by Peter Jones, CFA
Vice President, Equity Research
On October 29, 2018, Indonesia’s Lion Air Flight 610 crashed 13 minutes after takeoff. Months later in March of this year, Ethiopian Airlines Flight 302 suffered a similar fate. Both flights were flown using Boeing’s much heralded new airplane, the 737-MAX or “MAX.” While most argue there was an element of human error in both crashes, the consensus is that a component of the automated flight control system incorrectly interpreted that the planes were stalling, causing the system to push the nose of the plan downward. The pilots were unable to override the malfunction which resulted in a tragic loss of life. The similarities between the two crashes led global regulators to ground the MAX fleet until Boeing was able to address a software fix and provide more thorough pilot training protocols.
Since the grounding of the fleet in March, Boeing had continued to produce the plane in order to maintain the health of their supply chain and avoid layoffs. While this was in the hope that the software upgrade would receive swift approval, allowing the plane to return to service in short order, re-certification has proven much more difficult than Boeing… and Boeing investors… anticipated. While regulators have indicated Boeing’s software fix is sufficient and that the plane is entirely safe to fly, they are taking extreme caution before allowing the plane to return to the air. Regulators now plan to inspect every single MAX that Boeing has produced (over 400 in inventory) and require a rigorous pilot training for all carriers that use the plane. As a result, it is likely the MAX could become one of the safest passenger airplanes today.
On Monday, the lengthy approval process and resulting build-up in inventory proved too much for Boeing to handle. And the company announced that production of the MAX has been halted. Boeing has been using vacant parking lots to store the build-up in MAX inventory (picture below). The impact of this has not been lost to the media, with alarmist headlines discussing how the production halt will impact the U.S. economic growth and employment. Boeing’s influence on the economy is real. In fact, Boeing is the largest U.S. exporter of goods and the MAX is the most popular plane in U.S. history, with more than 4,500 placed orders. The supply chain for the MAX provides tens of thousands of jobs in the U.S. and for many suppliers, the plane’s components generate more than 50 percent of company revenues. That said, the impact is not only manageable for the overall economy but should be also be transitory in duration.
Source: Stephen Brashear - Getty Images
The commercial aviation industry represents about 3 percent of U.S. GDP, and the MAX accounts for 10-15 percent of this output. Estimates suggest that the production halt will shave 0.3 percent to 0.5 percent from GDP in the first quarter of 2020. This compares to estimates that GDP growth will be around 2 percent. In addition, as soon as the MAX returns to service, they will unload inventory, ramp up production and the headwind to GDP will become an economic tailwind. On the employment side, it is estimated the MAX touches approximately 50,000 U.S. jobs, including 12,000 at their Renton, Washington facility, our neighbor to the north. For reference, the U.S. has been adding roughly 150,000 new jobs each month this year. So, again, even if all the MAX-related jobs were lost, the impact to the U.S. economy would be nominal. At this point, Boeing has committed to retaining their employees, re-assigning them to other projects or providing them with paid leave.
In summary, the MAX saga is likely to continue to cause turbulence for Boeing and its supply chain, but it is in the best interest of all parties that Boeing succeeds in returning the plane safely to service. As we often observe, alarmist headlines from the media overstate the economic impact of attention-grabbing events. We continue to believe the economy is on sound footing with the consumer continuing to be the workhorse into 2020.
Week in Review and Our Takeaways
It is in the best interest of all parties that Boeing’s 737-MAX returns safely to service
The economic drag from Boeing’s production halt will be manageable and transitory
Equity markets achieved fresh all-time highs with the S&P 500 up another 1.75 percent for the week and is now up 31.1 percent on the year