Fixing Boeing

Good morning and happy Fed day. Microsoft and Google reported last night. Both stocks fell in late trading, Microsoft’s by a little (1 per cent) and Google’s by a lot (6 per cent). Google’s ad revenue was just a bit softer than expected. A bad start, then, for Unhedged’s bet that the cheaper Big Tech stocks (Google and Meta) would outperform more expensive ones (Microsoft, Nvidia and Tesla). But we live in hope. Email us: robert.armstrong@ft.com and ethan.wu@ft.com.

Can Boeing come back?

Boeing reports earnings this morning, and it’s going to be interesting. The company is in trouble, and its problems do not appear close to a solution. From The Wall Street Journal on Monday:

Bolts needed to secure part of an Alaska Airlines jet that blew off in mid-air appear to have been missing when the plane left Boeing’s factory

Boeing and other industry officials increasingly believe the plane maker’s employees failed to put back the bolts when they reinstalled a 737 MAX 9 plug door after opening or removing it during production . . . 

Planes should come bolted together. Unsurprisingly, the incident is slowing approval and production of Boeings planes. The Financial Times yesterday: 

Boeing has withdrawn a request for a safety exemption for a new version of its 737 Max jet that would have expedited its approval . . . 

Last week Illinois senator Tammy Duckworth urged the Federal Aviation Administration, the aviation safety regulator, not to certify the Max 7 . . . 

The withdrawal throws into doubt when the Max 7, the smallest model, will be certified by the FAA as Boeing works on a permanent design change. Investors had expected the Max 7 to be certified in the first half of this year

The Alaska Airlines incident “adds to the impression that Boeing has forgotten how to build aircraft,” as one analyst put it to the FT recently. It comes on top of 737 Max 8 crashes in 2018 and 2019 in which 346 people died, as well as various other production and sales issues. Last week the US Federal Aviation Administration blocked expanded production of the Max 9. Customers are unhappy with the company, too, the FT reported last week:

The chief executive of United Airlines warned on Tuesday that he was rethinking a multibillion-dollar order for new planes after being forced to ground 79 of its 737 Max 9 aircraft following a damaging mid-flight fuselage breach of an Alaska Airlines aircraft earlier this month. 

The strong emotions that, quite rightly, accompany any discussion of Boeing’s troubles make the question of the stock’s valuation complex and interesting. This is all the more true because the Boeing mess represents a recognisable type of investing challenge: the strong company fallen low. Two other recent examples are BP’s Deepwater Horizon crisis in 2010 and the Volkswagen Emissions Scandal of 2015; one might also think of the existential crises at Bank of America and UBS a decade and a half ago.

But Boeing is a uniquely vivid and important example of the phenomenon. It is structurally a much better business than VW, Deepwater Horizon or the banks. It has very high barriers to entry and, with France’s Airbus, is part of what is effectively a duopoly in large commercial aircraft, an industry with solid underlying growth. And the company is also strategically and politically important to the US. Boeing has a huge amount going for it, if it can get its act together.

A sense of the damage done is reflected, in a rough way, in the fact that the shares have underperformed those of Airbus by 85 per cent since the first Max 8 accident in 2018.

All through 2018 and 2019 Boeing traded at about $350. The stock is now at $200. If you think the company can reverse the losses of recent years (which reflect not only production slowdowns and groundings but troubles in its defence division) and return to roughly historic earnings and valuation levels by the end of 2025, it could be a $300+ stock again. That would imply 20 per cent annual returns over two years. That’s a stock you would absolutely want to buy.

Jason Gursky, who covers Boeing for Citigroup, walked me through the maths in a somewhat more disciplined way. The company said at an investor day in late 2022 that, assuming it got back to historic production and margin levels, it could generate $10bn in free cash flow by 2025 or 2026 — about $17 in free cash per share. Here’s the company’s slide:

That leaves investors with two questions: can Boeing hit the 2025 target, and does 2025 represent peak profitability, or a base to build upon? The second question is very important, Gursky pointed out, because industrial companies might trade at very different multiples at different points in the cycle. A multiple of 10 or 12 might be appropriate for peak earnings, which would suggest a price of $200; if 2025 is a base Boeing can grow from, a multiple closer to 20 makes sense, implying a price well over $300.

Those are hard enough questions to wrestle with. The Alaska Airlines incident, however, puts the whole Boeing recovery effort to date into doubt. It suggests the underlying problems in Boeing production, sales and training might not have been solved. To figure out if the stock can get back over $300, investors have to assess whether the underlying operational culture — for lack of a better word — has been fixed. That is difficult to assess from the outside. But the problem is worse than that: investors also have to consider whether, if the culture is fixed, Boeing can convince the world that it has been. 

I spoke with Rupert Younger, who runs Oxford university’s Centre for Corporate Reputation, about Boeing. He noted that, like BP or Volkswagen, Boeing is a very large, important company with a tradition of excellence and influence. Companies like this have a natural tendency to start believing that they know the right way to do everything, and that outsiders — or even internal dissidents — know nothing. This results in failure to anticipate and correct incipient problems. There are lots of signs that Boeing had become insular in this way, he says, going back to the merger with McDonnell Douglas in 1997. 

The only cure for a company that has fallen into this trap is a clean sweep of leadership processes and, crucially, personnel. “BP only started to get better when they fired [CEO] Tony Hayward,” Younger pointed out. He thinks that Boeing CEO Dave Calhoun, who took the job in 2020, is not enough of an outsider to reboot the company convincingly, having served on the board since 2009.  

I myself do not have a view on whether Calhoun, who has an excellent reputation, is the right man for the job. But I am convinced that, in today’s investor call and in the months and years to come, individual financial targets or regulatory approvals will be of secondary importance, because they cannot banish the worry that another ugly mishap could happen any time. What will be primary is whether the company can demonstrate to investors that the overhaul of the company culture has been comprehensive and ruthless; that the old leadership structure is gone, the old processes ripped out and replaced. That is the only path back above $300. 

Two good reads

The sublime and the ridiculous: John Plender on the lessons of a life spent watching the market, and Joshua Chaffin on the apartment building styled after a strip, er, nightclub.

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