Podcast: Boeing Strike Goes From Bad To Worse

As the strike by Boeing’s machinists enters a new, uncertain phase, the company’s suppliers, customers and investors are grappling with the rising damage. Listen in as Aviation Week editors and special guest Scott Mikus of Melius Research discuss the state of the strike.

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Transcript

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Joe Anselmo:   

 Welcome to the Check 6 Podcast. I'm Joe Anselmo, Aviation Week's Editorial Director and Editor-in-Chief of Aviation Week & Space Technology magazine. As the strike by 33,000 Boeing machinists nears the three-week mark, concerns are mounting over the financial blowback on the aviation industry's fragile supply chain, and critics are questioning whether Boeing's leadership has fumbled the ball in its dealings with the International Association of Machinists union or IAM for short.

Joining me today to break this all down, our Aviation Week's chief Business Editor Michael Bruno, who will cover the financial implications of the strike. Jens Flottau, who leads Aviation Week's global team of commercial aviation editors, tells us what buyers of airplanes are saying, and special guest Scott Mikus, Vice President of Aerospace and Defense Research at Melius Research, will weigh in with the Wall Street angle. Michael, let's kick off with you. In your recent Aviation Week column, you wrote, "Prospects are worsening quickly for suppliers," because of the Boeing strike. Tell us why.

Michael Bruno:   

 Yeah. It's turning into kind of the nightmare year for Boeing suppliers, particularly on large commercial aircraft. I mean, if you had a long-running, enduring, and entrenched battle between management and labor on your bingo card, well, bingo, you win. You get the worst thing you could basically ask for. The reason is because, as we all know and we've talked about many times on this podcast, suppliers were already behind the curve in catching up with what Boeing wanted and Airbus wanted in master schedules for large commercial aircraft, at Boeing, the 737 MAX in particular. Boeing was just struggling because of the door plug crisis it found itself in January. They've been producing somewhere in the mid-20s of new 737s. We're talking about production of new aircraft here. That's what's important to most suppliers, is the purchase orders they get, which are the work they’ve got to do right now, this week, this month, to then go deliver to Boeing, not some long big master schedule that says, in 2026 they want to be building 50 aircraft a month, but what they need to order right now.

Boeing had been slowing things down for the past several months as they were trying to work through this latest crisis. Now you've got this big long strike, which is going to slow things down even more, and Boeing management has just explicitly come out and said, "We're going to start holding purchase orders. We may ask some suppliers to hold onto inventory." They may ask suppliers to go ahead and produce things, but then hold it. There was already a growing mountain of inventory across the landscape, and all this strike does is make that mountain grow higher. Of course, if that mountain grows higher, then there become questions about, well, when will Boeing or some other super Tier 1 just stop placing orders and start destocking that mountain? You have to imagine that that comes, at some point, you don't know what it is because that threshold never gets shared with you, but you're afraid that it's coming.

Meanwhile, if you've been told to hold off on doing work, if your purchase orders have been slowed down, that's the worst thing you could ask for. Boeing's been screaming in your ear for a couple of years now. They want you to ramp up your capacity because they had this grand plan for producing 50 MAXs a month. They wanted you into invest money. They wanted you to go to your bank and get a loan to go increase your factory floor space, and suddenly, the money coming in from Boeing is dropping off because the purchase orders are being decreased because of the strike. It's a bad situation getting worse for a lot of suppliers. I don't hear anybody, no one, including people who expected a strike, nobody's happy.

Joe Anselmo:  

 Well, speaking of nobody's happy, Jens Flottau, you, last week, were at ISTAT Europe in Istanbul, a gathering of lots of lessors and airlines. What are the customers feeling about the strike?

Jens Flottau:           

They're basically sharing the same concerns that Michael just explained. One of the people I talked to was the Avalon CEO Andy Cronin, and he was very clear in his fears really. He's afraid that the strike will massively destabilize, particularly the weaker parts of the Boeing supply chain, making a recovery of production much, much harder if some of these might simply collapse or might have a really hard time financing the revamp following the strike. That is a really, really serious worry that customers are sharing. Conversely, what is their biggest hope and their number one priority on their wish list is guidance from Boeing for a production ramp up in '25, '26. People know they won't get what they originally ordered in the time that was agreed on, but they do want to know how many aircraft it will be in the end.

To be fair, they're also very unhappy with Airbus. The Airbus situation should be easier to handle. They don't have a strike, they don't have the MAX issue and so on. I talked to Firoz Tarapore, who's the CEO of DAE Capital, Dubai Aerospace Capital. He said it's hard to understand why this is dragging on for so long on the Airbus side this year. It wasn't a threat, but it was implicitly a threat, I guess. He said it's going to be even harder to understand if this drags on into 2025 or even worse. Back to Boeing, it's not only about aircraft production. Don't forget the 777X certification campaign, which is paused right now after the thrust link incident. No one is touching the aircraft, apparently, right now, so that is likely leading to other additional delays. Remember, the aircraft is already five years late.

The Lufthansa CEO said at an event here in Frankfurt the other day that he doesn't plan for the aircraft to be introduced into revenue service before the winter of 2026. Now, that's another year of delay that is admittedly not only linked to the strike but is now becoming part of the strike fallout as well. I guess my final statement on this part here is the customers do not understand how on earth Boeing could allow that strike to happen. It was so long in the making. It was so obvious that IAM was going to go on strike. Some people I talked to just are astonished by the lack of preparation that Boeing has implemented in case they are actually going on strike. There appears to be no plan on how to restart production of any significance, management being surprised by people actually going on strike. That part is also something that customers just don't get.

Joe Anselmo:     

Jens, a quick point of clarification. When you were talking about Airbus, this is Airbus's inability to deliver as many aircraft as they had forecast at the beginning of the year, correct?

Jens Flottau:          

Exactly. Airbus has delays in production.

Joe Anselmo:             

Scott Mikus, welcome back to Check 6. Good to have you here.

Scott Mikus:         

Thanks for having me.

Joe Anselmo:           

 You had noted, Scott, in one of your research notes that touch labor is 3-5% of the cost of a commercial aircraft program, minimal. You've estimated the strike will cost Boeing 1-$2 billion a month. Yet, Michael and his column cited estimates that giving into the union's wage demands, so not returning the pension as they want, but giving into their wage demands would cost about $1-1.5 billion over four years. It just seems like a no-brainer. Why hasn't management settled this strike?

Scott Mikus:  

I think a big part of it is, to some extent, Boeing was caught off guard with the rank and file voting overwhelmingly [to go on] strike. We weren't that surprised that the rank and file voted it down despite union leadership recommending [accepting Boeing’s offer]. We go back to last summer, Spirit AeroSystems machinists also struck after their union leadership recommended a deal. The rank and file rightly called Boeing's bluff. To your point, 3-5% of the total cost of a commercial aircraft program is touch labor, 65% of the cost is roughly raw materials. I would also, note you could say Boeing could settle this in their contracts with airlines. They have pricing escalators built in, and the escalators are based on indices. One of the indices that's commonly used is the employment cost index, so essentially, these cost increases on the touch labor will be passed along to the airlines and lessors.

Why Boeing is taking such a hard stance? I can't be exactly sure. Maybe the sticking point could be the pensions. I don't think that pensions will be reinstated. Maybe Boeing could sweeten their offer with better 401(k) contributions, maybe some changes to the healthcare plan where Boeing absorbs more of those costs. But if you think about this union, they've been through a lot in general. In 2014, they lost their pensions in a 51 to 49 vote. Production rates in Seattle have basically been halved. 747 production is over, 787 production has consolidated in South Carolina. I think part of it is these negotiations are almost personal, and the union wants revenge. I just don't know why Boeing has been this strict, but my guess is that the sticking point here is probably pension.

Joe Anselmo:           

As you noted in your note, this strike has been decades in the making.

Scott Mikus:             

That is correct. This is the first comprehensive negotiation since 2008. But if you think about Boeing under [CEOs] Jim McNerney and Dennis Muhlenberg, this strike is just a microcosm of all the issues at Boeing and the adversarial relationship that they have with key stakeholders, whether it's their employees, the suppliers, customers, regulators. Boeing needs these stakeholders to work with them if the company wants to succeed, but Boeing was squeezing its suppliers for price concessions, threatening the union by moving work out of Seattle. They have these adversarial relationships, and now none of those stakeholders want to give Boeing the benefit of the doubt. Suppliers want their long-term agreements repriced. The union wants big wage increases. The regulators are putting an unprecedented level of scrutiny on everything that Boeing does It's just no one wants to do them any favors because of how they treated everyone in the past 15 to 20 years.

Joe Anselmo:   

I received a note from a senior industry veteran who told me, “I have to think Kelly Ortberg got himself blindsided by his own team on what happened last weekend.” Last weekend being Boeing's made a second final offer to the union and gave them a deadline to accept it, and the union didn't even bother to vote. Kelly Ortberg came into this company with really high expectations. Scott, you were on Check 6. We talked about that. We all said great things about him. We all think very highly of him. Is he disappointing us a little bit with this strike and how Boeing's handling it?

Scott Mikus:     

It's interesting. The union made a comment that they'd like Kelly to be more involved in the negotiations. I wonder if he's giving Stephanie Pope the lead role in the negotiations here. She's Boeing's COO and she's now the head of Boeing Commercial Airplanes. I don't know if it was his decision or her decision to make that offer public. My guess is they figure by bypassing union leadership and just sending it, making it public, rank and file might say, "You know what? We should vote on this deal. It's pretty good." Clearly, it backfired, and it's just not working out for Boeing.

To your earlier point, the 2008 strike lasted 58 days, and the impact of Boeing was $6.4 billion of sales and $2.5 billion cash flow. Boeing desperately needs cash flow and it's who's going to blink first. Is the union going to come back because the employees can't do without a paycheck? But if we look now, there's a gig economy, unemployment's only 4.2%. If you go back to 2008, we were entering a recession. There was no gig economy, so you couldn't supplement your wages by driving for Lyft, Uber. It's who's going to give in first, and Boeing might have to give in if the rating agencies threaten them with a downgrade.

Michael Bruno:       

I just want to follow up on Scott's comments there. We need to acknowledge that there's a whole lot of palace intrigue and Kremlin watching that goes on. We're not privy to the internal conversations between Kelly Ortberg, and Stephanie Pope and Brian West, the CFO. We can try to read the tea leaves here and talk to our sources, but there's a lot that just the whole world doesn't know. But some of that is irrelevant, because here we are at this point where Kelly Ortberg had plausible deniability on the "best and final offer" that was made before the strike. He was in office, but it was one that got put together by a team of people under Dave Calhoun.

But the second "best and final offer" that came out of Boeing, that one starts to come under Kelly Ortberg's domain of responsibility. Whether he actually crafted it or not, there's no deniability that he can plausibly claim there for saying, "Well, I'm still not really involved." If he's not involved, there's clearly now an expectation and a demand by the counterparty, by the union, for him to get involved. If he needs to go smack some heads on the Boeing board and try to get their consent to make a big final offer for the union, that they'll accept, that's what Mr. Ortberg's job is to do at this point. But clearly, there's a demand for leadership to step in and finally resolve this, because as Scott mentioned before, there's been a whole string of surprises.

A whole lot of people on the Boeing side didn't think they would strike, then they didn't think they would go beyond the second offer and reject that one. Here we are now and people are starting to see there's no clear way out of this unless you dramatically offer the pension, or come back with a 45% pay raise over four years, or something that's just so overwhelmingly generous that the union laborers have to say, "Oh my gosh, we have to take that." Nobody really knows how you're going to get out of it, and that kind of situation is going to take Mr. Ortberg's probably direct involvement to start to resolve.

Joe Anselmo:        

Well, speaking of that, Scott, we had a Check 6 Podcast when the strike began. Michael and Richard Aboulafia of AeroDynamic Advisory, at that time predicted a relatively short strike, a couple of weeks. Dan Williams, Aviation Week's “numbers guy” predicted a long strike. You're in Dan's camp, aren't you? You don't see a quick end to this.

Scott Mikus:                 

Yeah, I don't know exactly when it will end, but if we look at IAM strikes at Boeing Seattle and Wichita locations, on average, they've lasted 58 days. According to our research, the longest strike happened in 1948, and it was 145 days. These can go on for a long time. It depends how quickly do the union members exhaust their savings. For Boeing, the big driver for them getting back to the table is, are they going to be threatened with a credit downgrade? There's been a report from Bloomberg that they may look to issue about $10 billion of equity to shore up their cash reserves. They've already burned $8 billion of free cash flow this year, and through 2025, they have another $4.6 billion of debt maturities coming due. That's on top of all their other operating expenses. They need to shore up their cash reserves. The problem is doing an equity issuance before you have this collective bargaining agreement done is kind of a tough sell. Boeing may need to get back to the table and sweeten their offer.

To Michael's point, maybe if they go to 45% general wage increase, that might be enough where you then don't have to reinstate the pension. Now, there is some debate, some of my peers have said, "Why not go back to the pension?" because that could be a great tool to attract and retain talent. Now, I come from a Boeing family. My dad worked at the company for over 30 years as an engineer. The reason why he stuck around so long was Boeing offered really good benefits. That was why he joined the company in the 1980s. He retired in the 2010s.

Right now, what is Boeing's differentiator for a younger hire? A 401(k) is the employee's assets. They get to take that wherever. But if it's a pension, they're more likely to stay longer. It takes time for these employees to get skilled train, do their work proficiently, so Boeing should be trying to actively reduce turnover as much as possible. So maybe reinstating a pension is not a bad idea. I would also point, my wife works for the city of Philadelphia. Her pay isn't that great, but she has excellent benefits and a pension. That's why she takes the lower pay. There's certain trade-offs you have to make in any negotiation, and Boeing should be evaluating these trade-offs in their offers.

Joe Anselmo:             

Before the Boeing strike, one of the key themes of the year was the inability of the commercial aviation supply chain to keep up with record demand for aircraft. If, as Michael warns, the supply chain comes out of this, suppliers come out of this strike even weaker, that's bad for everybody, isn't it? Not just Boeing.

Scott Mikus:        

If you go back to the 2008 strike and you look at some of the commentary from suppliers at the time, the third quarter probably won't be that impacted because they have purchase orders that they'll fulfill. But Precision Castparts, we don't have great visibility into them now because they've been acquired by Berkshire Hathaway. But on their earnings call back in 2008, they did a great breakdown where they said a strike that's shorter than three weeks is minimal impact. Once you get four to five weeks, you have about a 30% reduction in your sales to Boeing. Five weeks and beyond, it's about a 50-60% impact on your Boeing sales. Once you get beyond eight weeks, it's 80% or more. Some of the financially precarious suppliers, like a Spirit AeroSystems, you do have to wonder, are they going to start furloughing employees? Will Boeing have to inject them with more capital to get them through to the acquisition?

Other suppliers, say a Hexcel in 2008, their Boeing sales in the fourth quarter were down 40%. They also had sales declines in the early part of 2009, and that's because of inventory corrections. If Boeing slows down their purchase orders to the Tier 1s, the Tier 1s just cascade that down and you get a bullwhip effect throughout the supply chain. It can just be a lot of chaos. If you think about delivery cadence pre the 2008 strike, it took Boeing about nine months after the strike ended to get to those pre-strike delivery volumes. It's basically a nine to 12-month delay. Boeing was hoping to get to 38 per month by the end of this year on the 737. That's probably now a late 2025 timing issue.

Jens Flottau:       

Just to go back to Scott's point about Spirit, that's the prime example for how interested the rest of the industry is in in this being settled very soon. As most of you know, Spirit has substantial work on the A220 and A350 programs and is being split up between the Boeing part and the Airbus part going into Airbus ownership. Now, [Airbus CEO] Guillaume Faury has told us in an interview just a few months ago how worried he is about the situation at Spirit, and that was back then. Now, a few months onwards, it's gotten worse, much worse actually. Whatever happens there, whatever happens at Boeing has at least an indirect effect on everyone.

Joe Anselmo:      

Michael, you want to take us to the finish line?

Michael Bruno:    

First, as a side comment, I just want to say that I think we all feel for Tom Gentile, who's now CEO of Hexcel. Having come from Spirit AeroSystems, that poor guy can't seem to catch a break in working for Boeing, but that's just a side comment. Now, in all seriousness, I want to go back to the number of surprises and just leave us all with the reality that labor negotiations and happy workers are going to be a primary, if not the most important, issue for the aerospace and defense sector for the next several years. What we're living with right now with the Boeing strike is just one hardcore example of when things can go wrong, they can go wrong big, and they can have lasting implications, consequences, as Scott mentioned.

This is not the last labor negotiation that's happening, even if this one gets resolved. Boeing has got a couple of more in the coming years. Other companies have them. Each of the major defense primes have some degree of unionized workforce. This is something we're going to be watching for. I would just say to the whole sector, if you are not paying attention to what's happening in your workforce, they will make you pay attention one way or another. That precedent's now been set by Spirit, by the Boeing workers. If it happens again, nobody should be surprised.

Joe Anselmo: 

To that point, we have a strike at Textron, as you noted, and the U.S. dockworkers have gone on strike, so lots of strikes these days. Guys, thank you all for sharing your insights, taking the time. That is a wrap for this week's Check 6. A special thanks to our podcast editor in London, Guy Ferneyhough. To our listeners, we thank you for your time. We will see you again next week for another Check 6.