A Longtime Aerospace Analyst Questions Boeing's Future

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1:37Hello and welcome to another episode of the Odd Lots podcast. I'm Tracy Allaway. And I'm Joe Weisenthal. Boeing, have you, Boeing. Keep that in. Don't keep that in. No, keep that in. Now you got to keep it in. I've said before, I have a soft spot for Boeing. So that's why I'm mixing Boeing and Joe up. Okay, Joe, have you seen Boeing shares recently? Actually, I haven't looked in a while, except, you know, like we did an episode on Boeing about three or four weeks ago. So not good. Yeah. And they have not recovered much. So not good. So shares are down 20 percent since the start of the year, which is never a good sign when you lose a fifth of your market value in about six weeks.

2:19but probably one of the more damning things that has happened recently in terms of the share price is do you remember when the company announced it was pausing 737 production for a day and the shares went up like six percent that seems bad when the market is rewarding you for not making your signature product there's two funny things to me and again funny you know all the caveats than it entails. It's funny that Boeing has the reputation of being the company that's obsessed with its share price and pleasing shareholders. Airbus doesn't. And of course, Airbus has a much better share performance than Boeing.

2:56It's done phenomenally well over the years. And it's also just kind of crazy, setting aside competition, that Boeing is still nowhere near its peak in 2019, despite what we know to be like a booming global market for aviation. Like that's one thing we know, like pre-pandemic, post-pandemic, just absolute boom. You always hear about this expansion of new airlines in the Middle East and Asia and et cetera. And so we know that there's this huge general bull market going on and Boeing doesn't seem to have capitalized on any of it. Well, not just a booming market in commercial aircraft, which you're totally correct, as you observe it, has been a busy few years.

3:32But also we've had so much defense spending. That's right. And things like the IRA and things like that. And even with that happening in the background, America's premier aerospace and defense company just doesn't seem to have benefited from it. The share price has basically been flat for the past three years. Kind of amazing. And I think it's worrisome, right? Absolutely. Because, you know, setting aside the concerns of Boeing shareholders and they're probably pretty unhappy. Like if the U.S. wants to be a big manufacturing powerhouse and again, or be able to build more complex stuff domestically, it's really a bad sign that the sort of premier domestic manufacturer for global markets, one of only two companies that basically controls the commercial jet industry, like is getting worse at building plans.

4:26Yes, absolutely. So we have previously recorded an episode on Boeing with our Bloomberg colleague, Peter Robison. He's also the author of Flying Blind, the 737 Max Tragedy and the Fall of Boeing. And we talked about what the Alaska Airlines door blowout actually meant for the company and also the emphasis that Boeing seemed to place on financial performance and ironically, its stock price versus a culture of safety and engineering. But I feel like there is so much more we can say about this topic and so much more to dig into. And I'm really happy that we do, in fact, have the perfect guest for today's episode.

5:05This is the guy, the aerospace guy, back when I was covering airlines and aerospace in like 2006. He was the expert back then. And in 2024, almost two decades later, he is still the guy to talk to on aerospace. So I am very happy to say that we're going to be speaking with Richard Abulafia, again, a longtime aerospace analyst and managing director at Aerodynamic Advisory. So, Richard, thank you so much for coming on All Thoughts. It's good to talk to you again. Yeah, same here, Tracy. Thanks so much for having me on. Thrilled to be here. You know, I should say, in addition to being the aerospace guy and just an all-round expert on this industry, you also have a reputation for telling it like it is.

5:50And I think at this point, a lot of the cultural changes at Boeing are probably well known. But you pointed to a pretty interesting development that I will confess I hadn't even noticed. It happened late last year where the current Boeing CEO, David Calhoun, basically dissolved the company's strategy department. What was that about? Yeah, I mean, that's a mystery. But like all good mysteries, it just sort of lends itself to theorizing and indeed conspiracy theorizing. And the most obvious statement was, we don't have a future. Not only was it the dissolution of the company-wide strategy department, but there was a wholesale gutting of a lot of the business unit strategy departments.

6:37So it wasn't a devolution story. It was a we don't care story, which was, of course, as baffling as it gets. it sort of fits in with this nagging feeling in the back of my mind that the really awful performance is kind of okay to the folks at the top, because ultimately their playbook is, well, about as deep as the Jack Welch GE playbook, which is if things go to hell, you simply break up the company. And in that case, you know, performance doesn't matter. The future and strategy doesn't matter. you simply think, you know, and indeed, maybe the bad performance is kind of a plus in a strange way to regulators and everybody involved, customers, whatever.

7:18It almost becomes a relief when the company is broken up. That's, of course, an extreme departure scenario. But I can't think of any other explanations for doing that. Well, maybe what is a strategy department? And what is it? So they said, I think, I guess it was in November that their strategy boss was leaving, that the strategy teams would be folded into the business units that they support. What do these words actually mean in practice? What are strategy teams? I thought everyone did strategy. Yeah, everyone does, right? It's kind of impossible to imagine a large corporation not having a strategy function.

7:55A strategy is about the future. A strategy is about allocating capital for future technology development, for future acquisitions, for allocating people, for developing people and their skills and capabilities. Basically, it coordinates resources across business units. And within the business units, of course, it thinks about new products to develop, who their competitors are and are likely to be, and what key enabling technologies are needed to compete in the future. One of the reasons we wanted to talk to you is because you are well-connected in this industry, in addition to being an expert on it.

8:31But can you describe like the mood at Boeing at the moment or how people within aerospace and defense actually feel about this company? After 35 years, I've never seen anything like it. And it kind of resembles that common trope in horror films. Very often the call comes from inside the house. You know, I mean, I spent last week in Seattle and, you know, it's nothing short of horrifying, but it also sort of illustrates one of the strange aspects of this so-called crisis, which is that the problem is purely at the top. There are a lot of really good people at Boeing and a lot of really good products and a lot of really good technologies.

9:07You just have some people who are really, really bad at their job at the top. So as you can imagine, people within the company, and there are again many good ones, are often mortified by what's happening. Well, so I understand in the abstract we can say things like, oh, the bean counters took over and they don't have as much of an engineering culture or safety culture or they just worry about the stock price. And I get all like why that's all bad. And I guess on a sort of theoretical level, it sounds very bad. But why don't we talk concrete? If you're an engineer at Boeing today working on something, how is your life different than it was, say, 20 years ago?

9:48Well, there's no future, right? And, you know, the astonishing thing. Like what do you, like day to day, like what is, some boss three levels up has made decisions and various priorities have changed. So how does it like manifest itself on a sort of day to day basis or quarter to quarter basis where it's not as compelling of a place to work? Like what has changed about the nature of the job? You need something to dream for. You need something that represents the future. And, you know, Dave Calhoun, the CEO at the top of the heap, said about a year and four months ago that, don't worry, we won't be launching anything new for at least another decade.

10:30other than sheer demoralization and encouraging the competition i mean the only way to explain it is that he's he's the best ceo airbus could ask for uh but from the standpoint of being an engineer getting the heart of your question joe if you're an engineer you hear that what are you working for exactly you're coming up with work packages on the basis of i don't know minor tweaks of existing products stuff that's already in the pipeline you know it's a tight market for technical labor, you're probably going to be pretty interested in going to work for somebody else. So you might also notice that the demographics are changing because the young and enthusiastic folks who have a future are leaving or not joining.

11:10And that too, of course, is a significant change in the fabric of your workplace. So you mentioned launching something new, and this kind of goes to the heart of, you know, I guess the current crisis within Boeing, but also the origins of the safety issues and the idea that instead of doing a clean sheet aircraft, as it's called, Boeing decided to make amendments to its existing 737 model. And that resulted in the 737 Max and its stablemates. And then that led to the crashes, which claimed, I think, almost 350 lives and the resulting controversy over Boeing and what we're basically discussing now.

11:50But just to back up, Could you maybe talk about what are the decisions or the factors that go into whether or not to design a completely new aircraft? Well, I'm afraid I must disagree with that narrative. I thought the MAX was the right decision at the time. There were few enabling technologies for a new jet in that class except turbines. So put a new engine in it. We didn't know then the sheer popularity of the middle market. But even if we did, I'm not so sure that would have changed anything. What was important is that the Macs go ahead and then the company do what it does every decade, launch a new product.

12:29And in that case, that product would have been a notch above the Macs. You know, as for the development of the Macs, there were cultural problems at play that led to the MCAS problems and the tragedies that resulted. But it wasn't economics. I mean, the economic difference between MCAS done right and MCAS done poorly is zero. Zilch. This was purely a cultural driver that led to these tragedies. Now, if you've got the MAX out of the, you know, OK, it was the right thing to do. It should have been done different, but it was the right thing to do. What should have happened next is they should have said, OK, look, back in the past, we had this other aircraft in that middle segment, the 757.

13:11It's dead. we need to think about a replacement. And they were thinking about a replacement. And that was the first thing Dave Calhoun killed when he came in. How would you characterize the cultural failings that led to those tragedies? Very simply, a disconnect between the people at the top and the people who are focused on the core business of the company, which is, of course, designing and building aircraft. You know, the folks at the top, and this started under Jim McNerney back in the late 2000, you know, first decade of the 2000s, he decided that the supplier base and the workforce were mere disposable commodities that should be crunched.

13:53They should be regarded as one giant ATM. You take money out of them, there's no consequences. People will always want to work there and people will always want to be suppliers our way or the highway. This was bound to have consequences. And it just got worse and worse through the 2010s. And as a consequence, you had a badly demoralized workforce. Now, as part of his strategy, of course, McNerney back in the 2010s, it became necessary to replace people on the board with people who had no technical degrees. They were one step away from being complete randos who sold accordions. And, you know, the most farcical moment was Nikki Haley was on it and she left because she didn't think the company should be taking government money.

14:37It's a defense contractor. She was like, seriously? So it was it was a bizarre organization designed to rubber stamp and not much more. It's gotten a little bit better in the aftermath of the MCAS tragedies. But, oh boy, that terrible culture of bad governance and that complete disconnect with the people who are charged with actually doing their jobs, a complete lack of redress and inability to push bad information. You know, I remember very well on 7807 when the 787 Dreamliner, their last clean sheet design, was rolled in. And I was talking to McNerney and he told me, like, this plane's going to fly in September.

15:18Well, maybe October. Nope, it's September. I didn't say that. And it took someone completely outside, way lower down on the organization chart to say, actually, Richard, that plane is filled with sand. It's not flying for another year, which was correct. And he's not going to be caught in a lie. He simply had no way of knowing, and there was no mechanism with which to transmit bad information up the food chain.

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17:18Discover how at mastercard.com slash commercial acceptance. On the topic of culture, the other thing that tends to come up is the acquisition of McDonnell Douglas and the idea that, well, you brought in these new executives and they had much more of a numbers-based focus. And I'm always kind of curious, is that true, first of all? And then secondly, why did they seem to wield so much influence within Boeing, given that they were the company being acquired? Presumably they were, in terms of social hierarchy, on a lower rung. Yeah, it's a complicated one. And of course, the bitter joke told at Boeing is that McDonnell Douglas used Boeing's money to buy Boeing.

18:06It's just a bizarre chain of events. There were all sorts of interpersonal reasons, minor scandals and whatever else that resulted in a decapitation of some of the key Boeing executives. And as a consequence, McDonnell Douglas folks were there to fill the void because they were kind of squeaky clean until they too were toppled. A couple of them were toppled by scandals too. It was a bizarre chain of events. Now, is it true? Well, you know, there's no question McDonnell Douglas was far more financially focused. It had been on a 30-year glide path towards irrelevance because of this focus on, you no finance and nothing more between the creation of McDonnell Douglas in 1967 and its absorption into Boeing.

18:49It was pretty clear the way things were going all those years. Having said that, it was still an aerospace company, right? What happened in the mid-2000s with Jim McNerney and now Dave Calhoun is that Jack Welch GE culture, which has nothing to do whatsoever with aerospace. They might as well be hedge fund managers or somebody who's merely concerned with numbers and has no knowledge of the industry whatsoever came to rule. So yes, you can put some of the blame in McDonnell Douglas people, but really it's more that Jack Welch influence or that I suppose heritage of Jack Welch influence about seven or eight years later.

19:28Jumping back towards the present. So you mentioned the comment from the CEO last year where they're like, we're not in any rush to introduce a new clean sheet plane. I assume that that's kind of the thing shareholders like to hear because it means you're not going to have a big upfront budget, that you have a lot of, no pun intended, runways still left with the existing product set. But what are the costs of launching a brand new product? And how do companies think about the cost benefits of like when to launch one versus when to just try to get more out of the existing product? Yeah, that's a contentious issue, an important area of discussion.

20:16I'm kind of an outlier. I don't think it would have mattered at all to investors. And indeed, there would have been more positives than negatives. And, you know, if you look at it, this is a company now with$40 billion in net debt, down from$45 or so a couple years ago. So to start a new program would be maybe$2 billion incremental per year in independent research and development funding for, you know, probably about six years, seven years, with overruns could go higher. Now, that's obviously a drag on shareholder returns. But put it another way, we're now in a situation where Airbus' competing jets are getting hundreds, thousands of orders.

20:54They're losing market share at Boeing. Wouldn't some investors have been galvanized by the sight of Boeing getting those orders with its new jet and said, what a great place to park my cash because this is a long-term growth story. I'm not concerned with dividends and buybacks. I just really like the idea in a land where there's plenty of capital available, not a lot of good ideas out there. This is a safe bet. Well, is there some part of the market? So like, theoretically, is there some part of the market that right now Boeing would be competing better in if it had a different product? Or like, I mean, I don't know.

21:32I don't know what the end buyer is, but if you're sort of dreaming what that or imagining what that next plane would look like. What is the end buyer that they're not tapping into that may be going to Airbus? This has been apparent for at least a decade. Basically, there's this middle market of about 200 to 230 seats, about 5 ,000 nautical miles. It's a fragmentation machine. It allows people to bypass crowded hubs and fly point to point where they want to go. Now, right now, Airbus has a license to mint money with the A321neo. It's not very good at that, frankly, that mid-market, but it's the one product you can buy if you're an airline.

22:08So guess what? Everyone is buying it. The order book for the 321neo is now about the same as the order book for all variants of the 737 MAX family. And last year, after Dave Calhoun said, don't worry, we won't compete in that class, they sold a record 1 ,300 of those jets. And what's frustrating is it's not a very good jet. You could defeat it the way Boeing has always defeated. Boeing has had a second mover philosophy. 767, 777, 787, 777-300ER, all of them were responses, and they all did somewhere between 5 % and 10 % better than the jets they went against. They won. That's how the company conquered the universe.

22:50This just reminds me, it's kind of ancient history, but wasn't there an argument that when Airbus actually started developing the A320s, I guess it would have been in the 1980s, that Boeing could have and probably should have in retrospect just like immediately killed it and gone head to head by developing a new aircraft. Nah, I don't believe that because the 320 is a good plane. But, you know, the response to it basically, well, it was right in the middle of the 737 34500 series, which continued to do pretty well. And they replaced it with the NG. It did amazing. So I'm just, you know, this is clearly, the Max is clearly the last stop on the 737 line, no question of that.

23:33And it really is having, they're having a hard time scaling it up to be that middle market machine. Matter of fact, it's impossible. So there are limits, but the 737 in of itself, I think is actually a pretty good product. It's how it was executed. That's the problem. So this was actually going to be my next question. But Calhoun says they're not going to develop anything for 10 years, which could mean that they don't have a clean sheet aircraft flying like until 2040 or something like that. And at the same time, Airbus is taking massive amounts of market share. The two used to be Boeing and Airbus used to be fairly evenly matched.

24:09That is definitely no longer the case. But A, what does Boeing do in this situation to catch up? And then I guess B, is there actually a desire to catch up? this looks like a glide slope towards oblivion. Because remember, it's not just the loss of market share. It's also the demographics. You know, engineering workforces have that muscle memory that needs to be maintained. And it's been since 2004 that they've launched, since they've last launched a clean sheet design. They've done some good work since. But again, you're talking about an aging engineering workforce that's not attracting new people.

24:45Will they have the kind of core skills needed to create a new jet in the 2030s? I have no idea. That is such a fascinating point that, I mean, we talk about it in some context, this idea of like internal know-how, but I hadn't thought about this idea. If you have nobody or if it's been decades since you've started a plane from scratch, do you still have anyone there? What makes a good plane? I have no idea. I fly. I don't really pay much attention. I never know what kind of aircraft I'm on. If it gets me there, that's fine. When you say it's a good plan, or it's not a very good plan when you're talking about the newest Airbus one.

25:18What makes a good plan? Well, you know, obviously safety is table stakes. Let's get that out of the way. But the most important thing is to acknowledge that your customers, and you need to talk with at least 15 or 20 of them before launching a jet, have incredibly narrow profit margins, which means if you can do specific routes for them that's, you know, 5 or 10 percent better, you win. That's what happens this is so we talk about fuel efficiency the the cost of like a mechanic like how much repair they need like your total operating costs you know it's a function of fuel efficiency and of course maintainability but really fuel efficiency now revenue too is important so things like belly cargo the ability to put revenue producing cargo under the hold of the jet obviously getting passenger configuration right that's absolutely key and then there's the extraneous stuff like you know little frills passenger comfort you know blue lights whatever That matters a whole heck of a lot less than the importance.

26:14The 321neo is, you know, the latest development of that 1980s era A320 family. It should have bigger wings to do longer routes, more powerful engines. It should have, you know, basically it should be more of a proper mid-market jet rather than a scaled up 150 seater that's trying to do the job. Is it catastrophic? No. That's why everyone wants it. You know, it's good enough. But the point is that in an industry where everyone has 2 % profit margins, if they're super lucky and super good, yes, you can beat that by 5 % or 10 % in efficiency. Probably more like 15 % or 20%, I'm thinking, at this stage.