Boeing's Turbulence: Impact on Berkshire Hathaway

As major supplier in the aerospace industry, Berkshire Hathaway's Precision Castparts (PCC) had a fantastic comebacks from the dramatic impacts of the pandemic, especially in 2022 ↗ and 2023 ↗. However, due to Boeing's continued quality issues, PCC might be affected significantly. Let us try to understand the situation.

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Introduction

In recent times, Boeing has navigated through a series of turbulent challenges that have raised significant concerns among stakeholders and industry observers alike. From quality control issues and mid-air incidents to production slowdowns, the aerospace giant's troubles have not only impacted its own operations but have also sent ripples through the broader economy. For shareholders of Berkshire Hathaway, these developments are particularly noteworthy due to the company's substantial investment in Precision Castparts Corp. (PCC), a key supplier to Boeing.

Boeing's 737 Max line has faced multiple setbacks, including a recent incident where an Alaska Airlines flight had to turn around after a panel blew out at 16,000 feet ². This is just one in a series of issues that have plagued the 737 Max, which has previously been linked to deadly crashes caused by flaws in its automated flight control software. These problems have led to significant production cuts, job losses, and a sharp decline in Boeing's share price. For PCC, which has historically employed around 3,000 people in Oregon and relies heavily on Boeing as a major customer, these issues pose a direct threat to its financial health and operational stability.

Historically, Boeing has been a cornerstone of the aerospace industry, renowned for its innovation and engineering prowess. Its long-term relationship with PCC has been mutually beneficial, with PCC supplying critical components for Boeing's aircraft. However, past issues at Boeing have shown how quickly fortunes can change, impacting not just the company but the entire supply chain. The current predicament is no different, with potential economic ripple effects that could affect the broader American economy. Boeing employs over 140,000 people and plays a significant role in the nation's GDP, meaning any prolonged disruption could have far-reaching consequences.

The immediate financial concerns for Berkshire Hathaway are evident. With Boeing's production issues, PCC could face substantial revenue losses, which in turn would impact Berkshire Hathaway's overall financial performance. This article aims to delve into the interconnectedness between Boeing's troubles and PCC's performance, shedding light on the broader implications for Berkshire Hathaway shareholders. We will explore Boeing's current problems, the impact on PCC, historical and economic insights, and the broader ramifications for Berkshire Hathaway.

Boeing's Current Predicament

Boeing's current situation is marked by a series of quality control issues that have come to light following a comprehensive F.A.A. audit. The audit revealed multiple instances of noncompliance by Boeing and its supplier, Spirit AeroSystems. Out of 89 audits conducted, 33 resulted in failures, highlighting significant lapses in the production process ³. Specific problems identified included the use of inappropriate tools like a hotel key card and Dawn soap by Spirit mechanics, raising serious concerns about the adherence to approved manufacturing processes and quality-control documentation.

The following CNBC documentary "Why The Boeing 737 Max Has Been Such A Mess" might be a well-suited summary of Boeing's current situation:

Adding to these woes, U.S. regulators have imposed production caps on Boeing's 737 Max jets, leading to a notable decline in deliveries. In the first quarter, Boeing reported its first revenue drop in seven quarters, with revenue falling to $16.57 billion from $17.92 billion a year earlier ⁴. The company also anticipates a sizeable cash burn in the second quarter, further straining its financial resources. Additionally, Boeing recorded an earnings charge of $443 million related to legal actions stemming from the Alaska Airlines incident.

Safety concerns have also taken center stage, with recent mid-air incidents casting a shadow over Boeing's reputation. The Alaska Airlines flight incident and a separate issue involving a 787 Dreamliner have not only affected Boeing's stock price but have also led to increased regulatory scrutiny ²⁵ ↗. The National Transportation Safety Board and the Justice Department are investigating these incidents, adding another layer of complexity to Boeing's challenges.

Regulatory bodies have given Boeing a 90-day deadline to develop a comprehensive quality control plan, emphasizing the need for immediate and effective action ⁴. Meanwhile, Airbus has overtaken Boeing as the world's largest aircraft manufacturer, capitalizing on Boeing's ongoing issues and further intensifying the competitive landscape ⁵. The political and economic ramifications of Boeing's troubles are also significant, with potential tariffs on the horizon that could adversely affect the U.S. aircraft manufacturing sector while benefiting the European market.

Warren Buffett is well aware of the impact of Boeing on Berkshire Hathaway and the overall economy. After the crash of a brand new Boeing 737 Max by Ethiopian Airlines in 2019, Buffett told CNBC's Becky Quick: "Obviously, Boeing has a lot of work to do very promptly" ⁷. Also, reflecting on the general importance of Boeing, Warren Buffett remarked during the 2020 shareholder meeting , "If you think about Boeing, it is one hell of a company and it's important. It's a huge exporter and it affects a lot of jobs. And some of them are with us." ⁶ This sentiment underscores the interconnectedness between Boeing's fortunes and those of its suppliers, including Berkshire's PCC.

Buffett's comments are now about 5 years old.

Impact on Precision Castparts Corp.

Precision Castparts Corp. (PCC) is a key subsidiary of Berkshire Hathaway. PCC finds itself in a precarious position due to its substantial dependency on Boeing. Our rough estimation is that approximately half to two-thirds of its revenue presumed to be derived from Boeing. Therefore PCC's financial health is intricately tied to the fortunes of its (presumably) largest customer. Boeing's ongoing production and quality issues, particularly with the 737 Max and 787 Dreamliner models, pose a significant threat to PCC's revenue stream.

PCC's revenue in 2023 was a robust $9.3 billion, marking a 22.7% increase from the previous year ¹. However, this impressive growth is at risk. By our estimation, about $6 billion of the total revenue are made with Boeing. Given Boeing's production slowdown, we estimate that PCC could face a potential revenue loss of around $1 billion annually. This projection underscores the vulnerability of PCC to fluctuations in Boeing's production schedules and market demand. Note that the provided value is only a rough order of magnitude estimation based on PCC's revenue from Boeing and Boeing's recent revenue decline ⁴. The numbers could be significantly larger if another major issue arises.

The financial implications for PCC are profound. In 2023, PCC reported pre-tax earnings of $1.5 billion ¹. However, with Boeing's issues, these earnings are under threat. A significant revenue loss could translate into reduced profitability, affecting PCC's contribution to Berkshire Hathaway's overall earnings. By the same approximations as discussed above, Berkshire's pre-tax earnings might be affected by about $50 to $150 million annually.

The historical context provides a sobering reminder of the potential impact. During the pandemic, Boeing's production cuts led to job reductions at PCC, reflecting the direct correlation between Boeing's operational health and PCC's workforce stability ². This historical precedent highlights the potential for similar disruptions if Boeing's current issues persist.

PCC has already faced increased costs for labor, training, materials, utilities, and supply chain disruptions, which affected its results in 2022 ¹. These operational challenges could be exacerbated by Boeing's production problems, leading to further financial strain on PCC. The company must navigate these complexities while maintaining its competitive edge in the aerospace market.

Despite its heavy reliance on Boeing, PCC is not without options. The company also counts Airbus, General Electric, and Rolls Royce among its major customers ¹. Diversifying its customer base could mitigate some of the risks associated with Boeing's production issues. By strengthening relationships with other aerospace giants, PCC can reduce its dependency on a single customer and stabilize its revenue streams.

Boeing's issues, coupled with PCC's dependency on the aerospace giant, introduce an element of uncertainty. Berkshire Hathaway might take steps to mitigate them.

If you like to view a bit of the actual products PCC is making, please have a look at the following marketing video of the company. It is a bit short but still might help you understand that PCC / Berkshire Hathaway actually provide state-of-the-art technology:

Looking ahead, the long-term industry forecasts are promising. There is an anticipated growth and strong demand for air travel and aerospace products ¹. This positive outlook suggests potential recovery and future opportunities for PCC. As the aerospace market rebounds, PCC is well-positioned to capitalize on the increasing demand for its complex metal components and investment castings.

Broader Implications for Berkshire Hathaway

The potential revenue loss for PCC has broader implications for Berkshire Hathaway. As a significant contributor to the conglomerate's earnings, PCC's financial health directly impacts Berkshire Hathaway's overall financial stability.

Berkshire Hathaway's diverse portfolio is a strength, but the potential revenue loss from PCC could still have a noticeable impact. Shareholders should be aware that PCC's challenges might slightly affect the conglomerate's profitability and, consequently, its stock performance. The financial health of Berkshire Hathaway is intertwined with the success of its subsidiaries, and PCC's struggles could ripple through the entire organization. Historically, Berkshire Hathaway has faced challenges within its subsidiaries but has managed to navigate through them successfully. After all, any business is more or less risky and prone to destructive means of the market.

Boeing's production issues have broader market implications ↗. Delays in aircraft deliveries could lead to higher airfares and weaker economic growth ⁵. A production shutdown of the 737 Max jet could shave 0.4% from US GDP, highlighting the significant economic impact ⁵. Moreover, weaker demand for Boeing planes could lead to fewer exports, affecting GDP growth and market dynamics. These economic insights underscore the far-reaching consequences of Boeing's troubles, extending beyond PCC and Berkshire Hathaway to the broader market.

Boeing's current predicament poses significant challenges for Precision Castparts Corp. and, by extension, Berkshire Hathaway. The financial health of PCC, heavily reliant on Boeing, is at risk, with potential revenue losses and operational challenges on the horizon. However, diversification of its customer base and positive long-term industry forecasts offer a glimmer of hope. For Berkshire Hathaway, the broader implications highlight the importance of strategic resilience and adaptability in navigating such turbulent times.

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Conclusion

The challenges faced by Boeing have significant implications for Precision Castparts Corp. and Berkshire Hathaway shareholders. The interconnectedness between Boeing's production issues, PCC's revenue dependency, and Berkshire Hathaway's financial stability underscores the complexity of the situation. While Boeing grapples with quality control problems, production slowdowns, and regulatory scrutiny, PCC faces the risk of substantial revenue losses and operational challenges due to its heavy reliance on Boeing.

However, there are potential avenues for PCC to mitigate these risks, such as diversifying its customer base and capitalizing on long-term industry forecasts ↗. Berkshire Hathaway shareholders should remain vigilant, understanding the potential impact on the conglomerate's profitability and stock performance. Drawing on historical lessons of resilience and adaptability, Berkshire Hathaway has the strategic acumen to navigate through turbulent times.

The broader economic and political context further accentuates the significance of Boeing's issues. Delays in aircraft deliveries could have ripple effects on airfares, economic growth, and GDP. Understanding these implications is crucial for stakeholders to make informed decisions and strategize for the future.

In essence, while the challenges posed by Boeing's turbulence are formidable, there are opportunities for PCC and Berkshire Hathaway to weather the storm. By staying informed, proactive, and adaptable, stakeholders can navigate through these turbulent times and emerge stronger on the other side.

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