Via SeekingAlpha.com

It seems that the COVID-19 threat to the global economy is no longer the only factor we have to worry about. With new sanctions against China’s Huawei set to be implemented, as well as other measures it is likely that China will resort to retaliation measures. A number of companies have already been mentioned as probable targets, including Apple (AAPL), Cisco (CSCO), or Qualcomm (QCOM). But Boeing (BA) is the one that is most likely to be targeted because it makes the most sense to do so from a Chinese perspective.

Why Boeing and not others

If The US continues to go after Huawei, trying to put it out of business by depriving it of much-needed components such as high-performance chips China will have to retaliate not only out of strategic considerations but also due to public pressure at home. Apple would be an obvious choice at first glance. It is a major US tech company and a rival to Huawei, especially in the mobile device sector. Apple’s manufacturing activities employ many Chinese workers, therefore there is a great deal of risk of China losing out as heavily as the United States if it goes after Apple. Somewhat similar dynamics are in place in regards to other US tech companies.

Boeing is a completely different story. It employs over 160,000 people worldwide, about 90% of which are employed in the US. China on the other hand is currently the second-largest market by passenger flights and it has been the fastest-growing major market in the last two decades.

Passenger flights by countrySource: World Bank.

Boeing would stand to lose a lot by being blacklisted by China, while China’s economy would not suffer much as a result, because its airlines have alternatives including Boeing’s main rival, Airbus (OTCPK:EADSY), but also its own emerging airplane manufacturers, as well as potentially Russian plane models such as the MC-21 which is meant to compete with the Boeing 737. In fact, China would benefit from such a move because it would clear the way for its own industry to establish itself on the domestic market and regionally.

Boeing is also an obvious target because it is already in a weakened state, therefore it is likely to suffer massive production shut-downs, which would have a very real impact on the US economy. We have to keep in mind that it is not just the Boeing employees, but also those employed by Boeing’s sub-contractors, as well as the jobs in the community that are derived from the presence of Boeing or Boeing’s supplier’s plants. We should remember that when Boeing cut the production of the 737 MAX, it was estimated that the net impact on US GDP will be minus 20% of the total US economic growth rate.

Beyond considerations such as how it would affect the US economy, China has a strategic long term interest to beat down one of America’s most important industrial entities. Currently, the global civil aviation industry is dominated by planes produced by just two companies, Airbus and Boeing. China is looking to compete within this space, with its own emerging champion, Comac, which is looking to start capturing a larger part of China’s domestic passenger plane sales particularly with its new C919, which is meant to compete with the troubled 737. It remains to be seen to what extent the plane will be successful, but if it turns out to be a successful project, between all the factors which are going against Boeing, it could take a serious bite out of its business in China and then perhaps elsewhere in the developing world.

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The 737 safety issues are leaving Boeing in a weakened position at the worst possible time.

Even before the COVID-19 pandemic hit, which hammered airlines particularly hard, given that there is very little air travel still going on due to fears of contagion, Boeing was already taking a hit due to its 737-MAX safety issues. In the latest quarter, Boeing suffered a loss of $1.4 billion. Revenues declined by 26% to $16.9 billion from $22.9 billion in the same quarter a year earlier.

More worrying is the increase in long term debt from just under $20 billion in the first quarter of 2019 to over $33.75 billion as of last quarter. Interest expenses rose to $262 million for the latest quarter, compared with $123 million in the first quarter of last year. I don’t usually pay as much attention to interest costs for non-commodity related companies, but the significant spike in this particular case cannot be ignored, especially since it is likely to get worse. Even though there has been a spectacular deterioration in Boeing’s debt and debt servicing situation in the past year, it is still looking solid at least for the moment. Interest on debt took up only 1.6% of revenues in the last quarter. Even if things will deteriorate further and that ratio will triple in the next few quarters, it is still a manageable situation. I personally tend to only start worrying once interest on debt starts to take up more than 5% of revenues.

The COVID-19 crisis is the more immediate and pressing problem that Boeing is faced with. Airlines are not doing particularly well at the moment. People are simply not traveling this year. Even though we are talking more and more about opening up the economy in the US, in Europe and many other places around the world the airline industry will take a long time to recover. When people will fly, they will have plenty of options to choose from, given that air travel demand will be weak for years to come. It is not inconceivable that customers will increasingly opt to avoid flying on the Boeing 737-MAX, as one of their likely options. In response to subdued demand overall and for passenger demand for the 737-MAX in particular, it is entirely possible that the current trend of cancellations of orders, as well as deferral of deliveries, will continue at a furious pace. Boeing’s financial situation will continue to deteriorate accordingly.

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The military side of Boeing’s business has been doing much better in the past year, although its performance was not stellar in that regard either. It helped to blunt the massive hit that Boeing took on the civil aviation side of the business. Revenue from the military side of the business did decline by about 8% in the past year, and it incurred a loss of $191 million in the first quarter of this year. Compared with the same quarter from a year ago, it was a poor performance given that it had a profit of $852 million. It may suffer from a decline in export demand going forward, especially from ME petro-states, which are currently suffering due to low oil prices, but also elsewhere as governments increasingly allocate money to keeping their economies afloat.

If the US-China tensions over trade and recently over Huawei will continue, Boeing stands a very good chance of being blacklisted by China for its airline purchases, which would be a huge blow. It would be a blow it cannot afford given the damage that is already being done by the 737-MAX accidents, as well as the COVID-19 outbreak. It is also a blow that may see it permanently lose ground to competitors. I voiced my opinion in this regard before, and I find that investors still have a hard time coming to terms with it, but it seems increasingly likely that when it comes to developing world markets Boeing will have more than just Airbus to worry about as a competitor in coming years.

Russian and Chinese alternatives to 737 series have a very strong chance of displacing Boeing sales in the developing world

Popular wisdom dictates that the two big plane manufacturers practically have a duopoly hold on the passenger airline market. Their strength lies in their broad airplane services network which makes it easy for airlines to service their planes wherever they may be destined around the world. For this reason, only Airbus is seen as a serious competitor against Boeing. Until recently it was thought that Airbus is and will be the only potential alternative for airlines looking to drop their 737-Max orders. Russia’s MC-21, which is comparatively a good replacement for the previously very popular Boeing model is set to get certified for the domestic market this year and international deliveries are set to start in 2023. It currently has orders with fourteen airlines domestically and abroad. There is a real chance that more orders will materialize, especially if the plane will live up to expectations.

China’s C-919 will likely do well on the domestic market, even if it will have inferior performance relative to the MC-21. Being a domestic producer for the world’s fastest-growing market, which is already the second-largest on the planet definitely has its advantages. China may also use its increasing economic weight and influence to convince developing countries around the world to buy its planes. Both Russia and China are also looking to outcompete both Boeing and Airbus on airplane costs as well as operating costs. Russia’s MC-21 is supposedly going to cost about 15-20% less, while its operating costs are also projected to be lower, due to a number of factors, including better fuel efficiency.

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Boeing’s problems started long before the industry-wide challenges posed by COVID-19, as well as arguably the Greta effect, namely flight shaming started to take a bite out of demand for air travel in a growing number of markets. The above-mentioned challenges are starting to take a heavy toll on Boeing’s financial performance and will continue to do so for a while longer, which will have long-lasting consequences for the financial health of the company. The worsening relationship between the US and China could further aggravate Boeing’s problems as it could find itself shut out perhaps permanently out of the Chinese market, which could potentially become the most important market for passenger aircraft manufacturers, based on past trends. The net effect on Boeing’s future may very well be that it will find itself unable to answer the challenge of growing competition for what may in fact be a shrinking industry in the short to medium term.

There is no denying the fact that even with all the troubles it experienced in the past year, Boeing is still a financially solid company, even after the terrible financial results it recorded in the last few quarters. If its China sales will cease, it will be yet another hard hit for Boeing, but not a terminal one by any means. A few more quarters of poor financial performance will still leave it in a decent financial position whether we are looking at its debt situation or at its revenue prospects going forward, given that it still has years-worth of orders on its books, and many of those contracts should materialize, even if some will be ultimately canceled. Having said all this, Boeing will be left in a weaker financial position within a few years, assuming the worst-case scenario, namely a China shut-out, just as the likes of Russia will be ramping up deliveries of competing aircraft. What this means is that more money will be needed to be spent on innovation as well as price discounting in order to outcompete emerging competitors. Boeing may not be able to allocate those extra funds, therefore this may be the start of a permanent decline.

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