Apr 6 2020 - Boeing 737 MAX Cancellations Wave Certain

With recertification milestones, production restart and delivery delays, the coming months are pivotal for the Boeing 737 MAX.

Changed near-term demand for air travel weakens appetite for Boeing 737 MAX deliveries and clouds long-term prospects.

As demand for air travel weakened, customers now have another reason to cancel orders.

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Boeing's (BA) share price has steeply declined year-to-date despite a strong recovery during the last full week of March. The declines in Boeing’s share price are understandable They have more been driven by fear on strings attached to an aid package for Boeing, and fully utilizing the .8B delayed draw term loan caught investors by surprise than by the Boeing 737 MAX crisis itself, which already provided a justification on share price declines months before coronavirus hit the world. While the past year have been challenging, the most challenging parts for the MAX have yet to come. In this report, we look at those reasons and how COVID-19 is increasing pressure on the Boeing 737 MAX exponentially.

Source: Trouw

Recertification

The first reason why the coming months are pivotal is the Boeing 737 MAX timeline. The aim still seems to have a certification flight in April this year, which should allow for a recertification by mid-2020. Boeing’s expectations in that regard remain unchanged and that timeline also still fits our previous projections as it became clear that Boeing was working on significant changes to the flight control system software. The sole element of the certification flight already can be considered pivotal as Boeing has continuously missed re-entry windows for the Boeing 737 MAX. A further slip in the schedule for the certification flight or need for additional changes could negatively affect the theoretical re-entry of the Boeing 737 MAX.

Restarting production

Source: Everett Herald

The coming months are also pivotal for another reason. Boeing aims to restart production prior to recertification. The company already had placed the orders for that production resumption with Spirit AeroSystems (SPR) for the fuselages and CFM for the LEAP-1B turbofans to support these production plans. Recovery of the production and pace in which this happens is important to the full production recovery profile for the Boeing 737 MAX. On the 23rd of March, Boeing announced a temporary suspension of production operations at its Puget Sound area facilities in light of the state of emergency in Washington state and the company's continuous assessment of the accelerating spread of the coronavirus in the region.

Boeing began reducing production activity the same day and projected the suspension of such operations to begin on Wednesday, March 25, at sites across the Puget Sound area. The suspension of production operations will last 14 days. We see that not only from a demand perspective COVID-19 is affecting Boeing but also its ability to supply customers is being impacted. So, the coming weeks will be important for Boeing as we should get an idea whether Boeing can indeed get the flow from the supply chain going to restart production and meet a revised production schedule for the Boeing 737 MAX.

Boeing 737 MAX cancellations

The last reason but a very important one for Boeing why the coming months are pivotal are cancellations. In previous months, we saw some Boeing 737 MAX crisis-related cancellations, but it wasn’t a huge wave. In February , we saw the first uptick in Boeing 737 MAX cancellations for the year. Not all value from those orders is lost as some orders are converted to Boeing 787 orders which likely relieves some cash pressure that Boeing would face if customers would cancel their orders without signing for other aircraft. In our February piece on the Boeing 737 MAX cancellations and the order overviews for February, I pointed out that cancellations were certain and this was reconfirmed by the recent cancellations from Avolon for 75 MAX jets.

One trigger for the Boeing 737 MAX cancellations is placed in March as delivery delays will start exceeding what Boeing calls “Delay in Delivery of Twelve Months or Less.” Important to keep in mind is that the clause holds for an excusable delay. I would hardly call the Boeing 737 MAX delays excusable ones and the nature of how the crisis is being treated by Boeing and customers also does not signal it's considered an excusable delay. However, we do know that for an excusable delay beyond the 12-month mark both parties can terminate the purchase agreement, obliging Boeing to repay all pre-delivery payments at once. I wouldn’t be surprised if Boeing has previously agreed with customers to pay damages while coming to some sort of agreement not to cancel orders within 12 months. What we are seeing now is that delivery delays are stretching beyond that 12-month mark, so for customers , whether delays are considered excusable or non-excusable, parts of (renegotiated) agreements could start allowing or further allow customers to walk away from their orders. In fact, Boeing is even in the position to cancel orders unilaterally if they determine liquidated damages exceed compensations (which will be the case for most customers). It is, however, not likely that Boeing prefers this approach as it will weaken Boeing’s order books, the market position and the position at the negotiation table in future negotiations.

Demand for air travel has weakened and there likely won’t be much of a base to negotiate further liquidated damages for airlines canceling or deferring orders, which is becoming more and more likely on top of the fact that delivery delays will now start to exceed 12 months. It has always been the case that customers could start walking away from their orders due to the nature of the delays, but under current circumstances with a weak demand profile customers will be more willing to defer and cancel orders.

In that regard the coming months also are pivotal. In April, the order and delivery data from March, including cancellations, will be released so from April (onward) we could see what airlines are actually doing with their orders. Are they giving up on their Boeing 737 MAX orders or are they keeping orders in place or, highly likely, with slight additions to the delivery schedules to align deliveries with demand? The coming month will show whether the Boeing 737 MAX order book and loyalty to Boeing is as robust as it has looked over the previous 12 months or not.

Conclusion

The Boeing 737 MAX program and Boeing are facing some pivotal months for a multitude of reasons. When it comes to the recertification timeline, there are some important milestones planned for April and May while Boeing also is looking to restart Boeing 737 MAX production. At the same time, delivery delays will start exceeding 12 months so we will start seeing whether customers are still keeping their orders. Airlines that were already considering canceling their orders could be opting to cancel their orders as the demand profile has changed while airlines who were planning to stick to their orders might now also be looking to cancel orders. The biggest challenge is the gap in demand. This would open up opportunities to cancel orders with Boeing and in the future negotiate with Airbus for fleet requirements, but also re-open negotiations with Boeing in a renewed setting. The air travel market hasn’t been beaten down permanently, but COVID-19 is certainly something that's going to shape the market to some extent in the same way that happened after 9/11, but possibly with a lot more damage done to the industry. The coming months are really going to give us a better idea about Boeing’s market position with the MAX.