Boeing Faces Higher 787 Deferred Production Costs Even As Its Profit Rises

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The Boeing Company

Boeing (NYSE:BA) said that deferred production costs related to its 787 program crossed $25 billion during the third quarter. [1] The airplane maker had earlier anticipated to cross this figure in 2015, so this sooner-than-anticipated increase in deferred 787 production costs indicates that Boeing could take longer to make an actual profit on its 787 program. Currently, the company is losing money on every 787 that it sells, but accounting rules allow the company to allocate overall 787 production costs over an extended period of time, allowing it to book profit currently. This is the standard procedure employed for accounting for the development of commercial airplanes, which require huge initial capital investments.

In our view, even though Boeing breached this cost figure earlier than expected, the company’s future is bright as global demand for commercial airplanes remains strong. This strong demand environment will allow Boeing to make a healthy profit on its 787 program despite the company taking longer than previously anticipated to break even on this program. We currently have a stock price estimate of $136 for Boeing, around 10% ahead of its current market price.

See our complete analysis of Boeing here

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Higher Commercial Airplane Deliveries Lift Q3 Results

In the third quarter, Boeing’s revenue and profit rose strongly as it delivered more commercial airplanes to airlines around the world. The company’s third quarter revenue rose by 7% annually to $23.8 billion and its third quarter core earnings (which excludes one-time items) rose by 19% annually to $2.14 per share. [2] During the quarter, the airplane maker delivered 186 commercial airplanes, up from 170 airplanes that it delivered in the year ago period. [3] [4] This growth in the company’s third quarter commercial airplane deliveries was driven by production rate hikes in its 737 and 787 programs. In December last year, Boeing raised its 787 production rate to 10 airplanes per month, from 7 per month, and in March this year, the company raised its 737 production rate to 42 airplanes per month, from 38 per month. These two production hikes increased Boeing’s overall commercial airplane deliveries in the third quarter, driving solid growth in its results.

Looking ahead, this trend will likely persist over the next few years, as Boeing plans to further raise its 737 and 787 production rates. The company currently plans to raise its 787 production rate to 12 per month in 2016 and then to 14 per month by the end of this decade. The company also plans to raise its 737 production rate to 47 per month in 2017 and then to 52 per month in 2018. [1]

In our view, Boeing is executing these rate hikes as backlog for both 737 and 787 has increased sharply over the past few years. With global air passenger traffic recovering strongly in the aftermath of the financial crisis, airlines from around the world placed large orders for these jetliners. Through September 2014, Boeing’s backlog for the 737 swelled over 4,000 airplanes and backlog for the 787 Dreamliner increased to about 860 airplanes. At current production rates, the company will take approximately 7-8 years to clear off this backlog. The issue with this long time period is that airlines will have to wait many years before taking delivery against their orders. This long waiting time period could compel a few airlines to look towards other manufacturers, especially Airbus. So, in order to prevent airlines from looking towards other manufacturers just because of a long waiting time period, Boeing is executing production rate hikes in its 737 and 787 programs.

Lower U.S. Military Spending Tempers Top Line Growth

On the flip side, Boeing’s defense business, which constitutes about 35% of its top line, posted lower revenue in the third quarter due to lower U.S. military spending. Through the first three quarters of 2014, Boeing’s defense segment revenue has fallen by about 4% year-over-year. [2] To temper the impact from this declining revenue, the company has slashed operating costs at its defense segment through various measures which include headcount reduction. Gains from these cost cutbacks were evident in the third quarter results, as the defense segment’s profit rose despite declining revenue. Looking ahead, Boeing plans to further reduce operating costs at its defense segment by about $2 billion. [1]

In addition, to reduce dependence on U.S. government’s military spending, Boeing is focusing on growing its international military sales. And we figure the company will likely generate a greater portion of its total military sales from the international market in the coming years as international orders already constitute about 37% of the company’s defense segment backlog, compared with 28% of military segment revenue that international sales currently constitute. [1]

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Notes:
  1. Boeing’s 2014 Q3 earnings transcript, October 22 2014, www.seekingalpha.com [] [] [] []
  2. Boeing’s 2014 Q3 earnings form 8-K, October 29 2014, www.boeing.com [] []
  3. Boeing’s 2014 Q3 deliveries, October 3 2014, www.boeing.com []
  4. Boeing’s 2013 Q3 deliveries, October 3 2013, www.boeing.com []