Boeing’s space business notches a win, but many questions remain about the company’s long-term future. Listen in as analysts Byron Callan and Ron Epstein join the podcast.
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Rush transcript
Joe Anselmo:
Welcome to this week's Check 6 Podcast. I'm Joe Anselmo, Aviation Week's editorial director.
Boeing achieved a much needed win late last month successfully docking its CST 100 Starliner spacecraft with the International Space Station, and then returning it to Earth. The flight test marked a significant step forward in the company's long term goal of operating passenger transportation services to lo earth orbit. But the company's long-term future remains a focus of much discussion amid operational challenges that keep popping up across the company's business lines. Such speculation has accelerated with Boeing's recent move to relocate its corporate headquarters from Chicago to the Washington DC suburb of Arlington, Virginia.
Joining us today are three guests with their ears to the ground. Michael Bruno is Aviation Week's senior business editor. Byron Callan is a regular Aviation Week defense columnist and a director at Capital Alpha Partners. And Ron Epstein is the senior U.S. aerospace analyst at Bank of America Merrill Lynch. Michael, let's kick things off with you. In one of your recent Boeing concerns columns, you wrote that quote, "Boeing cannot shake the specter of an existential crisis." Tell us what you meant by that.
Michael Bruno:
Thanks, Joe. And I just want to say it's a real honor to be here with Byron and Ron, always a pleasure to appear with them and listen to their expertise. So you referred to my latest column and the subtitle I had of that column was “Groundhog Day” . And that's a reference to a favorite American film from the 1990s with Bill Murray about this guy who wakes up and it's the same day over and over again.
And I used that as a reference point because when Boeing reported its first quarter 2022 results in late April, it was a bit of a Groundhog Day feeling I think for folks like Ron, who cover it from the financial perspective, Byron, who's looking at it strategically and the rest of us who are just wondering, "Hey, we thought we heard all the bad news already." I think it's well known by now that Boeing reported a bunch of red ink for the first quarter and that wasn't necessarily surprising, but what caught a lot of us off guard was the breadth and the depth.
There were programs all over the place, in commercial, in defense that were all reported as having more charges, more problems. The 737 MAX recovery was being acknowledged as going slower. There were just a lot of things that Boeing was having to admit that was not quite as optimistic as you could say they led us to believe, or just people were believing as recently as about a quarter ago.
It became significant because I think a lot of us thought that Boeing had already done what I call the kitchen sink report, at least in January when it reported its 2021 results. Or you could think that they did their kitchen sink report sometime last year. We thought we'd been through all the bad news and yet we continue to hear more of it.
So to fast forward to what you were talking about in the intro, there's now a point there, and I find it fascinating that people in the industry are openly calling for more change at the top of Boeing, at the very top, the CEO, the chairman, plus more change within the management ranks. A lot of it is related to a desire for a culture change at Boeing. We can discuss what kind of culture, if so, but there's a lot more call for change in people. There's a lot more call in change for strategy. And then there's just people who are plain worried about whether Boeing can be a going concern.
Now I say that not in a sense that Boeing is about to go bankrupt. It is not. Boeing is absolutely a going concern right now and I will leave it to Ron to correct me on any of this, but I don't think anybody has real issues with where they stand in this exact moment. The problem is strategy, where are they going to go?
And one of the things people are starting to talk about is what if. What if you break up the company? What if you try to put together the parts differently? And it's just fascinating. We're at this point, it's now mid 2022, and people are talking about Boeing looking very differently and being a very different sized company in the future. And I don't think anybody would've said we were going to be here, I don't know, even last year.
Joe Anselmo:
Byron Callan, you focus on the defense side of the company. Michael just threw out there a breakup of the company. Is that even within the realm of possibility from where you sit?
Byron Callan:
It's conceivable. I think you'd have to look at, there is a standalone defense, space and security segment, but you'd also have to consider the defense part that goes on in the global support business, which is pretty significant. Ron may have a better bead on that, but Boeing used to report that separately under a broader defense segment heading. And it's important to recognize like a lot of the logistic support things like even F-15 modifications for the kingdom of Saudi Arabia were done under that segment.
If you think about peeling the two apart, there's still a commingling of the service and support business with the other business, which is primarily production -- development and production of platforms. So it's possible. I'm sure there are other combinations you could envision with other major defense contractors. Now would the Department of Defense want to see that happen? I think that's very much an open question in the current regulatory environment, but I wouldn't rule it out in the future. And I also wouldn't rule it out that it couldn't be a standalone entity in it in its own right. But again, I think that's all speculative.
Joe Anselmo:
And Boeing Defense Space and Security has a new leader, Ted Colbert. What is the state of the business he is taking over in your opinion?
Byron Callan:
Well, it's really been kind of a transition for a number of years. You've had these core legacy programs in things like the F-18, the F-15, some of their helicopter programs, P8, that they're seeing an eventual wind down or sunsetting of those programs. And so it really kind of went back to Michael mentioned the kitchen sink charges that Boeing took. I think it was in the third quarter of 2018 there was a charge that was taken for a couple of development programs that they won, the T-7, the MQ-25 and there was a helicopter program too as well. So they've won some smaller programs and I think one question is, could you grow some of those into larger markets in their own right?
Can the T-7 become an FA-7 at some point in the future? What do you do with the MQ-25 program longer term as an unmanned platform? And then back to the P8, KC-46. P8 a couple of years is really just going to be an international program for all intents and purposes. And there was some good news also with the Air Force announcement that they're going to be getting at least 18 of the E-7 Wedgetail aircraft and the German selection of the Chinook I think was also a positive in building some visibility on that heavy lift helicopter.
There are puts and takes here obviously, but I think one point maybe going back to where Michael framed this, of all the major defense contractors, Boeing is the one that's had the most persistent number of recurring, non-recurring charges on individual programs. And maybe Ron has more thoughts on what's at the core of that because it really stands out compared to the other defense primes.
Joe Anselmo:
Good time to bring Ron in.
Ron Epstein:
Thanks, Joe. Thanks. After the last quarter, we put out a note and we titled it quoting William Shakespeare, "Nothing is, but what is not." Just kind of going across every single thing at Boeing. If you look at the defense charges, they've taken almost $8 billion so far, and there's no end in sight. We all know when you start taking charges on these programs, you keep taking them and taking them. T-7A they just bid too low. That's why their competitors didn't bid against them.
Tanker is just sort of a litany charges. 787, it's a long road to fix and sustain. They've got to start delivering them, but they've got about 115 of them parked and de-pickling those airplanes is going to be just as tricky as de-pickling the 737s and that's been proved to be far more difficult than they originally thought. The MAX 10 certification, as you all know, that's at risk to get that done.
They took engineers off of 777X, deployed them on 737 MAX 10 to try to get that thing done. And then theyed push out 777X. So 777X is essentially already in a forward loss and it hasn't even been born yet. Their cash profitability kind of across everything is weak. We've done some work and I think this gets the core of some of the issues, they're having an engineering shortage and it's affecting everything. Every program. They've been scrambling to try to put out fires everywhere with a shortage of resources to deploy. And that effectively puts them, they're facing headwinds everywhere where Airbus is really starting to face some nice tailwinds.
And that gets to the whole question around, should they be doing a new airplane or not? And when they do it, what is Airbus's response going to be? And then have they effectively painted themselves into a corner? Where for, if they do something, Airbus is effectively a second mover, can they just drop a product on top of it that's better? There's just a whole litany of issues. And then when you think about on the financial side, if you got $45 billion of net debt, when you talk to investors in the fixed income community, the fixed income community wants them to do an equity raise. But to be fair, the fixed income community always wants them to do an equity raise. So that's kind of them talking their book.
But that being said, the debt is kind of on a precipice where it could go from investment grade to high yield. If that were to go at a high yield, that has all kinds of ramifications. A, the DOD doesn't like that, one. Two, their interest expense would go up. And then three, and this is sort of like one of the dirty little secrets, they help finance their supply chain. And they do that through programs that are based on their investment grade rating. If they were to go to high yield, that would complicate that. So kind of across the board financially in the commercial business and Mike, Byron's highlighted in the defense business, there's a whole litany problems.
Joe Anselmo:
We're hearing Ron from both suppliers and customers a lot of concern that this imbalance in favor of Airbus could last a long time if Boeing doesn't field a competitor, a robust competitor, to A321neo. Is time running out for that? Could we be looking at a long term advantage for Airbus?
Ron Epstein:
Well, when you look at the market share shift in the narrowbody market, it's not because the MAX 8 is a bad airplane, MAX 8 is a fine airplane for the mission it does and you're not going to find anything more fuel efficient. The A320 has got a wider fuselage so it just takes more gas to push it through the air, but Boeing is a big beast to feed with just one airplane. The MAX 9 and MAX 10, A, the 10 has to get certified, but let's assume it does, they're mission constrained. And I think Boeing would tell you that they can cover a lot of missions, which is true. But in my experience over the years, airlines like to buy the airplane that can do that extra mission, gives them flexibility, so on and so forth.
So when you look at our outlook for Boeing's narrow body market, it's not that the MAX 8 is a problem, it's that they don't have a really good competitor to the A321 and the share losses are at the high end of the market. And then if you look at the low end of the market, the A220, both versions of it, particularly the larger version of it, the 300, is a fine airplane. And then you have to scratch your head and say, "Hmm, if Airbus were to do an A220-500 and plunk that right on top of the MAX 8, all of a sudden, that's a really, really nice airplane."
And they can do that at their choosing whenever they want to. So from the perspective that since Airbus hasn't been chasing their tail putting out fires, they're kind of in the catbird seat right now because they can just think about recovery from COVID and product strategy, where Boeing has to deal with recovery from COVID, product strategy and putting out fires everywhere. So they're in a much more compromised position. And as you all know, the product cycles in commercial lasts for decades. So if you fall behind, there's no way you just fall behind for two years. It's at least a decade. That's kind of how it goes.
Joe Anselmo:
Michael had mentioned some dissatisfaction with the leadership ranks at Boeing. You guys in the investment community, are you hearing any such talk or is it just more irritation at the results?
Ron Epstein:
Well, I think the market speaks for the investment community. If you look at Boeing shares just this year, or Boeing shares off their peak and Boeing shares peaked around $440 a share, I think it was about a $220 billion market cap company. It's well off that peak. I think you're seeing the market tell you what it thinks of management right now.
Byron Callan:
I would agree with that. I just think maybe risk aversion, although in some instances it's be careful what you wish for. That's been, it really kind of even goes back to McDonald Douglas days, these managements reach these pinnacles where they have to make some strategic decisions. It might be good for intermediate term cash flow and profitability, but to Ron's point, you eventually dig yourself in a hole. It's going to take probably another management team to dig itself out of. So, yeah, I think probably the latest fall in the stock has more to do with the commercial airplane side than the defense side.
And Joe, as you start out, I think at the margin at least, put the operating issues aside, there's been some minor positive news on the defense and commercial space side. And there are a couple of things I'll just mention, we don't know where Boeing might be participating in the NGAD [U.S. Air Force Next Generation Air Dominance] program, which I think is an interesting, potentially longer term question. But to Ron's point, if you don't have the engineering bench depth and you're showing these persistent manufacturing problems, again, be careful what you wish for, you might win that kind of program to only see the same sort of charges emerge that have been a problem.
Michael Bruno:
And I just want to follow up on what Byron and Ron are talking about in regards to management and remind everybody that we're a little bit over a year past when Boeing made the announcement about raising the retirement age for Dave Calhoun. Now he would have to ostensibly leave at 70. I believe he's 65 as of April. And traditionally, there was a cap at age 65 for the chief executive, but the board made the change around April of last year to allow basically another five years for Mr. Calhoun to try to clean up operations.
And I think there was some dissatisfaction at the time, perhaps it wasn't the majority of people, but it was a significant minority and now you're past it and there's a majority of dissatisfaction was just generally the direction that the company is going. Even if there aren't people who are specifically calling for a change in the CEO, they're definitely looking for more change in management plus change in strategy, because as Byron just mentioned, there's an assumption I think often, particularly in the financial world that it takes new leaders, new eyes, new vision, to come in and reset a company.
Joe Anselmo:
Ron, I wanted to wrap up. We talked about an engineering shortage at Boeing, that Boeing needs engineers. You followed Embraer very closely for decades. There seems to be a bit of buzz now going on that Boeing is looking maybe to Brazil to fill some of this engineering talent gap. Are you hearing any of that or Byron?
Ron Epstein:
Yeah, it's absolutely a hundred percent true. Boeing has been recruiting engineers in Sao Jose dos Campos, Embraer's home looking for talent, but Embraer is too. I'm certain you guys have heard Embraer's looking for a couple thousand engineers and it seems like we might hear something at Farmborough, not to have a plot spoiler here, but maybe Embraer will announce something at Farmborough. But they're definitely hiring engineers in San Jose dos Campos and as is Boeing and I know Embraer is doing what they can to kind of keep their folks. It's one of those things where it's sort of rubbing sand in a wound where that whole deal fell apart and Boeing's going in trying to poach some of their talent.
My sense is, however, it's going to be a harder task for Boeing to do there than maybe they think. In the region, Embraer's a national champion. I like to tell people that in Brazil Embraer's a religion. It's going to be tough recruiting those folks. But they are looking for talent. And one of the things we've noticed is they've lost engineers at the higher levels. Boeing has been recruiting younger engineers and bringing in less experienced folks, but the engineers who have worked on multiple programs, they're hard to find. And Brazil's a logical place to go because Embraer has developed so many airplanes over the last 20 years. You do have a whole cadre of engineers who have a lot of experience on multiple programs.
Joe Anselmo:
Byron, let's give you the last word. What is the next inflection point we should be looking for?
Byron Callan:
I think it's really just basic blocking and tackling. Can Boeing start to show evidence that they're actually settling down here a little bit? I think the problem that Ron talked about is it's not just Boeing, the secretary of the Army was on one of the think tanks yesterday and mentioned that her number one concern is recruitment, the scarcity of talent. So it's an issue that I think cuts across the sectors, although Boeing maybe have had some unique issues because of historic labor relations and maybe some of these have come home to roost after decades, but I don't have... Go ahead, Ron.
Ron Epstein:
The one thing I would add to this is, and I think Byron's exactly right, it goes across the sector. But if you look at a young engineer graduating from school today, they could go to Boeing. That's cool. When I was a young engineer getting out of school, Boeing was one of the only places you could go. There was only a handful of places you could go to work on an airplane. But if you're a young engineer today, hey, you can go work for Beta Technologies up in Burlington, and work on maybe the future of what EVTOL's going to be. Or maybe you could go work for Planet Labs and work on new CubeSats. There's a whole litany of things. You can go work for SpaceX, you can go work for Rocket Lab. There's such a litany of interesting things for young engineers to do today, just recruiting in general across the sector is difficult. But I would imagine recruiting at an old guard company that's having some issues is going to be even more difficult.
Joe Anselmo:
Okay. Unfortunately, guys, we are out of time, but I wanted to thank you, Byron and Ron, you're always generous with your time with us. Byron's latest column is in the new print edition of Aviation Week magazine. It's on the Ukraine war. And Ron, always appreciate you being generous with your time and joining us. Michael, thanks again for sharing your insights.
That is a wrap for this week's Check 6 podcast. Special thanks to our producer in London, Guy Ferneyhough.
Today we've been talking about Boeing, but if you want to learn about its airline customers, check out Aviation Week's Window Seat Podcast. Like Check 6, it is weekly and it is available on all of the same podcast platforms. And one last request, if you're listening to us in Apple Podcast and want to support this podcast, please leave us a star rating or a review. Thanks to all of you who have shared your positive feedback so far. It's great to hear you appreciate what we're doing here. Have a great week.
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