richard Aboulafia:

I completely agree. We saw a bit of this with the accelerated payments program during the pandemic, the Pentagon was really, frankly, heroic in what it did to save the supply chain. And people said this is going to be also another crisis point when the ramp up happens, and people have to find all that working capital. we didn't realize it would be for this reason, Boeing, but this was kind of a potential place for just this sort of crisis, and maybe suppliers are justifiable in seeking that kind of relief.

Ron Epstein:

And then the only point I would add is there's a lot of stakeholders here, not just shareholders, it's shareholders, employees, a supply chain and a nation, right? So there's a lot of stakeholders here to get this ship righted.

Joe Anselmo:

And unfortunately, we are just about out of time so we'll have to end it on that note. But I would like to point out that none of us takes any delight in talking about this. We're not happy. This nation needs a strong Boeing, needs a healthy Boeing, and I think we all agree on that. So that is a wrap for this week's Check 6 Podcast. A special thanks to our podcast producer in the UK, Corey Hitt, join us again next week for another Check 6, and until then, have a great week and stay safe.