#boeing787

737 MAX is more Audi TT than Ford Pinto

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The NY Times has come out with a hit piece on Boeing and the ill-fated Boeing 737 MAX. Yet to CM, the problem seems more an Audi TT or Mercedes A-Class than a deliberate case of manufacturing flaw that was the Ford Pinto.

Recall that Ford deliberately placed the fuel tank to save money, knowing that it could spontaneously combust if hit from the rear. Yet the financial boffins deduced that the cost of making the move to a safer position would not be worth the risks of such a scenario playing out. Boeing never designed the 737 MAX to have inherent instability. The computer modelling power now is such that the most extreme scenarios would have passed muster. The FAA felt confident that the plane was airworthy to approve it.

Audi had an issue in 2000 with the TT. The sleek 2-door sports car was built off the VW Golf platform. However, the car was found to be prone to uncontrolled spins which killed 5 drivers. Audi was forced to install a spoiler and more sophisticated driver aids (software) to prevent the problem from occurring again. Same for the Mercedes Benz A-Class which failed the elk test conducted by a Finnish motoring magazine in 1997. It flipped when trying to avoid a dummy elk on a test track. This forced Mercedes back to the design room to install stability software to overcome the problem and restore its reputation for safety.

This is essentially what has happened at Boeing. While the press wishes to point to evil doings, the reality is that poor internal communication on such a big project was to blame, not willful negligence. Planes are pushed well beyond what they would ever be likely to encounter in real life. Take the 787’s wing flex test at 30% more than the plane would ever encounter while flying in the worst conditions.

It makes absolutely no sense for Boeing to take such massive risks on the 737 MAX, its #1 selling aircraft, by making it in such a way that it had a high propensity to crash.

The Boeing 737-400 series had inert fuel tank issues where near empty scenarios could cause the vapor to ignite in the centre tank that could lead to a deadly explosion. Several did. Some in the air. Some on the tarmac. These planes weren’t grounded. World aviation authorities, like Australia, issued advisories on how to mitigate the risk of it happening.

The 737 also had a rudder hard-over fault which led to several crashes. The design flaws were rectified when one pilot was able to recover the near-death experience. It was a faulty rudder actuator which could stick under certain temperatures.

The list of 787 airworthiness directives (from fire issues, wings, flight controls to landing gear) stands at 52. FIFTY-TWO. Sure a 787 has not crashed yet but where have the authorities been trying to ground the type until it has no ailments at all? Do they need a crash to rally into action? Or do they look at the issue on its individual merits? The 737 can fly without this AOA safely, which is why the FAA still allows its operation.

Having been a former aerospace analyst, this is the first time in a very long time CM can remember that a virtual global ban was put on any aircraft type. When Qantas flight QF32 (an Airbus A380) had an uncontained engine failure which ruptured the wing tanks and severing hydraulics, the airlines grounded their own planes as a safety measure, not the authorities. Singapore Airlines suspended its A380 flights for one day before resuming operations.

When AA587 crashed in Queens after the tail and engines sheared off, Airbus A300s weren’t summarily grounded. When AF447 crashed into the ocean off the coast of Brazil, A330s weren’t grounded as a precaution. It was pilots not paying attention to basics protocols, becoming overreliant on systems.

Ultimately the market will decide on the 737MAX. The plane has a 4,000+ unit backlog. Even if airlines wanted to change to A320neos, the switching costs would be prohibitively expensive in terms of pilot certification, maintenance and joining the end of an equally long queue. The order book is unlikely to suffer widespread cancellations.

Airlines run on razor-thin profit margins and the extra efficiency the MAX will offer over the existing fleet is why airlines want them now. The new LEAP-X engine technology is a once in 50-year event. The engines offer more power, 15% better fuel economy and lower emissions. The components are now ceramic matrix composites (CMC) which allows the engine to burn hotter and increase performance without suffering extra fuel burn. Nippon Carbon is the sole supplier of this magic material.

There has undoubtedly been a breakdown in communication with the FAA and Boeing. This engineering flaw can be safely encountered by software. While the NY Times has tried to over-exaggerate the fault in design, the reality is that all aircraft have engineering limitations. The 737 is a 50 years old airframe with over 1 billion passenger miles.

CM has stated many times that pilots have become too reliant on safety systems. AF 447 was a perfect case in point. When these glass cockpits with all manner of electronic trickery go wrong, pilots only need first principles to fly.

CM is sure that Boeing will recover from this incident and 737 MAX deliveries will continue as they had. The press just seems too eager for click bait, not understanding the complexities of developing new aircraft.

Nippon Carbon – hidden black diamond

Nippon Carbon (5302) is a hidden gem. CM stumbled over this company in 2012. A decade prior to this, one of the commercial jet engine makers spoke of a new space age technology on the horizon. He mentioned there was a secret sauce that went in to make ceramic matrix composites (CMC). However, because of the secretive nature of R&D, the supplier wasn’t disclosed. So 12 years after that meeting and years of trying to hunt down this miracle ingredient, CM stumbled into meet Nippon Carbon to discuss its mainline graphite electrodes business. In the lobby, a dusty glass trophy cabinet revealed a mysterious cotton reel with black fibres wrapped around it (pic above).

Needless to say on application, the investor relations director told CM it was Hi-Nicalon which goes into CMC! Bingo. Forget the mainstay graphite electrodes! CM found the missing link. In the process, he told CM that the company had spent 40 (yes, forty) years developing it. Who does that? Only in Japan. What the material does is enable jet engines to burn hotter which means longer life, more efficiency with fewer emissions and lower weight. Win, win, win, win.

CFM International (GE/Safran JV) has 8,000 jets (16,000 engines) in the order book. Nippon Carbon’s JV to make Hi-Nicalon was lifted 10 fold in recent years to 10 tons (full capacity will be hit this year) and GE has licensed another 100% capacity increase from Nippon Carbon to produce locally in the US. It is black gold of another dimension.

What is often underestimated, is that passing new technology in commercial aerospace is way harder than seeking new drug approval in the pharmaceutical world. A new drug might have drowsiness as a side effect. A jet engine can’t have that level of failure risk. So now that this product is already flying in the B737 MAX and A320neo, the technology will be rolled out on all new commercial jets from this point. The next generation Boeing 777x will sport Hi-Nicalon in its GENx engines which will use about 5x the material than a B737. 340 orders for the B777x have already been placed by airlines. Deliveries begin in May 2020. GE will be the only engine choice on 777x.

Nippon Carbon is the sole CMC source ingredient producer for GE, the world’s largest jet-engine/turbine maker. The wonderful part about that is the fact that no substitutes will replace it. There are no competitors because in aerospace, quality of material matters. Only source suppliers get a look in. Nippon Carbon owns 50% of the NGS Advanced Fibers business where Hi Nicalon sits. GE & Safran own 25% each of the remainder. 

Ube Industries (4208) has Tyranno-fiber and is partnered with Rolls-Royce. Yet it is tiny part inside a business dominated by construction cement.

Nippon Carbon shares were hit hard the day before 1Q earnings on the back of a downward revision by competitor Tokai Carbon (5301). This is what happens when stocks have no official stockbroker coverage and get tarred by having “Carbon” in the name.

Nippon Carbon’s 1Q results came out after the close the following day, reporting a 46% increase in sales vs last year and a 168% increase in EPS. Full-year earnings were left unchanged.

Nippon Carbon mentioned tougher pricing position in graphite electrodes like Tokai Carbon, but the volume side appears healthier. It would not disclose customers but said demand was still healthy.

Sadly, disclosure is not a strong point of many Japanese companies and Nippon Carbon is no exception. Yet Japanese retail investors get hysterical over homegrown technology winding its way onto globally famous products. Toray (3402), the massive textile manufacturer, signed an exclusive supply contract with Boeing for the 787’s carbon fibre needs. The share price did the following. The slump came on the back of GFC.

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Toray’s stock trebled. Carbon fibre was only 12% of its earnings at the time. It is around 20% today. The rest of the Toray business was low margin textiles. Buying Toray to get exposure to 787 was like buying a fruitcake to get some raisins.

Osaka Titanium

Osaka Titanium Technologies (5726) had an even more bonkers reaction to the 787 which was loaded with titanium parts. Coupled with a global production shortage of titanium sponge and sharply higher contract prices, OTT shares jumped 28x! From relative obscurity, the stock became the most liquid stock in Japan. This is what happens when the small-cap retail lunatics are running the asylum.

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Based on Nippon Carbon’s FY2019 EPS forecast of ¥1,148 it trades on a 3.6x PE ratio. It trades below replacement cost and invested capital. CM thinks that if it manages to hit 20t of Hi-Nicalon by 2020 its EPS could approach ¥1353. That would put it on 3.05x.  Writing in an Armageddon scenario (literally nuking the core graphite electrode business) of ¥210 EPS the stock would be trading at a trough 19.6x. Normally industrials in a downturn would face losses or 50-100x multiples. 

To be honest its biggest problem is that the Nippon Carbon has such woeful marketing of itself. A visit to its Tokyo HQ reveals a 1950s lobby. It doesn’t spend a lick on itself which is also a relief. No frills. It is a proper engineering company. Unlike Toray and Osaka Titanium (at the time), Nippon Carbon has no official broker coverage meaning it remains in obscurity.

Hi-Nicalon is truly revolutionary. It is a once in half-a-century product. It will become the defacto standard jet engine material. At the moment it stands at around 5% of revenue and minimal profit as it ramps up but by next year it could be as high as 15-16% in a few years, which maybe conservative. Depending on the demand for aircraft, it may head higher. It is worth noting at the time of GFC, airlines many upgraded to more efficient aircraft to lower operating costs. Leasing companies obliged. That isn’t to say that Nippon Carbon is isolated by any means but the product itself is unique which provides relative stability.

Worth taking a long hard look at the story. This is a game changer material. We only need for the retail investor to cotton on to this story and let the Pride of Nippon push it to absurd valuations. We have the history of Toray and Osaka Titanium. At 3.6x it is already at absurd valuations (just at the opposite end).

Air India seconds from disaster?

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Typical to see the press try to link the tragic accident caused by engine failure on a Southwest flight and a poorly fitted window frame on an Air India 787. The press once again went for clickbait talking about “smashed window…three rushed to hospital” instead of trying to search fact that this was a cosmetic folly and nothing more.

The main difference was in the Southwest accident, engine parts flying at 3,000rpm punctured the EXTERIOR window causing rapid decompression. In Air India’s case a poorly mounted interior window which has the functions of sound deadening and aesthetics popped out of a mount which would cause zero risk of compromising the plane’s structural integrity. If you look at the picture the oxygen masks haven’t deployed which would occur automatically if it did.

The sad truth of the Southwest uncontained failure is that the engine casing is supposed to catch any debris that breaks off. Such metal fatigue is more likely on such aircraft types (737) is that the short haul nature puts more stress on components. Such aircraft make more than half a dozen cycles (takeoff/landing) a day meaning wear and tear is higher. Tyres make a good reference- a 737 gets new tyres on average every 20 days. A long haul aircraft despite being heavier gets tyres every 40-60 days.

So typical press phooey to connect two completely unrelated accidents.

Kobe Steel scandal may make Takata look like a picnic by comparison

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Actually this could be so much worse than the Takata scandal. Kobe Steel’s data falsification on its products – especially to Subaru Corp – could raise the risk of insolvency of the former. Subaru is responsible for the MOST crucial part of the Boeing 787 – the centre wing box (CWB). While Boeing has assured us that there is no imminent safety risk, the question is one of determining the fatigue of the substandard materials supplied to Subaru by Kobe are part of the CWB. What many fail to realize is that commercial aircraft approval by the regulators makes getting drugs approved by the FDA as easy as shelling peanuts. Every time a plane is in the air it has to be as near as makes no difference 100% safe. Drugs that give you a side effect of drowsiness is not a big deal to the FDA. In fact for aircraft it gives “do not operate heavy machinery” a whole new meaning.

The CWB effectively is the piece that connects the wings to the body. It is without doubt the most important structural piece on the plane. Worse, it is perhaps the most difficult part to replace in terms of man hours. Effectively the plane would have to be broken apart and reassembled. The sheer logistics of this would also be mind boggling. The retrofit (if even feasible) would be a $20-30mn per job including the parts, labour and time out of service (compensation to airlines) and recertification. That’s per aircraft. So that would cost around $10-15bn.

The question then becomes of the 500 odd 787s in service what the FAA decides to do. Perhaps the planes’ useful 25 year life are reduced to 15 years. That would smack residual values and airlines would demand compensation for the gap and the potential for lost revenues. So were 500 aircraft to lose 40% of the serviceable life at $150mn a copy that is $75bn.

While this is worst case scenario analysis for Kobe Steel which would be liable for the lot, we are staring at the risk of a wipe out. Kobe Steel has $1.8bn in cash. Somehow it’s $8bn market cap may fall much further.

Hardly any of this is priced because the FAA doesn’t take things lightly until it has all the facts.

This article is not intended to be sensational rather highlight the potential for a huge weight from the US (not Japanese) regulator to push for a safety recall of epic proportions. We won’t know yet but buyer on dips beware.

Flake News

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Fake news, very fake news or in many cases it is just flake news. Flake news? The lack of context and perspective and trying to draw parallels with irrelevance. Take this piece from Robert Reich taking a trademark swipe at Trump rationalizing it with a very poor understanding of the industry he seeks to convince his audience he is an expert in:

“I just watched Trump give a speech at South Carolina’s Boeing facility where the new 787 “Dreamliner” is being unveiled. Trump said it was “built right here” in South Carolina, and that “our goal as a nation must be to rely less on imports and more on products made here in the U.S.A.” He also called for “a very substantial penalty to be paid when they fire their people and move to another country, make the product, and think that they are going to sell it back.” And said he’ll lower taxes and get rid of regulations that send our jobs to those other countries. “We want products made by our workers in our factories stamped by those four magnificent words, ‘Made in the U.S.A.'”

All fantasy. In fact, almost a third of Boeing’s Dreamliner comes from abroad — from countries with high taxes and high regulations, good wages, strong unions, excellent schools including technical education, and universally-available health care.

1.The Italian firm Alenia Aeronautica makes the center fuselage.

2. French firm Messier-Dowty makes the aircraft’s landing-gear system.

3. German firm Diehl Luftfahrt Elektronik supplies the main cabin lighting.

4. Swedish firm Saab Aerostructures manufactures the access doors.

5. Japanese company Jamco makes parts for the lavatories, flight deck interiors and galleys.

6. French firm Thales makes its electrical power conversion system.

7. Thales selected GS Yuasa, a Japanese firm, in 2005 to supply it with the system’s lithium-ion batteries.

Oh, and the first delivery of the Dreamliner is scheduled to take place next year – to Singapore Airlines. Currently there are 149 orders for it from worldwide customers including British Airways and Air France.

In other words, contrary to Trump, the Boeing Dreamliner is made all over the world and will be sold all over the world.

His “America First” economics is total demagoguery. We get a first-class workforce by investing in their education, training, infrastructure, and healthcare — not xenophobic grandstanding.

What do you think?

Well Mr Reich. Here is what I think.

The Boeing 787 Dreamliner has been one of the biggest program failures in the company’s history. While a technical marvel it was three years late, largely exposed by Boeing’s disintermediated supply chain, a break with decades of practice.

Aircraft production is a precise business. It requires that all parts arrive on time and to achieve that all suppliers must be on board. The 3-month delay of a $1 plastic fastener can mean a plane can’t be fully completed let alone delivered. So multi million dollar wing set production gets impacted. So do landing gears, engines and stabilizers. Everything is affected. Boeing’s delays sent many suppliers into financial distress. In some cases it was so bad Boeing had to step in to buy out suppliers (e.g. Spirit) to prevent further delays and cost overruns.

The second big flaw in Mr Reich’s article is that Boeing is a multi-nation aircraft for a reason. It is what is known as risk and revenue sharing partnerships (RRSPs). Companies bid to be on the project and pay a part share in it. It is an investment. They are shareholders to all intents and purposes. Companies like Mitsubishi Heavy and Kawasaki Heavy bought a stake in the project. Boeing was the project manager and designer. In short international companies bought themselves a ticket to be on the 787 with the hope if it was a success they’d be higher up the technology curve when 777 or 737-Max went to similar production materials and processes.

Boeing enthusiastically embraced this outsourcing, both locally and internationally, as a way of lowering costs and accelerating development. The approach was intended to cut the 787’s development time by 30% and with it, development cost from $10 to $6 billion. Estimates show that cost ended up being $20bn and 3 years late and is expected to break even in its 10th year. It is far from the success it was meant to be.

Another thing with aircraft suppliers is their scarcity. Aircraft manufacture comes at huge fixed costs and low lot volume. Around 120 Dreamliners are made a year and the reason the supply chain is like it is makes perfect sense. Suppliers need guarantees to ensure production levels meet their financial objectives. Parts certification is a tricky business.

Boeing needs to be sure suppliers meet certification requirements. If people think pharmaceutical companies going through the FDA process to sell a new drug is a nightmare, they should try to get a new aircraft past FAA regulations. While a drug might have minor side effects like drowsiness, a plane has to fly safely every time in almost any condition. Therefore the quality, durability and safety aspects for a plane that flies for up to 40 years is second to none. There are no short cuts.

The Boeing 787 was also made with all new production processes and materials not used before on this scale. The wings were carbon fibre composite. Mitsubishi Heavy not only agreed to be a RRSP but was willing to invest to meet Boeing’s production goals. Toray, the maker of the composite material was seen as the most reliable and stable supplier. These were cold hard facts and when building a new aircraft, airline customers want to minimize risk. Boeing needs to guarantee risk minimization and made rational decisions based on that. Had those suppliers been all in the USA you can be assured US suppliers would have been picked. Sadly many have lost competitiveness. An unknown fact is that Lockheed Martin called in Toyota to help it finesse its production processes for its disastrous F-35 programme.

So while Reich points to the ‘social’ qualities (education, healthcare, strong unions and good wages) of what goes to make an airliner they are generalizations to say the least. Japanese unions are far from strong and definitely not militant. Mitsubishi Heavy wing workers would be paid the same as their elevator assembly brothers across the hall. They wouldn’t necessarily be on high wages. I would imagine that many of Boeing’s designers have Ivy League or similar pedigrees. Assemblers would also possess serious qualifications.

In any event the point Trump was making was the same jawboning at election time. Make America First and keep jobs at home. Ideally he would be saying to Boeing that following Airbus’ example of assembling a portion of A320s in China is not his wish. In fact Boeing now has a joint venture with a Chinese entity that installs interiors and paint exteriors on 737 airliners. Is he a criminal for requesting companies stay at home?

Yes Mr Reich, President Trump is not perfect but he is doing his level best to turn around the fortunes of a country sold out by the establishment over many decades. Indeed if he cuts corporate taxes and incentivizes companies to stay at home because of a rational reason to do so that will be key. Instead of sticking it to him Mr Reich, try look beyond your prejudice to see why 64mn Americans put him in charge of their future. He may well fail but voters took that risk when they put him in office. They care not for the petty issues you raise in your articles.

This article seeks to take pot shots without assessing the full facts of an industry. What you wrote wasn’t fake news but flake news.