Shares of Boeing have taken a deep dip on Monday as the situation in Ethiopia continues to unravel in a more complicated manner that may extend beyond a software fix related to the Maneuvering Characteristics Augmentation System (MCAS) function.
As a result of the tenuous situation, Boeing will cut production on the 737 MAX 8 model. More than 300 of the MAX 8 planes remain grounded since the disaster, with little hope for a quick fix to resume service.
The South China Morning Post reported that China has delayed its order for 100 MAX 8 aircraft amidst the uncertainty, stinging the company's much-touted backlog as it continues to deal with lawsuits from airlines that had become reliant on the craft.
"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," CEO Dennis Muilenberg said. "We have decided to temporarily move from a production rate of 52 airplanes per month to 42 airplanes per month starting in mid-April."
Clearly this is bad news for buyers of Boeing stock who expected a rapid response and rebound in the shares. However, it is also worth recognizing the ripple effect that this disaster has on many of its suppliers, namely General Electric (GE) and Honeywell (HON) .
The key tie in for GE to Boeing is its supply of LEAP engines for the Boeing 737 MAX 8, the model in question in the recent crashes that killed nearly 400 people.
We are deeply saddened by the loss of #ET302. We extend our heartfelt sympathies to the families and loved ones of all those on board.— CFM International (@CFM_engines) March 10, 2019
While there is still some question over the true cause of the crash, there is as of yet no connection to the engines.
The cut in production would immediately seem to be a problem, though, as a delay or decline in orders would reverberate to GE, which has built in engine deliveries to Boeing for its 787 Dreamliner and 737 MAX 8 models to estimates for 2019. The company currently generates 5% of its sales of engines to Boeing, not an immaterial aspect of the overall business.
However, it might actually offer an opportunity to catch up on the ramp of its engine pipeline that is currently operating at a loss due to the behind-schedule status of the program.
"On the LEAP engine ramp, GE continues to play catch up (737 MAX issues a potential opportunity), and at last check the company was behind where they thought they'd be a year ago," J.P. Morgan analyst Stephen Tusa commented. "While ]Safran] (SAF) management noted they are on track with deliveries and engine performance, it revised and pushed out its forecast for peak losses/break-even from the CFM56/LEAP transition to show a step up in headwind in 2019 from this "mix" dynamic, while pushing out timing for LEAP breakeven to beyond 2020."
As such, Barclays analyst Julian Mitchell noted that a slower delivery ramp in the near term could mean tempered losses for the program in 2019 as the ramp timeline extends.
"The last time there was a major such grounding was on the Boeing 787 program," Mitchell added. "During this time, Boeing continued to produce the aircraft, and suppliers continued to be paid."
Additionally, the impact of any problems at Boeing are couched by the company's exposure to Boeing's chief rival Airbus (EADSF) as the company also produces the LEAP engines for the ACJneo model that will look to gain ground on Boeing's top-selling plane and the emerging effort of Commercial Aircraft Corporation of China (Comac).
"[We have] over 1,200 engines in service at 100 operators across the 320Neo family and the 737 Max, a terrific product positioning," GE Aviation CEO David Joyce told investors in March. "We're holding 58% win rate on the [Airbus] 320Neo's, 320s, family and a sole source on the [Boeing] 737 Max and the COMAC C919, which is still in development."
Further, the aviation business that houses the CFM International joint venture that produces the LEAP engines is bolstered by defense spending globally.
So, while a long-term issue with the 737 MAX 8 program could provide a headwind, the hiccup in the short term could actually serve as an opportunity for the program to gain some breathing room.
"Boeing the best read through there is for Honeywell," Action Alerts PLUS portfolio manager Jim Cramer commented earlier this year.
In recent months, that might leave many investors apprehensive about upcoming results from the Darius Adamczyk-led company.
Honeywell may likewise be able to sidestep some of the negative news, as its technology supplies to Boeing do not extend to the navigation and flight management systems being investigated in the crash.
The MCAS system was instead a software patch for the plane designed by Boeing itself.
Adamczyk told CNBC following the crash that the impact on his business has been minimal so far.
"We haven't seen any impact on our business at all," he told Sara Eisen in March. ""Anything that Honeywell can do to help Boeing, to help the [National Transportation Safety Board] NTSB, we'll do and that's our number one focus. But in terms of business slowing, we haven't seen that. At least not yet,"
To be sure, that does not mean investors shouldn't be mindful of the broader aerospace impacts that could impact the company.
"We think the world of CEO Darius Adamczyk and his management team, and we know organic sales growth is off to a strong start this year, however, we are being a bit watchful here due to the company's (minimal) exposure to the Boeing 737 MAX program, which if temporarily paused, would carry a small amount of risk to the broader aerospace market," the Action Alerts PLUS team before trimming its position amid the uncertainty.
As more details emerge, investors should be able to at least breathe a small sigh of relief as the impact appears to be minimal at present.
"Honeywell is a very small supplier to the 737 program. The amount of sales Honeywell generates from it is not at a level where we are being forced to take action," the Action Alerts PLUS team clarified. "If we felt this way, you would see a more aggressive sale trim and not one that still leaves HON as one of our largest positions."
For more on their aerospace industry outlook and more pertinent factors to watch at Honeywell, click here.