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Boeing 737 MAX: Indonesia Blames Design Flaws, Vetting

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Yesterday, The Wall Street Journal reported that Indonesian investigators had identified design and regulatory flaws and “pilot errors and maintenance mistakes” as the cause of the Boeing (BA) 737 MAX Lion Air crash on October 29, 2018.

The investigation report is still in the draft phase. The final document is set to be published in early November. According to The Wall Street Journal, the above is the “first formal government finding.”

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In March, The Seattle Times reported that the US FAA (Federal Aviation Administration) had delegated crucial technical evaluations of MAX aircraft to Boeing. The Wall Street Journal reported that “U.S. air-crash investigators are preparing to make public a handful of separate safety recommendations, ranging from bolstering the manual flying skills of pilots to enhancing FAA vetting of new aircraft designs.

Boeing 737 MAX software problem

The Lion Air crash was the first of two deadly accidents involving the Boeing 737 MAX 8. Within five months of the Lion Air accident, a Boeing 737 MAX operated by Ethiopian Airlines crashed.

Preliminary investigations into both crashes pointed to design flaws in the Boeing 737 MAX, specifically the MCAS (Maneuvering Characteristics Augmentation System).

Boeing has been trying to resolve the MCAS issue since mid-March. However, during a simulator test on June 26, the FAA discovered that Boeing’s updated software’s response was still delayed.

Boeing, which is working with the FAA to fix the issues, has stated it plans to submit the final documents for certification this month. It hopes to get regulatory approval in October.

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Boeing 737 MAX crisis financial impact

Boeing’s 737 MAX has been under a global flying ban since the Ethiopian Airlines crash on March 10. Before the Ethiopia crash, the 737 MAX was a fast-selling aircraft. The airplane accounted for nearly 70% of Boeing’s overall commercial jet shipments and 30% of its total operating profit. Due to its shipments being frozen in mid-March, Boeing’s total aircraft deliveries fell 54% YoY (year-over-year) to 90 units in Q2. As a result, the company’s revenue plunged 35% YoY. It posted a net loss for the first time in 12 quarters.

The company also faces massive compensation expenses. Together, Southwest Airlines (LUV), American Airlines (AAL), and United Airlines (UAL) own 72 MAX planes. Due to the MAX grounding, these airlines have had over 40,000 flights canceled since mid-March. All three companies are demanding compensation for their foregone revenue and operating losses.

In the second quarter, the grounding cost Southwest and American $175 million in pre-tax income. The companies’ overall capacity fell 3.6% and 0.8%, respectively, in the second quarter. On August 20, Reuters estimated that the MAX crisis had cost Boeing over $8 billion. The company set aside $4.9 billion in estimated compensation costs for MAX customers in the second quarter.

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Stock performance

Since the Ethiopia crash, Boeing’s market capitalization has shrunk by 10.2% ($24 billion). Due to the MAX crisis, Boeing stock’s YTD (year-to-date) return has eroded to 17.6% from 31% on March 8. Before the MAX grounding, Boeing was the top Dow Jones 30 stock. It has now slipped to 15th place.

The stock has underperformed the US iShares Aerospace & Defense ETF (ITA) and the S&P 500, which have risen 31.3% and 19.4% YTD, respectively.

Several analysts have cut their target price for Boeing stock or downgraded it. Of the analysts covering the stick, 63% suggest “buy,” down from 77% before the Ethiopia crash. None were bearish before the crash, but now two suggest “sell.” Their average target price has fallen to $411.14 from $440 before the Ethiopia accident.

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