2024-01-10 08:00:00 ET
Summary
- In reaction to an explosive decompression on a 737 MAX 9 delivered to Alaska Airlines less than three months ago (no casualties), Boeing shares fell sharply.
- The article discusses whether Alaska Airlines, Spirit AeroSystems or Boeing could be to blame for the incident.
- I explain why I don't think BA stock is a compelling contrarian investment opportunity - even after a 13% drop from its 52-week high and despite good growth prospects.
Is Boeing Stock A Compelling Contrarian Investment Opportunity?
After a spectacular performance in late 2023, The Boeing Company ( BA ) stock had a difficult start to the new year. Investors were startled on Friday, January 5, by news that Alaska Airlines Flight 1282 had suffered an " explosive decompression ". Part of the fuselage blew out, resulting in some pretty shocking video and photo footage on the internet. Fortunately, and also because the incident occurred shortly after takeoff, the plane was able to return to its originating airport (Portland, Oregon) and land safely with no casualties.
In this update (see my original article on BA stock ), I share my views on the incident, who might be to blame, whether I expect any lasting impact on Boeing's already tarnished reputation, and why I don't think the stock is a compelling contrarian investment opportunity - despite the 737 MAX being Boeing's most important cash flow driver and accounts for a significant portion of its order backlog.
Who's To Blame, And What To Make Of The Incident
While some media are - unsurprisingly - focusing on "another Boeing aircraft" suffering from a quality issue, I think it's important to take a balanced view of the situation.
After all, the 737 MAX 9 had reportedly already had pressurization issues on earlier flights. So the airline may not have inspected, let alone fixed, an issue that was apparently already announcing itself. I should add that I am not an expert in aviation safety and am not familiar with the relevant regulations, so it is of course possible - and even quite likely, see below - that Alaska Airlines did no wrongdoing. Keep in mind that the airplane in question (N704AL) was removed from extended range operations ((ETOPS)) shortly after the pressurization issues were first noticed. Hence, I doubt that the issues went unnoticed by Alaska Airlines maintenance personnel and I think it is reasonable to conclude that the issue was handled according to the maintenance manual issued by Boeing. Finally, N704AL is a very young aircraft that was only delivered to Alaska Airlines on October 31, 2023 - a further indication that the incident is most likely not due to a lack of scheduled maintenance, but to a manufacturing or assembly defect.
The fact that the airline immediately grounded its entire MAX 9 fleet (65 aircraft) indicates, in my opinion, that management was acting prudently to preserve the airline's reputation. That said, it did not take long for the Federal Aviation Administration ((FAA)) to issue an emergency Airworthiness Directive ((AD)) ordering an immediate grounding of all MAX 9 aircraft operated in the United States.
It is therefore possible that Spirit AeroSystems ( SPR ) is responsible for this issue - after all, Boeing's supplier manufactures the fuselage part of the 737 MAX 9. Judging by the photos , and especially considering the fact that it was a deactivated door (no longer recognizable as such, i.e. a door plug with a passenger window) that blew off, it is possible that mounting brackets of the door plug were not properly assembled. However, it is possible that what could turn out to be a mere assembly error was exacerbated by the already apparent pressurization issue. In this regard, it should be kept in mind that the plug came loose at an altitude of over 16,000 feet. According to Reuters , the National Transportation Safety Board ((NTSB)) has not yet been able to determine whether the plug was properly installed as part of its ongoing investigation, as investigators " not yet recovered the four bolts that restrain it [the door plug] from its vertical movement ".
It is therefore important to look at the incident from Boeing's perspective. In this context, I find the recent findings of United Airlines ( UAL ) - the U.S. airline with the most MAX jets in operation (88 out of 868, total mainline fleet, p. 35, 2022 10-K ) - particularly noteworthy: UAL's investigators have apparently found several instances that point to installation issues - " for example, bolts that needed additional tightening " .
While it is impossible to give a definitive answer to the question of who is to blame for the incident before the investigations have been completed and it is also inappropriate to link this issue to the two tragic incidents ( Lion Air flight 610 and Ethiopian Airlines flight 302 ) involving the then-new Maneuvering Characteristics Augmentation System ((MCAS)), I think it is nonetheless fair to say that Boeing has issues with its product governance.
This is underscored, for example, by the recently issued AD 89 FR 246 , which addresses a quality issue involving potentially under-tightened bolts on some flight attendant seats in production for certain 787s ("Dreamliner"). More importantly, with respect to its 737 MAX fleet, Boeing has issued a multi-operator message urging plane operators to inspect the rudder control system (certain tie rods) for possible loose parts, presumably after Boeing itself discovered a loose bolt in the rudder control system of one of its undelivered airplanes. However, I don't want to scaremonger here: The rudder control issue, while sounding serious, did not cause the FAA to issue an emergency AD and ground the affected portion of the fleet.
The ongoing inspection into the issue with the rudder control system linkage and the door plug will reveal how prevalent these (likely) quality escapes are and whether they could point to a larger lapse in production quality. However, the fact that these issues are quite different from, for example, the high-pressure turbine disk issue in Pratt & Whitney's (RTX Corp., RTX ) flagship PW1XXXG engine, gives me pause. I reported on RTX's issue in detail in my article in August and the follow-up published in October .
Unlike the Pratt & Whitney issue (which once again proves that cutting edge technology and extremely low fault tolerance are critical to achieve the necessary performance goals), Boeing's latest issues look like simple quality control escapes that should be relatively easy to avoid - which raises the question of why they weren't avoided. When I did the bulk of my due diligence on Boeing in 2022, it was problems like these that dissuaded me from investing in the company's stock. The question is whether Boeing is able to improve its manufacturing quality and product control, especially against the backdrop of its large $469 billion backlog (p. 36, 2023 10-Q3 ), of which more than 80% is for commercial aircraft ( >5,100 aircraft , with the 737 being by far the largest contributor).
Although I do not believe that the latest problem per se will have any significant further consequences for Boeing's already tarnished reputation, I maintain my conclusion to avoid BA stock - also from a valuation perspective. Even on a forward-looking valuation, I don't think the stock is a good deal - both from an earnings (Figure 1) and free cash flow (Figure 2) perspective.
Figure 1: FAST Graphs chart for The Boeing Company (BA), based on adjusted earnings per share (FAST Graphs) Figure 2: FAST Graphs chart for The Boeing Company (BA), based on free cash flow per share (FAST Graphs)
Summary And Conclusion
In reaction to an explosive decompression on a 737 MAX 9 delivered to Alaska Airlines less than three months ago (no casualties), Boeing shares fell sharply.
Looking at the issue from the perspective of Alaska Airlines, the operator of the affected aircraft, and considering that N704AL had already experienced pressurization issues on previous flights, it is possible that the problem was due to inadequate maintenance. However, since the aircraft was pulled from ETOPS shortly after the pressurization issues became known, it is unreasonable to conclude that the problem was improperly handled by maintenance personnel, who (most certainly) followed the maintenance manual issued by Boeing.
Likewise, it is doubtful that Spirit AeroSystems, the supplier of the fuselage part (a plugged door that is no longer recognizable as such), delivered faulty components to Boeing, as investigations after the incident by United Airlines found several instances pointing to installation issues, such as loose bolts.
Taken together, and in light of other recent Airworthiness Directives and a Boeing-recommended inspection regarding certain rudder system tie rods, it is reasonable to conclude that the incident is due to quality defects during assembly and insufficient quality control. Of course, however, it is impossible to give a definitive answer to the question of who is to blame for the incident before the investigations have been completed. I don't think this latest issue will have a material additional impact on Boeing per se , but it is another confirmatory sign that the company has issues with its product quality and its quality control. In light of Boeing's huge backlog of over 5,100 airplanes, I have doubts about the company's ability to improve the quality of its manufacturing and assembly lines, and its quality control.
For this reason, and because it is only about fairly valued even on a rather uncertain and very forward-looking basis, I continue to avoid BA stock.
Thank you very much for reading my latest article. Whether you agree or disagree with my conclusions, I always welcome your opinion and feedback in the comments below. And if there's anything I should improve or expand on in future articles, drop me a line as well. As always, please consider this article only as a first step in your own due diligence.
For further details see:
Boeing: A Contrarian Buy Now After The Latest Incident? No, Here's Why