What's up With Lithium in the Air?
Ramesh is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Boeing (NYSE: BA) has been losing ground lately over news that there might be flaws in the design of its latest Model 787-8 aircraft.
The Federal Aviation Administration (FAA) issued an Emergency Airworthiness Directive (AD) on Jan. 16, requiring modification of the battery system on any 787s currently under manufacture, plus a few already in service at United Airlines (NYSE: UAL) and All Nippon Airways among others. As a result, 787 aircraft all over the world are being grounded.
The AD was issued as a result of recent incidents involving the lithium-ion batteries used to power most of the plane's onboard systems. The stock has been weighed down by these recent reports, along with the recent FAA action, and has lost about 5% of its value since the beginning of this year. Should investors be worried?
The Lithium-ion Battery Conundrum
Lithium-ion batteries have caused previous problems on jet airplanes. In 2010, the FAA issued a Safety Alert For Operators (SAFO) that addressed “Risks in transporting Lithium Batteries in Cargo by Aircraft.” The FAA indicated that tests showed that these batteries had certain characteristics that caused them to overheat, thus posing the dangers of fire and smoke.
In fact, the FAA notes that these batteries are suspected to have contributed to United Parcel Service (NYSE: UPS) Flight 006's crash in the United Arab Emirates on Sept. 3, 2010. That flight carried large quantities of Lithium-ion batteries as cargo. The FAA has not placed definitive blame on these batteries; however, the TSA follows FAA limits on the size of lithium batteries that passengers can carry on board.
Given the previous anecdotal experiences with transporting lithium-ion batteries by aircraft, one would have expected Boeing to conduct extra testing and due diligence on any new aircraft that used these batteries extensively. Lithium-ion batteries are preferred mainly because of their light weight, along with other advantages such as no memory effect, which would progressively reduce battery life.
Boeing has stated in a press release that it stands behind the safety of the 787. However, there is still the question as to what it will take to identify the problem and fix it. That could involve redesign of the battery systems on already built aircraft, resulting in delays in aircraft delivery schedules.
The 787's Importance For Boeing
In its third-quarter 2012 earnings release, Boeing raised year end guidance for revenue, earnings and operating cash flow and talks about growing momentum of 787 deliveries. What happens when that “momentum” gets reduced due to these battery problems, which could potentially delay deliveries?
Boeing would likely have a cash flow problem, at least temporarily. Given the company's $378 billion backlog, and its status as a duopoly along with Airbus (owned by European-traded EADS), these problems are unlikely to be devastating to the stock.
Commercial airplanes form the bulk of Boeing’s revenue, according to its latest earnings release. The 787 model has over 800 orders, as shown on the company's orders report. 49 have been delivered so far, based on their 2012 & 2011 reports.
The popularity of this airplane owes to the expected fuel savings resulting from the use of lighter materials. Airlines are looking forward to these deliveries, and delays might affect their plans, but don’t expect a rash of cancellations. A radical redesign requirement might be the only reason for increased worry, but that possibility is remote. However, any redesign, even if minor, requires FAA recertification, which will cause delays.
Prospects for Boeing
The stock is generally a stable one that also pays a dividend. The company has a strong balance sheet that should allow it to weather any hit to future earnings. In fact, Boeing's Q4 2012 results are scheduled to be released on Jan. 30. It would be wise to wait until them to initiate a position, if one is so inclined.