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Boeing Pitch Deck Vf Boeing NYSE: BA Recommendation: BUY Connor Campbell, Tom Daly, DC Morris, Andrew Seketa 1 Introduction Source: Wall Street Journal 2 Investment Thesis Recommendation: Given recent investor panic relating to the grounding of the 737 Max, Boeing Co. (NYSE:BA) is undervalued in the market with substantial 3-12 month upside; therefore, we recommend a buy Rationale: Boeing’s strong fundamental business model and entrenched position in the market are largely unaffected by the grounding of the 737 Max 1 Current issues with the 737 Max are easily rectified with low costs 2 Previous Boeing aircraft groundings made minimal impact on Boeing’s performance 3 Switching costs in the airplane manufacturing industry limit the loss of Boeing’s customers Price Target: $426.52 13.98% upside to current price $374.21 3 Situation Overview What happened? What went wrong? Lion Air Flight 610 MCAS (Maneuvering Characteristics Augmentation System) • Oct 29, 2018 – Boeing 737 MAX • Newly designed software on 737 MAX to prevent stalling crashed shortly after takeoff, killing situations by automatically pushing plane’s nose down all 189 on board on flight from • To achieve more fuel efficiency on 737 MAX, plane’s engines Jakarta to Pangkal Pinang were positioned closer to nose which increases stall risk • System was triggered by false alarm – typically not a problem Ethiopian Airlines Flight 302 • Mar 10, 2019 – Boeing 737 MAX Pilot Training crashed shortly after takeoff, killing • Pilots, per international regulators, were not required to all 157 on board on flight from comprehensively retrain to fly the new 737 MAX Addis Ababa to Nairobi • Black box findings show pilots tried to stop the MCAS system using incorrect procedure – the procedure for older 737’s Regulator Involvement Potential Liabilities† Derivative Classification by FAA Cost Est. Amount • FAA classified the 737 MAX design as a derivative of previous 737 models– leading to quick safety approval and little Legal Settlement $1.7 billion retraining required of pilots • Rushed approval process – A320neo development was 9 DOJ Settlement $1.0 billion months ahead of 737 MAX Compensation to customers $540 million Dissenting International Opinions • Brazilian regulators, prior to crashes, singled out MCAS as a Repair/Maintenance Cost $260 million change that necessitated pilot retraining for 737 MAX • International regulators grounded the 737 MAX prior to the Total Cost Estimates $3.5 billion FAA– traditionally regulators abroad followed FAA’s decision. Sources: Company 10-K, Bloomberg, Melius Research † Estimates projected by Melius Research based on previous settlements, penalties and groundings, as well as current jet lease rates 4 Company Overview Company Segmentation 1 Year Stock Chart Boeing Commercial Airlines: 450.00 • BCA is the core division within Boeing, manufacturing 400.00 airplanes for commercial airliners and shipping companies Boeing Defense, Space, and Security: 350.00 • BDS manufactures manned and unmanned military vehicles, 300.00 while also providing R&D services to governments. 86% of its revenue comes from the US government 250.00 Boeing Global Services: • BGS provides logistical, training, and maintenance services to Jul-27-2018 Boeings private and public sector customers Mar-27-2018 May-27-2018 Sep-27-2018 Nov-27-2018 Jan-27-2019Mar-27-2019 Extensive Backlog 2018 Revenue Breakdown ($ in millions) • Companies large and small across the globe have ordered Boeing planes years out into the future 17% • Boeing’s entire backlog currently stands at over $400bn, equating to roughly 6,000 planes and 7 years of production 6,000 • Airbus at max levels of production can make 756 5,000 23% A320neo aircrafts. 60% 4,000 • Backlogged 7.7 years • 3,000 Boeing at max levels of production can make 684 2,000 737 MAX aircraft A320neo 737 MAX BCA BDS BGS backlog backlog • Backlogged 6.8 years Sources: Airbus and Boeing Annual Reports, Yahoo Finance, Bloomberg 5 Airplane Manufacturing Overview Overview Boeing and Airbus’ Duopoly • Air traffic has exploded in the 21st century, growing at an average Market Share for Single Aisle Planes rate of 6.75% since 2010 • To meet this explosion in demand, manufacturers have been Airbus and Boeing forced to make significant investments in increasing production make up 99%+ of rate 41% the commercial • Most airlines around the world are being forced to update their aircraft fleets as environment regulations and pricing pressure require 59% manufacturing companies to fly incredibly fuel efficient planes market share • Ecommerce is also driving growth in air cargo manufacturing Airbus Boeing Changing Airline Industry Landscape Industry Model • In the airplane manufacturing industry, companies must place orders years in advance • In the case of the Boeing 787 Dreamliner, the first order was placed in 2004 and the first delivery was in 2012. Meanwhile, some 737 MAX’s are not set to be delivered until 2030 • Once a company places an order, it is very difficult for them to rescind their commitment. • Generally, about 50% of the cash is sent before the plane arrives, and companies do not want to find another buyer and move to the bottom of their backlog Sources: Bloomberg, Company Annual Reports, Wall Street Journal 6 1 Fixing the 737 MAX MCAS Hotfix Strong Catalyst • Boeing is currently working on a • A major catalyst for upside in Boeing will be the expedient hotfix for the current MCAS system success of its software patch and retraining that they are looking to launch as • Entire grounding situation unlikely to change airline soon as next week opinions on the company’s products as shown in 2013 • This fix will change the MCAS 787 Dreamliner incident system to require both sensors to • Once grounding order is lifted, Boeing can also deliver planes engage the system, and the system it is currently producing to customers will only attempt to bring the nose • 40-60% of revenue from 737 MAX’s comes at down once delivery • Boeing is also introducing a • Lift of grounding order will also have a positive effect retraining program, particularly for on Boeing’s share price the MCAS system on the 737 MAX When will 737 MAX’s fly again? Restoring Image: is an aircraft a B2B or B2C product? • Likely months before 737 MAX’s will be approved to fly again internationally • FAA, in light of their culpability in original situation, will be much more comprehensive in reapproval • International regulators in multiple countries will no longer rely on FAA data and will be conducting their own tests of software update • Department of Justice has issued subpoenas to at least one person involved with 737 MAX development • Unclear what is under investigation, likely safety and certification procedures conducted by Boeing Sources: Boeing, 10-K, Bloomberg, Google Flights 7 2 787 Precedent Issues Battery Fires and Fuel Leaks on the 787 • In January 2013, only months after the introduction of the Boeing 787 Dreamliner, there were six incidents of battery fires and fuel leaks aboard 787’s that led to international groundings for over four months • All Nippon Air, the only company to comment on its losses from the groundings, reported to lose $15 mm from 17 grounded planes • While the total amount to all companies that Boeing had to pay out then was undisclosed, analysts believe it was around $500 mm • These grounding costs for Boeing proved relatively minimal after insurance, and following the secondary review process the Dreamliner emerged with the reputation as a safe, fuel efficient product. • Sales recovered quickly and outpaced the original target of 1,300 orders Current 737 Issues Per Unit Cost of Grounding (Totals in MM) • Despite the fact that the 737 incidents have resulted in two fatal 6 weeks 8 weeks 10 weeks 12 weeks 14 weeks crashes, many airline consultants believe this grounding will be shorter than the 787 one in 2013 $40,000.00 $1.68 $2.24 $2.80 $3.36 $3.92 • The current issue centers only on the MCAS system, whereas $50,000.00 $2.10 $2.80 $3.50 $4.20 $4.90 previous 787 groundings dealt with battery and fuel tank issues that took months to identify $60,000.00 $2.52 $3.36 $4.20 $5.04 $5.88 • FAA regulators have said they expect the groundings to last until mid-May $70,000.00 $2.94 $3.92 $4.90 $5.88 $6.86 • United, meanwhile, has taken the 737 MAX series out of its $80,000.00 $3.36 $4.48 $5.60 $6.72 $7.84 schedule until at least June 6th Sources: Bloomberg, Company Annual Reports, Wall Street Journal 8 3 Prohibitive Switching Costs Overview Alternatives? § Backorders for Boeing's 737 Max are roughly 4,700 (about § With such high levels of backorders, it is simply unfeasible 80% of the company’s backorders) and roughly 5,800 for its for all Boeing orders to be recalled and switched to Airbus rival, Airbus’ A320neo § Airlines would have to wait much longer than usual § Airlines demand for these fuel efficient single aisle aircraft and this would negatively impact operations and like the 737 MAX and A320neo is simply insatiable, as both sales with limited amounts of aircraft Boeing and Airbus are backordered 6-8 years each § In order for airlines to switch from being a Boeing carrier to § Airlines are switching out of their aging and fuel inefficient an Airbus carrier would lead to massive fixed costs (ie pilot fleets as margins are trimmed across the industry by retraining, entire new inventory of spare parts) introduction of budget airlines such as Frontier, Allegiant, § For example, Southwest only flies 737s (249 737 Max). It and Spirit would be simply too massive of a cost
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