A Trade War Could Put 20% of Boeing Deliveries at Risk

Despite the buzz around the aluminum and steel tariffs promised by U.S. President Donald Trump this week, aerospace investors shouldn’t panic over cost increases. Aluminum, which would garner a 10% tariff under Trump's plan, represents only 15%-20% of an aircraft’s cost on older planes and less than 10% on newer aircraft. Also, average aluminum prices rose 23% last year, and the aerospace industry managed to absorb the increase. Investors should be concerned about a trade war, though, because Boeing delivers around 70% of its aircraft to non-U.S. customers. Retaliation from China, which accounted for more than 25% of 2017 total deliveries and represents an estimated 20% of Boeing’s backlog in unit terms, remains the most significant threat.

We expect no material impact on Boeing's costs from tariffs. First, steel exposure is minimal: steel (25% tariff under Trump's plan) accounts for about 15% of weight on older aircraft and around 10% on newer models. According to Alix Partners, a consulting firm, aluminum accounts for 79% of the weight of the 737. However, aerostructures represent roughly 30% of aircraft costs, meaning that if 100% of the 10% tariff hits Boeing, we estimate the airframer will experience only a 2.5% cost increase. We’d note that customer contracts contain escalation clauses, which means Boeing might be able to pass through the increase. Newer aircraft, the 787 for example, use about 20% aluminum as a percentage of weight, making the impact more negligible.

We’re more concerned about Spirit Aerosystems because, as the largest independent aerostructures manufacturer, aluminum is a significant production input. But we’re not planning to change our fair value because we believe the tariff can be absorbed and that Spirit is contractually protected. Spirit procures nearly all its raw materials from Boeing and Airbus, leveraging their scale to secure better pricing. We understand that these contracts include abnormal-price-increase clauses.

The potential for a broader trade war with China remains the greatest concern for us. Although Boeing’s official backlog figures peg Chinese orders at 304 aircraft, we think over 70% of the 1,090 of unidentified orders on Boeing’s books will be delivered to Chinese customers (airlines and lessors). Taking the unidentified backlog that we attribute to China and adding the 304 disclosed orders leads us to conclude that about 20% of Boeing’s backlog sits with the Middle Kingdom.

China could potentially shift aircraft purchases from the U.S. manufacturer toward Airbus. While the existing backlog most likely isn’t at risk, new orders most certainly would be. Chinese airlines took 202 Boeing aircraft last year (26% of total deliveries) and we forecast China to remain between 18% and 22% of total aircraft deliveries for Boeing and Airbus over the next decade. If we assume deliveries to China are 20% of total deliveries in 2018 and make the simplifying assumption that the aircraft model mix for Chinese customers is similar to the overall commercial aircraft unit, we conclude that the Chinese market alone will drive about $1.3 billion of operating profits for Boeing in 2018 (11% of our consolidated operating profit forecast). And we'd note that this figure might be higher because the Chinese backlog is likely tilted toward more-profitable 737 aircraft.

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