Boeing To Halt 737 Output In January In Move That Will Strain Its Supply Chain

Since the grounding of the 737 MAX following the second of two deadly crashes in March, Boeing has sought to keep the production line moving and to minimize disruptions to the intricate web of smaller companies it relies on to supply roughly 80% of the components that make up its best-selling plane. However, with the Chicago-based company’s hopes dashed of winning approval by year-end for the 737 MAX to return to service, it has decided to halt assembly of the plane in January.

That could have far-reaching consequences for Boeing’s suppliers depending on the duration of the production freeze. The company didn’t address how long it could last.

“This decision is driven by a number of factors, including the extension of certification into 2020, the uncertainty about the timing and conditions of return to service and global training approvals, and the importance of ensuring that we can prioritize the delivery of stored aircraft,” the plane maker said in a statement Monday evening.

No layoffs are planned. The company said that the 12,000 workers at its Renton, Washington, factory will continue 737-related work or will be temporarily reassigned to other factories in the Puget Sound area.

Layoffs or furloughs could be forthcoming, however, at some suppliers. Among those that could face the greatest stresses are its aerostructures suppliers, chiefly Spirit AeroSystems, which makes the fuselage for the 737 MAX, analysts say.

The airframe is the largest portion of a plane, but building it is one-off work, with none of the highly profitable maintenance and repair sales that suppliers of other components enjoy. And smaller aerostructures suppliers have been left financially stressed as they tooled up to prepare to raise production of the 737 MAX while Boeing stretched out payment terms to 90 to 120 days, says Kevin Michaels, a consultant with Aerodynamic Advisory.

If it’s more than a one-month production pause, “Boeing and Spirit would need to be prepared to intervene to make sure small, vulnerable suppliers are there on the other side of this,” he says.

Boeing has been burning through $5.5 billion a quarter as it has built roughly 400 737 MAX aircraft it can’t deliver because of the worldwide grounding of the plane, and its balance sheet can no longer sustain that rate of spending, Bank of America/Merrill Lynch analyst Ronald Epstein said in a research note earlier Monday.

No deliveries means precious little revenue for Boeing: It typically only collects 1% to 5% of the purchase price of a plane as a down payment, with the final 50% due on delivery and the balance coming in payments as the delivery date approaches.

The darkening skies for airlines also were likely a factor in Boeing’s decision to halt production. Airlines placed thousands of orders for new airplanes while passenger numbers were expanding briskly this decade, peaking at 7.6% growth in 2017. This year passenger growth has slowed sharply, to a rate of 3.4% in October, and airlines aren’t likely to go out of their way to help Boeing expedite delivery of new planes next year for fear of adding unnecessary capacity, says Richard Aboulafia, an aerospace consultant with Teal Group.

Boeing had been planning to ramp up 737 production this year from 52 planes a month to 57. Instead, in April it reduced output to 42 a month, but it had Spirit continue to build 52 fuselages a month in what may have been a concession to the more sensitive condition of aerostructures suppliers. With no aftermarket revenue, they require certainty and consistency in delivery schedules to make the business work, says Michaels. “It’s a ballet that’s choreographed,” he says.

Spirit is working with Boeing to determine what the freeze means for the company and what steps it will take to mitigate the impact, a spokesperson told Forbes. In its second-quarter earnings call, Spirit CEO Tom Gentile said the company had game-planned pausing or reducing output in the event that Boeing halted 737 production.

Spirit reduced thousands of employees to four-day workweeks for 10 weeks over the summer to cut costs.

If Boeing’s production freeze lasts for three months, it could cut Spirit’s 2020 profit by 23%, Vertical Research Partners estimates.

Another public aerostructures supplier that stands to be squeezed is Ducommun, which makes spoilers, engine inlet bulkheads and exhaust fairings for the 737 MAX using titanium that it orders 12 months in advance. The 737 accounted for roughly 16% of Ducommun’s revenue in 2018.

Boeing didn’t respond to questions on what steps it would take to support suppliers through the freeze.

If suppliers halt production, Boeing will need to pay some to keep capacity in place, says Aboulafia.

The decision to halt production rather than slow the rate promises to make it more difficult for Boeing and its suppliers to raise output when it’s over. “Think of it as a standing start versus a running start,” says Aboulafia. A complete halt “puts enormous pressure on their supply chain and makes it hard to get back to 42 a month, let alone 52 or 57.”

Layoffs would further complicate the picture given the strong job market — skilled talent would likely find work elsewhere, and Boeing suppliers could struggle to staff back up.

General Electric and Safran, which produce the MAX’s LEAP-1B engines through their joint venture CFM International, could be forced to adjust production rates. Engine component makers could most likely handle a short production pause, but it remains the most stressed part of the supply chain, Michaels says, particularly casting and forging shops, amid teething problems for the LEAP and Pratt & Whitney’s geared turbofan. GE and Safran might need to help out some that are dependent on the LEAP, he says.

Interiors suppliers stand to be hurt a little more than other sectors by a production halt, he says, due to the lower share of aftermarket work in their revenues, he says. United Technologies unit Collins, Recaro, Safran and Hexcel are among the interiors suppliers on the MAX.

Large, diversified components makers like Honeywell and United Technologies won’t take as much of a hit due to the profitable cushion of sales of parts for maintenance and repair. With airlines delaying the retirement of older 737s due to the grounding of the MAX, that business has gotten a boost.

Smaller suppliers more dependent on Boeing may be in worse shape to weather the freeze due to the plane maker’s campaign to wring 15% to 25% in cost savings from them under its Partnering for Success 2.0 program, which has included a slowing of payment terms, says Michaels. “It’s made them more vulnerable to hiccups in production and pauses than in the past.”

Boeing warned in its October earnings report that it might halt or slow production if it were unable to win approval this year from safety regulators for revisions to the 737 MAX flight controls and related training changes.

FAA Administrator Steve Dickson told the House transportation committee last week that he would not clear the plane to fly until 2020, and summoned Boeing CEO Dennis Muilenburg to a meeting in Washington to address concerns that the company was attempting to publicly pressure the agency to move more quickly.

Dickson has stated repeatedly that he has no timeline for when the 737 MAX will return to service. Boeing made no mention of a date in its statement Monday. Bank of America analyst Epstein is forecasting March 1, but warns it could slip to April or May given uncertainties on Boeing’s progress toward meeting certification requirements and regulators’ deliberate approach.

Boeing shares fell 4.3% to close at $327.00; Spirit dropped 1.6% to $78.88.