Editor’s Note: This article was corrected on July 24.
A week before Boeing (NYSE:BA) stock’s second-quarter results date, the company announced that it will recognize an after-tax charge of $4.9 billion. This is related to 737 MAX grounding and associated delivery delays.
The announcement triggered a positive reaction and Boeing stock surged higher by 4.5%. However, I believe that it’s still too early to go long Boeing stock. This article will discuss the reasons to remain on the sidelines.
Concerns Related to 737 Max Grounding
In addition to an after-tax charge of $4.9 billion, the following point is a key concern:
Boeing’s estimated costs to produce the aircraft in the 737 accounting quantity increased by $1.7 billion in the second quarter, primarily due to higher costs associated with a longer than expected reduction in the production rate.
According to Boeing, this will translate into margin compression in 2Q19 and in the coming quarters. The important point to note is that Boeing is currently assuming that 737 MAX will return to service in 4Q19.
Potential delay in regulatory approvals would imply longer-than-expected margin compression. This is bound to have a negative impact on the stock.
The second-quarter results are likely to provide further insight on the extent to margin compression. It therefore makes sense to have clarity on this before fresh stock exposure to Boeing stock.
I am worried about regulatory approvals on safety because Boeing has already been accused of rushing to develop 737 MAX. The reason was to counter competition from Airbus. Regulators would be extra careful to ensure that there is complete conviction on all safety features before 737 MAX is back. It possibly implies delays and inventory build-up cost.
From a revenue perspective, the 737 NG/MAX had an order backlog of 4,601 aircraft, which has already declined to 4,415 due to contractual changes and cancellations. The company’s dependence on 737 for commercial aircraft segment growth is certainly a worry.
If provisional orders witness further cancellations, the company’s revenue visibility will decline. This translates into a double concern of lower margins and potentially lower revenue visibility. Just as an example, Turkish Airlines expects 737 MAX to remain grounded and the airlines further expects order cancellation of new MAX aircraft.
I want to emphasize here that I am not fear mongering and I do expect this 737 to be back in the future. In June 2019, International Airlines Group did sign a letter of intent for 200 Boeing 737 MAX aircraft. This is with the conviction that 737 will return to service.
My only concern is that the financial impact has yet to be priced into the Boeing stock price. Additionally, delays in regulatory clearance will add to the financial impact.
The Big Market Opportunity
Once the regulatory and financial headwinds subside, Boeing will be certainly worth considering. For the next decade Boeing forecasts aerospace and defense market of $8.7 trillion. This includes potential commercial aircraft market of $3.1 trillion, defense market of $2.5 trillion and services market of $3.1 trillion.
With higher geopolitical tensions globally and with escalating friction with Iran, the defense sector is likely to grow meaningfully in the coming years.
While the long-term opportunity is immense, the current global slowdown possibly implies relatively weak commercial aircraft market. According to World Bank, the global economy is likely to grow at 2.6% for 2019. This is the macro factor that backs my view to remain in the sidelines.
Earnings for BA Stock Looked Bad
Boeing’s earnings came in at a loss of $5.82 per share on revenues of $15.75 billion, both misses. Free cash flow came in at -$1.01 billion, and commercial aircraft revenue fell by 66%. the stock has dropped 1.3% on the report.
Looking forward, the most important upside trigger for Boeing stock will be regulatory clearance for 737 MAX. Boeing management will be hoping that the aircraft is back to service in 4Q19.
As of this writing, Faisal Humayun did not hold a position in any of the aforementioned securities.
