We’re catching up from a week out of the office and one thing that especially caught our eye is this comment in a research note late last week from JP Morgan:
Potential cash turnaround on 787 is enormous. By the end of this year, Boeing plans to have amassed $19 bil in 787 inventory, most of which will consist of so called deferred production costs, or the extra cost above the long-term average to build the first few dozen aircraft. We expect the initial 787 block to be 1,000 aircraft, which should take ~8 years to deliver. Even if the program never contributes a penny of earnings and ends after that initial block, it should therefore generate ~$19 bil of operating cash flow over that delivery period, or an average of ~$3/share annually. While from an accounting standpoint this would be a reduction of inventory, it is best thought of as underlying cash profitability on the aircraft (say 20% margin on 120 units/year times $100+ million each) that is offset perhaps entirely by the amortization of the sunk cost from the delays. The potential $3/share of positive 787 FCF compares to an expected cash outflow of $8/share from 787 inventory build this year, plus another $3/share of R&D and capex, making the total 787 outflow ~$11/share. Overall, the vast majority of the cash flow improvement opportunity results from elimination of the cash outflow, so while the difference between a 20% margin and a 10% margin might be significant, it pales in importance next to simply getting the program ramped up and into the black.
Other items of note:
From Wells Fargo, in a note from last week:
Boeing 737NG. Boeing still expects to decide on the 737 re-engine vs. all-new plane in 2011. Under any scenario, we estimate that commercial R&D should decline over the next few years to about $2.3B in 2013-2014. Based on our recent discussions, we expect Boeing will not re-engine but rather develop an all-new airplane with an entry into service in mid-2019. The key characteristics of an all-new airplane likely include (1) the baseline plane will be all-composite; (2) the plane will be optimized for the 170-180 seat market; (3) the engines could be 4-5% more efficient than what is being offered on the A320NEO; and (4) despite the larger size of the airplane, we would not expect this plane to offer a complete replacement for the 757.
I remain extremely wary of B’s current all-things-787-are-rosey scenarios, most recently from Jim McN that they will deliver 20-45 787s and 747-8s this year. They have been so wrong for so long, to say nothing of incompeitent and even deliberatly deceptive, that they have no credibility. I’ll take Dominique Gates’ recent piece portraying the 788 program as still besing in substantial disarray any day.
As for the “new” 737 replacement which Wells F predicts, I still think that getting athe 787 program on tract is so important that it trumps everything else, including what B does about the 737 and 777. B must not only get the 788 out the door in the third quarter, but seamlessly and on time deliver the 789. They cannot afford to spend on the 789 the kind of money they are spending now on th e788 just to get the first 788 delivered. This means lots and lots of things, inlcuding seamlessly building production to 10/mo or more, getting N. Charleston up and running, and most importantly reducing travelled work. I was amazing to learn that B is now also having travelled work problems with the 748. I just keep wondering, what is the problem with B’s managers? Even now, after they have botched 787 outsourcing in what is probably the greatest industrial failure of this or any century, they do not seem able get outsourcing right.
All this means that B cannot do anything that creates credible risk to the 788/789/7810 programs, and building a new 737 replaceement will do just that because B even now can’t get even the 748 out the door on time, a plane that involved only non-revolutionary modifications of a plane they are intimately familiar with. I think B know this, and that is the one of the main reasons they are waiting to make their 737/777 decisions. They need to be sure that the 787 will not remain a cash pit and preserve enough resources to resolve that situation if it arises before they allocate resources to a new plane which even they must know they are as likely to botch as do well.
How “inventive” is the accounting for $19b “worth” of inventory?
i.e. one of
accumulated production cost,
accumulated value from fullfillable contracts
accumulated value at _current_ list prices
Going by AllThings787 there should be about ~35 frames
in an “assembled or nearly so” state.
With the start of May production stop 20++
completed 747-8 were mentioned.
$19b / ((35*N)+(22*M)) ~= $542m per item.
With N ~= 0.5M ( price for 2 * 787 ~= 1 * 747-8)
M = $481m, ( per item 747-8 )
N = $240m ( per item 787-8 )
What am I overlooking?
Gigantic amounts of still unassembled parts?
money payd to subcontractors valued as attached to sellable inventory?
OK, the difference may lie in now versus endofYear.
Inventoried items per type need to double in the
next 7 month _and_ without any deliveries at all
to move values per item into plausible ranges.
I think the Wells Fargo assessment cannot really be considered a new information, it is rather a write-up of all the statements made by Boeing so far, which are to some extent deceptive.
This conclusion doesn’t seem right, or my non-existent US accounting expertise is coming to haunt me. But the usual definition of operating cash flow does not really cover 100% of inventory value when this is being sold at a lower than production cost price to the customer.
My view is that when the planes are being delivered, there will be cash-flow, but there will also be a realisation of unrealised accounting losses still buried in the inventory. Because I can not see customers pay for the extra cost of building the planes over the long-term average. So the actual cash-flow the planes would generate would only be the delivery payments. Let’s be charitable and say these are on the order of US$100m per plane. So we are looking at US$3.5bn (assuming Uwe’s number of 35 is correct) in total cash-flow, and at an (again) generous 20% margin, US$700m in free cash flow. Or about US$1 per share. If we are even more generous and include partially built frames worth another 35 units, and these ones sold at a higher price, you might get to US$2bn. Still far off US$3/share.
Of course, let’s not forget that even at US$3/share it will take them 4 years of production to make up the negative cash flow of just this year! Ouch.
This reasoning reminds me of the final days of Fokker. Their most profitable period was after they were bankrupt and in the process of being closed down forever. As they were delivering the final order backlog, while they were receiving cash payment for each delivered plane and at the same time they were cleaning out inventory without replacing stocks and also stopped all future investments and did only maintenance required to complete reduction, it resulted in a nice positive cashflow to creditors.
I pressume Boeing is not in the process of closing down, so this $19bn is a nice accounting number but it will never be realised and returned to investors. The cashflow coming in once deliveries start will be needed to ramp up production and clear out the huge order backlog. I have a gut feel that the 787 production ramp up will challenge the A380 ramp up for bad publicity.
Worth to note that deferred production cost also include penalties for late deliveries and supplier settlements – If I understood James Bell correctly yesterday.
Bottomline to me is that this will stay a sow’s ear, and no amount of stick-waving by analysts is going to turn this into a silk-purse.