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Boeing's Dividend Safety Score Downgraded to Borderline Safe on Growing 737 MAX Uncertainty

Boeing (BA) shares have slumped nearly 13% over the last week, driven by a report released by Reuters on Friday that surfaced new concerns about the aircraft manufacturer's safety practices and oversight.

Specifically, Reuters uncovered internal messages between two Boeing pilots stating that the 737 MAX's flight-control system acted up during a 2016 testing simulation, less than a year before the plane was certified for commercial service.
Source: Reuters

As you may recall, the 737 MAX is Boeing's best-selling plane model (expected to account for about 40% of total profits) and has been grounded since March 2019 following two deadly crashes.

Boeing had discovered these concerning internal messages some months ago but did not alert the Department of Transportation about them until after Reuters' report was released.

Naturally, the U.S. Federal Aviation Administration (FAA) wasn't happy about this and issued a statement late Friday:

"The FAA finds the substance of the document concerning. The FAA is also disappointed that Boeing did not bring this document to our attention immediately upon its discovery. The FAA is reviewing this information to determine what action is appropriate...

The FAA is following a thorough process, not a prescribed timeline, for returning the Boeing 737 MAX to passenger service. The agency will lift the grounding order only after we have determined the aircraft is safe."

Boeing responded on Sunday evening, stating that it had released this information earlier this year to government investigators. 

The company also said that the pilot's comments reflected "a reaction to a simulator program that was not functioning properly, and that was still undergoing testing... The simulator software used during the Nov. 15 session was still undergoing testing and qualification and had not been finalized..."

Regardless, it's not a good look that Boeing didn't offer up this information to the FAA and Department of Transportation (DoT) sooner. As Warren Buffett once said, "There is seldom just one cockroach in the kitchen."

Might Boeing have been too aggressive with internal deadlines to get the 737 MAX to the finish line, perhaps overlooking safety concerns raised by simulation data in the process? 

Or is Boeing's interpretation correct that the internal messages were simply about simulator software that was still a work in process?

As an outsider, it's impossible to know for sure. What is certain is that Boeing's public image continues taking a hit, and every day that the 737 MAX remains grounded increases the financial strain Boeing faces.

In July, Boeing issued guidance calling for regulatory approval of the the MAX to return to service early in the fourth quarter of 2019, with finished planes being delivered again to customers beginning in January 2020.

This would allow 737 production rates to increase throughout next year, and Boeing would begin generating substantial free cash flow once again. As you can see, Boeing's ballooning inventory has significantly hurt its cash flow this year.
Source: Boeing Investor Presentation

Unfortunately, regulators may no longer be keen on conducting a certification flight in November. This weekend's news doesn't necessarily raise new safety concerns about the MAX, but it further strains Boeing's relationship with the FAA and DoT.

It's possible that some sort of disciplinary action is imposed on Boeing while the 737 MAX is simultaneously approved to return to service, but a further grounding delay is beginning to feel more likely.

We published an in-depth note in July about Boeing's 737 MAX challenges and made the following remarks about the importance of a timely return to service:  

"If Boeing finds itself in a place where it can no longer predict when the 737 MAX is returned to service, and it worries about its future liquidity for whatever reason, then its nearly $5 billion annual dividend commitment could be tested.

Such an outcome seems like a low probability event, especially since Boeing appears open to ceasing production to preserve working capital. However, investors holding shares of Boeing should understand that the stock could be more volatile than usual in the months ahead. The stock's risk profile has increased following the MAX's grounding, and the short-term financial stakes are high if the return-to-service timeline is pushed out.

As we stated in our April 2019 note, we will continue monitoring the situation to ensure that Boeing's market share remains stable and the MAX grounding is indeed temporary rather than longer term in nature. Otherwise, Boeing's cash burn and liquidity position will need to be evaluated, and its Dividend Safety Score could be downgraded."

With return-to-service timing becoming murkier, potentially adding billions of dollars of costs, we are downgrading Boeing's Dividend Safety Score to Borderline Safe until more clarity is provided by regulators.

The firm's liquidity seems adequate to handle a delay of several months, but it's less clear how Boeing might respond to a prolonged delay, not to mention the potential for any order cancellations or rejections by disgruntled customers. 

Boeing still appears to be a quality business for the long term as global air traffic grows and the market remains a duopoly with Airbus. However, the short-term outlook is fuzzy and could get worse before it gets better. 

While a dividend cut still seems unlikely based on what we know today, we do our best to take a conservative stance with our Dividend Safety Scores, especially for low probability, high severity risks like this.

Boeing next reports earnings on Wednesday, and we should know a lot more about the return of the MAX by the end of the year. Should the plane return to service in a reasonably timely manner, I expect Boeing's Dividend Safety Score to be upgraded.

I plan to continue holding our Boeing shares in our Top 20 Dividend Stocks portfolio and will provide any updates as necessary.

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