MIAMI — The Boeing Company suffered its first quarterly loss since 2009 in the second quarter (Q2) of 2016, driven in large part by billion dollar write downs on the 787 and 747-8 programs.

The one-time charges belie a solid quarter otherwise with revenue and operating cash flow both coming in around expectations, but the headline remains a net loss of $234 million versus a net profit of $1.11 billion a year ago.

Boeing Earnings Highlights

  • Operating revenue of $24.76 billion, up 0.9% year-over-year
    • Commercial airplanes revenue of $17.46 billion, up 3.4% YOY
  • Operating margin of -1.7% versus 6.9% in Q2 2015
    • Commercial airplanes operating margin of -5.6% versus 7.1% a year ago.
    • Operating margin excluding special charges of 10.3%
  • Pre tax charges of
    • $1.23 billion on the 787
    • $1.19 billion on the 747-8
    • $354 million on the KC-46 tanker
  • 152 net commercial airplanes orders for the quarter, and 199 aircraft delivered
    • Total company backlog at the end of the quarter was 5,700 commercial airplanes and $417 billion.
  • Boeing ended the quarter with $9.3 billion in cash and equivalents against $11.0 billion in consolidated debt versus $8.4 billion and $10.0 billion

Notes and Observations from Boeing’s Quarterly Earnings Call

First and foremost, we should call out a few milestones achieved by Boeing during the quarter. For example, Boeing opened the 777X composite wing center, accelerated the 787 production rate to 12 deliveries per month, declared the 787-10 production ready, rolled out the first two 737 MAX production airplanes, and completed the 737 MAX 7’s firm configuration with two additional rows.

We have been beating the drum on this for a while now, but Boeing really is doing an excellent job with it’s technical execution and that deserves to be called out at every chance we can get.

Of course the major theme covered in the call was the charges taken on the 787 and 747 programs. With the 787, the major issue was whether or not to invest funds for the future sale of two initial flight test aircraft, and then a subsequent re-classification of unit costs associated with these aircraft (a cost of $847 million). However, this is not the primary outstanding accounting concern on the 787 program.

Newly minted Boeing CEO Dennis Muilenburg touched on the issue of the 787’s deferred production costs, noting that they declined by $1 billion in the quarter due to the cost reclassification. Excluding the reclassification, the deferred production cost saw a small increase of just $33 million, ending the quarter net at $27.7 billion.

Boeing claims that it can recover the $27.7 billion over the remaining accounting block of about 900 airplanes, which works out to a cash profit of roughly $30 million per frame. Boeing believes it can achieve this rate by increasing the mix of 787-9s and 787-10s in the overall delivery mix, improved pricing for 787-9s, and dropping supplier prices.

Boeing’s CFO Gregory Smith summarized this approach: “The profile of the 787 deferred costs remains intact of what we talked about. Again, as we focus on unit cost day by day, airplane by airplane improvement and getting that model mix up with more -9s, now the introduction of the -10, it’s all about cash. and so how are we improving the overall cash flow of that program.”

Smith also noted that Boeing broke even on a unit basis on the 787-9 late in 2015,  and the payoff to reduction in deferred production costs is likely to occur later this year.

We disagree with Boeing’s approach here – the 787 is an excellent product that is meeting operating goals, and we are comfortable with Boeing even being able to sell an incremental 1,000 of the planes over the next 10-15 years. But generating a profit of $30 million per frame, even with more 787-9s and 787-10s in the mix is going to be tough.

Our view remains that Boeing should increase 787 production even beyond the planned end of decade 14 per month rate, and extend the accounting block to say 1,600 aircraft.

Doing so would help Boeing avoid the fate of the 747-8 program, where Boeing has been forced to write down all of the remaining 747-8 deferred production costs to the tune of the $814 million after-tax charge that Boeing incurred. This reduces Boeing’s financial risk on the 747-8 program and makes it easier for Boeing to discontinue production. In that sense, we like the move.

Here were some other takeaways from the call:

  • Boeing repurchased $2 billion of stock and increased dividend per share by 20%
  • Boeing remains on track to raise 737 production from 42/month to 47 in 2017, 52/month in 2018, and the  57/month in 2019.
  • Boeing is targeting 40 more net 777 current generation orders to smooth the production gap to the 777X
    • 777 delivery slots are sold out in 2016 and 80% sold out in 2017. Production of 777X test aircraft will begin in 2018, and Boeing is 60% sold out at the lower planned delivery rate of 5.5 aircraft per month (66/year).
    • Boeing has only sold 8 of the necessary 40 777 current generation airplanes this year
  • All of the 787s so-called “terrible teens” have been sold
  • Boeing is still targeting a book-to-bill (net orders to deliveries) ratio of 1 to 1 for year end while maintaining that it will not cut prices. We don’t believe that this is achievable for Boeing because our market intelligence indicates that Airbus is being very aggressive with discounting certain programs (the A321neo of course isn’t overly cheap).
  • Boeing’s supplier cost cuts are not going to be accepted by the suppliers without a fight.
Earnings call quotes courtesy of Seeking Alpha