Following Boeing's news, customer Southwest and supplier Spirit were downgraded to Neutral-equivalent ratings
Shares of Boeing (BA) are sliding after the company announced that it was cutting the production rate for its 737 MAX. Reacting to the news, Bank of America Merrill Lynch analyst Ronald Epstein downgraded the stock to Neutral as he believes the announcement signals that the 737 MAX delay could last longer than previously expected. Also commenting on the production rate cut, his peer at Cowen argued that while the MCAS technical issues that Boeing has identified in its 737 MAX look "very fixable," "the 737 MAX crisis has morphed into a bigger PR issue" affecting the company’s brand image.
BOEING CUTS 737 MAX PRODUCTION RATE:On Friday, Boeing said that, "We now know that the recent Lion Air Flight 610 and Ethiopian Airlines Flight 302 accidents were caused by a chain of events, with a common chain link being erroneous activation of the aircraft's MCAS function. We have the responsibility to eliminate this risk, and we know how to do it. As part of this effort, we're making progress on the 737 MAX software update that will prevent accidents like these from ever happening again. […] We're also finalizing new pilot training courses and supplementary educational material for our global MAX customers. […] As we continue to work through these steps, we're adjusting the 737 production system temporarily to accommodate the pause in MAX deliveries, allowing us to prioritize additional resources to focus on software certification and returning the MAX to flight. We have decided to temporarily move from a production rate of 52 airplanes per month to 42 airplanes per month starting in mid-April. At a production rate of 42 airplanes per month, the 737 program and related production teams will maintain their current employment levels while we continue to invest in the broader health and quality of our production system and supply chain. We are coordinating closely with our customers as we work through plans to mitigate the impact of this adjustment. We will also work directly with our suppliers on their production plans to minimize operational disruption and financial impact of the production rate change.” Following Boeing's announcement, Spirit AeroSystems (SPR) said that the company will maintain its 737 deliveries to the former at the current rate of 52 shipsets per month. Spirit will store accumulated 737 MAX shipsets at its facilities. Spirit added that it will minimize any impact to its full-time workforce by reducing contractors and overtime, and suspending hiring to backfill open positions. Meanwhile, American Airlines (AAL) said it will extend cancellations of 90 flights a day through June 5 because of the grounding of Boeing 737 MAX aircraft, according to a report by Reuters.
MOVING TO THE SIDELINES: In a research note to investors, Bank of America Merrill Lynch's Epstein downgraded Boeing to Neutral from Buy after the company announced that it will cut 737 production rates, as he believes this likely means that the 737 delay could last longer than previously expected. Epstein pointed out that he now estimates 6-9 months of disruption, up from his previous estimate of 3-6 months, for Boeing's most profitable program. Further, considering the operating risks in Boeing's business made apparent by recent events regarding the 737 MAX, the analyst expects the stock to trade at its historical 25% discount to the S&P 500 on a price to free cash flow basis instead of closer to parity. Additionally, Epstein argued that Boeing could incur liabilities related to certification and testing costs, late delivery penalty to airlines, lives lost from the Ethiopian Airlines flight ET 302 and Lion Air flight JT 610, and production disruption penalties to suppliers. He lowered his price target on Boeing shares $420 from $480. While reiterating an Outperform rating on the stock, Cowen analyst Cai von Rumohr lowered his price target for Boeing to $460 from $475, citing the 737 MAX rate cut. While he believes the MCAS technical issues that Boeing has identified in its 737 MAX look "very fixable" and he is confident that the company's proposed software and training update will correct the deficiencies with the still-grounded plane, "the 737 MAX crisis has morphed into a bigger PR issue" affecting Boeing's brand image. Meanwhile, Canaccord analyst Ken Herbert told investors that he believes Boeing's 737 MAX rate reduction reflects "greater uncertainty" on the near- and longer-term outlook for both the program and the stock. While Boeing indicated that the move was temporary, Herbert feels the planned move to 57 per month on the 737 as possibly slipping to 2020, and sees the grounding of the 737 MAX fleet as longer than he had anticipated. He reiterated a Hold rating and $380 price target on the stock.
SOUTHWEST DOWNGRADED AT RAYMOND JAMES: Citing expectations of near-term earnings risk due to the grounding of Boeing's 737 MAX fleet, Raymond James analyst Savanthi Syth downgraded Southwest Airlines (LUV) to Market Perform from Outperform. The analyst expects the earnings risk to be extended into the summer months, while also seeing some additional pressure on the airline in 2019 coming from the mechanics' union dispute. Nonetheless, Syth remains confident in Southwest's ability to maintain its longer-term superior margins, free cash flow profile, and low leverage while capitalizing on technology catch-up and international growth opportunities. Moreover, beyond the near-term, the analyst noted that some of the impact of the grounding of the MAX fleet will likely be recouped in terms of maintenance credits or lower ownership costs of future aircraft.
SPIRIT DOWNGRADED AT CANACCORD: Meanwhile, Canaccord analyst Ken Herbert also downgraded Spirit AeroSystems to Hold from Buy and lowered his price target on the shares to $92 from $100 after Boeing announced that it is lowering 737 production levels to 42 per month starting in mid-April. In a research note to investors, Herbert argued that while Spirit has said it will continue to produce at a rate of 52 per month, he feels the slight adjustment adds incremental margin and free cash flow pressure in 2019, and believes the 737 MAX grounding will contribute to near-term headline risk.
PRICE ACTION: In morning trading, shares of Boeing have dropped almost 4% to $376.44, while Southwest's stock has slipped about 2% to $52.21. Also lower, shares of Spirit AeroSystems have dropped 6.5% to $83.83. Triumph Group (TGI), another Boeing supplier, is down over 4% to $22.94 per share.