Boeing tries to rise above quality failures at 737 Max supplier

The fortunes of Boeing and Spirit AeroSystems are linked like their factories, with railcars loaded with each 737 Max fuselage that the supplier builds in Kansas travelling through farmland and across the Rockies before ending half a continent away in Washington.

So Spirit’s troubles are also Boeing’s. The jet maker identified two separate quality failures on the work its supplier performed on the 737 Max, in April and August. While neither renders the aircraft unsafe, redoing the work delays Boeing’s deliveries to customers at a time when airlines are eager for planes.

Boeing and Spirit also reached a deal last week whereby the plane maker will help the supplier forestall a looming cash crisis next year by renegotiating contracts. Scott Hamilton, head of aerospace consultancy and news site Leeham, noted: “if Spirit were to collapse, Boeing would be the one most hurt, because 65 per cent of Spirit’s business is Boeing”.

While the new agreement gives Boeing an outcome it wants — a healthier supplier — the repairs to the 737 Maxes still could endanger Boeing’s own delivery targets for the year. Boeing, which will report third-quarter earnings on Wednesday, receives most of its cash from customers upon delivery.

The company’s chief financial officer said last month Boeing would be at the low end of its planned 400 to 450 Max deliveries, which was before it announced just 15 deliveries in September.

“Hitting 400 deliveries on the 737 might be a stretch,” said Melius Research analyst Scott Mikus.

Spirit used to be Boeing Wichita, nestled in the heart of Kansas’s aerospace hub and the state’s largest private employer.

The plane maker spun off the operation in 2005. The spin-off converted the fixed costs of factory and workforce to the variable cost of procuring parts, an advantage in the commercial aerospace industry where downturns can last years.

Boeing also wanted to shed unionised workers that it saw as profiting inordinately by living in Kansas while receiving wage increases at rates negotiated for workers living in metro Seattle, said Robert Spingarn, an analyst at Melius Research.

Spirit manufactures the fuselage for the Max, Boeing’s narrow-bodied cash cow, and fuselage and wing components for the wide-body 787. It also builds aerostructures for Airbus jets, including the A220, and wings for the A320 and A350.

Boeing is making 38 737s a month, with the goal of reaching 50 in the middle of the decade. It was making 52 a month before two fatal crashes of the Max led to the jet’s worldwide grounding in 2019, which slowed and then halted production.

The company also plans to make 10 787s a month between 2025 and 2026, up from the current four.

Production rates are critical to Boeing’s calculations of free cash flow, the principle metric investors use to judge the company. It has told investors that it will generate $10bn in free cash no later than 2026. For this year, it has said it will bring in $3bn to $5bn in cash.

But in April, Boeing discovered that Spirit had improperly installed two fittings on the vertical stabiliser on the 737, forcing the jet maker to delay deliveries to customers. Four months later a new problem arose: incorrectly drilled holes in the rear pressure bulkhead for some fuselages. The trade publication The Air Current reported earlier this month that Boeing and Spirit were examining a greater number of fuselages for defects than they had originally anticipated.

The quality problems plus inflation have cost Spirit money on its fixed-price contracts, “and whenever you have a supplier building things at a loss, their incentive to get things done is under pressure”, Spingarn said.

Spirit chief executive Tom Gentile departed abruptly earlier this month. The board named Patrick Shanahan, the former acting US secretary of defence who worked for three decades at Boeing, as interim head of the company.

Shanahan is viewed as someone who knows production and can help reset relations between Spirit and its most important customer. Hamilton called his hiring “a first step”.

“These problems were years in the making,” he said. “They’re going to take quite a while to sort out.”

But they took a significant step forward last week when Boeing and Spirit reached their new agreement. It requires Spirit to increase staffing in engineering and quality control and to carry buffer stock, “including two weeks’ worth of finished goods for 737”. It also says Boeing must agree to any “change in control” at the company — protection for the plane maker in case Spirit becomes a takeover target.

The two companies are working “shoulder to shoulder to mitigate today’s operational challenges”, Shanahan said.

Boeing called the deal “mutually beneficial” and said it would “enhance operational stability”.

The deal will primarily benefit Spirit through 2025, said TD Cowen analyst Cai von Rumohr, before shifting to favour Boeing. It pays Spirit another $455mn for the 787 and delays repayment of half the $180mn that Boeing advanced to the supplier for two years. Boeing also will pay $100mn towards tooling required by Spirit to increase production of the 737 and 787. But in 2026, Boeing receives a price cut on the 737 worth $265mn.

The deal should reduce Spirit’s $3.3bn in net debt and better position it to refinance $1.3bn in debt that will mature in 2025, von Rumohr said.

The increased revenue for Spirit through 2025 reduces Boeing’s estimated free cash flow by $198mn, but “a healthy Spirit is a net positive for Boeing in the long run”, said Jefferies analyst Sheila Kahyaoglu.

Spirit can affect its customer in another way. The International Association of Machinists and Aerospace Workers rejected an offer from Spirit and went on strike for five days in June before agreeing a new contract that ends mandatory overtime and raises wages 23 per cent over four years.

The strike could “set the tone” for labour negotiations at Boeing next year with the Machinists in Seattle, Spingarn said. Unions are “asking for significant increases to match the higher cost of living, and so it wouldn’t surprise either of us [at Melius Research] to see Boeing unions make strong demands”.