By Joseph F. Patton, III – Vice President of Investments | June 3, 2019
The failure of the Boeing’s 737 Max is well known by now. It is the second failed rollout of a Boeing airplane in under a decade. Obviously this is a disaster for Boeing, but it is also problematic for the entire aviation industry and the US economy on the whole.
Aviation manufacturing is an extremely capital-intensive industry. The cost of establishing and operating a company is highly prohibitive. For this reason Boeing has only one major competitor, AirBus. Comac is a third but mostly inconsequential competitor, having gained market entry solely through the heavy financial backing of the Chinese government.
Aviation manufacturing is a natural oligopoly. The capital required to create airplanes en masse has made it so that a competitive market nigh unfeasible in the long run. This capital restriction means that Boeing’s failure has not created meaningful opportunities for its competition. The long lead time in airplane manufacturing requires that new planes be ordered years in advance. This creates very large order backlogs. At the end of 2018, Airbus’ backlog was 7,577 aircraft. A backlog of that size will take Airbus an estimated 8 years to work through. Airbus simply does not have the capacity to take on new clients. Any civilian airline looking to switch to Airbus for supply might put its air fleet back a decade. Comac is also too small and unproven to take on Boeing clients at meaningful scale. It’s apparent that airlines will be forced to keep older 737 fleet in the air while Boeing’s 737 Max issue is addressed. This will likely mean longer flight delays because repair time will increase. The 737 Max debacle will be a clear headwind for the entire non-military aviation industry including the airplane manufacturers, airports, and airlines.
It is inevitable that the industry’s troubles will have a spillover impact elsewhere. It cannot be overstated how vital aviation is to the world’s infrastructure. As traditional industries become more remote/electronic, the rapid movement of physical goods and people become more important. According to the most recent report by the FAA, the aviation industry employs 1% of the US workforce. However, the industry has an outsized effect on the economy: civilian aviation contributes over 5% of the total US GDP. The contributory effect on local GDP is even greater in states where aviation is a central focus. For example, aviation makes up nearly 20% of the Hawaiian economy. The simple fact is many businesses, industries, and local economies rely heavily on Boeing to operate as an efficient player in what is essentially a functional duopoly.
Boeing also has an outsized effect on one of the major indices of the US stock market: the Dow Jones Industrial Average. This is problematic because the index, to many people, is the defacto barometer of the US economy and the global equity market (and it isn’t!). Also, the DJIA is a price-weighted index; the more expensive a member stock, the more that stock influences the total DJIA number. Despite its sharp fall this past quarter, Boeing remains the most expensive stock in the DJIA by over $100. Its drop weighed on the DJIA while other indices moved upwards. In other words: as Boeing went, the DJIA went. Unfortunately, as we mentioned earlier, many people only look to the DJIA when gauging the health of our economy and global equity markets. Consequently, the troubles for both Boeing and the DJIA have hurt investor sentiment.