Buckingham lowers Boeing to Underperform (sell), others increasingly bearish

Update: 24/7 Wall Street just published this gloomy outlook about Boeing.

Buckingham Research Group today lowered its call on The Boeing Co. from Neutral to Underperform, the equivalent of Hold to Sell. As far as we can tell, this is the first research analyst to put a sell on Boeing in recent years.

According to Thompson/First Call, 10 analysts rate Boeing as a Strong Buy, nine as a Buy and seven as a Hold. None rated Boeing as an Underperform or a Sell (Thompson separates the two ratings; Buckingham’s Underperform is a Sell). According to Thompson/First Call tallies on Yahoo Finance, there hasn’t been a downgrade to sell since 2008, when the 787 program problems were ramping up.

Buckingham has become increasingly pessimistic in recent months about Boeing, so the new rating isn’t necessarily a surprise, and Buckingham isn’t alone. Bank of America Merrill Lynch recently downgraded Boeing to Neutral and in June RBC Capital Markets downgraded Boeing to Sector Perform from Outperform. Wells Fargo and Credit Suisse analysts have been raising concerns in recent notes but haven’t downgraded Boeing, and UBS has been bearish for some time.

Buckingham cited anticipated worsening free cash flow as its principal reason for the downgrade, driven by BRG’s forecast of lower 777 production rates and higher than Boeing’s forecasted $25bn in deferred production costs for the 787. BRG also cited about 1,500 737s not yet added to the accounting block it believes have been sold at steeper discounts than historically.

UBS and Wells Fargo have also expressed concerns over Boeing’s ability to bridge the 777 production gap between the Classic and the 777X. Credit Suisse has been sounding increasingly bearish in its recent research notes.

BRG predicts Boeing will announce next year it will lower 777 production rates, initially to seven and ultimately perhaps as low as four. Although Boeing officials claim that sales campaigns, new firm orders, existing options and Letters of Intent will be sufficient to garner more than 300 sales between now and 2020, when the 777x begins delivering airplanes, the assumptions rely on 100% conversion of options and LOIs to support new sales. Buckingham concludes this is highly unlikely.

“We estimate there are ~705 delivery slots for the 777 Classic to be filled between
4Q14 and when the 777X reaches maximum production in 2022. About ~275 slots will be filled by the unfilled orders already in backlog leaving an additional 431 firm
orders needed for the 777 Classic to maintain 777 production at a stable 8.3/mo
through the introduction of the 777X,” Buckingham writes.

This amounts to 72 new orders and conversions per year, significantly higher than the 40-50 per year Boeing says it needs (although one public reference used 40-60 per year). Some of these orders will no doubt come from the Options and Letters of Intent already on the books.

[Boeing] has 201 options and LOIs (Letters of Intent) for the 777 Classic. Based on the
historical conversion rates into firm orders, we estimate 72 options and LOIs will be converted to firm orders leaving 359 open delivery positions to be filled to sustain production at a stable 8.3/mo. The additional 359 orders will come from (1) replacement demand and (2) capacity growth demand,” BRG writes.

BRG doesn’t think Boeing will obtain 359 orders, or 60 per year through 2020. The current fleets and orders are concentrated with carriers that already have young 777 fleets, Buckingham writes, limiting demand.

“Our data indicates that ~68% of widebody seats are located within the largest 24
airline fleets. [T]here are 9 airlines that hold 38.3% of widebody seats in the total active fleet and 15 airlines that hold 29.5% of widebody seats in the total active fleet. The remaining ~32% of widebody seats are located in 145 additional airline fleets,”
BRG writes.

“Our analysis points to a shortfall of 261 orders for the 777 Classic that is necessary
to bridge the production gap with the 777X in 2014-2019.”

British Airways, one airline that we know Boeing had proposed acquiring more 777-300ERs, said it’s not interested.

The continuing poor cargo market is still depressing demand for new-build freighters, including the 777F.

BRG also thinks Boeing will soon announce a termination of the 747-8 program, which ironically it views as a positive because the poor-selling airplane is a drag on cash, but resulting in a $1.7bn non-cash charge when it happens.

Buckingham thinks the launch of the Airbus A330neo will put pricing pressure on the 787.

Buckingham actually raises earnings estimates for 2015 from $8 to $8.41, somewhat below consensus of $8.46 per share, but lowers earnings for 2016 and beyond.

 

43 Comments on “Buckingham lowers Boeing to Underperform (sell), others increasingly bearish

  1. I am not a finance expert. let alone an expert for US GAP accounting practices.

    So my question:
    The “deferred cost” of the B787 are cost that already have been paid but that are accounted for in the “accounting block” (the first 1100 aircraft delivered). Hence, these cost do not appear on the balance sheet today, driving up profits.

    Wouldn’t such practice put a huge gap between reported profits (that include balance sheet tricks like these “deferred cost”) and actual cash flow?

    • IMU some of that gap is landfilled with value inflated “inventory”. A couple of years ago the conclusion was that Boeing seems to value inventory at accumulated cost even though expensive rework should not be able to increase value beyond the sales price. Selling the terrible teens would each remove ~$3..400m from inventory in exchange for ~$50..70m in cash.

  2. “forecast of lower 777 production rates and higher than Boeing’s forecasted $25bn in deferred production costs for the 787. BRG also cited about 1,500 737s not yet added to the accounting block it believes have been sold at steeper discounts than historically……. UBS and Wells Fargo have also expressed concerns over Boeing’s ability to bridge the 777 production gap between the Classic and the 777X”

    Topics discussed / substantiated extensively on / by Leeham News, but denied as extensively. Thats $25B (OMG..) was pushed out into the future to show short term profits to stockholders, but just doesn’t go away. Limitting the options to be decisive in the key narrowbody markets.

    If the 787 cost & EIS overruns had been just 10-20% Boeing could have bought BBD and launched the NSA. With e.g. a common cockpit. Now they are pushing second best 737s while A already sold 2300 A321’s (more then all 762s, 757s and 739s combined).

    In my opinion McNerney is fully accountable for the strategic damage done the Boeing company. His salary / bonusses have flabbergasted me during the last 5 years.

    • Interesting comment about McNerney’s ridiculous compensation. I agree.

      Boeing takes great pains to try to justify the outlandish executive salaries through peer group benchmarking provided by outside specialist firms (see the proxy statement). I always wonder what happens to those firms if they come back with an answer that says the executives are paid too highly. I am guessing it is probably not good for business.

      The other curious thing is Boeing lists all the benchmark companies and Airbus is never on the list. I imagine that is because the French aren’t dumb enough to pay the top executive 400 times what the average worker is paid. Only a Harvard MBA thinks that makes any sense.

      • Over the top Manager compensation.

        As a delayed action we see this in Europe too. LInked to a move from productive to redistributive earnings lead here by the banking sector.

  3. Maybe some day the Boeing shareholders will understand that you can not run a long-term business like this (successfully) when short term profit stands above everything else.
    I am running a small production company and sometimes we have to swallow hard on production cost overruns on new materials or products – but to defer them into an unkonwn future? Over my dead body!

  4. Program accounting makes sense in principal but the weak point is that there is no outside opinion on whether the maker’s estimates are realistic. Boeing will only be profitable if they can execute the 787 program in the way they claim. Originally the learning curve was to be 40% better than the 777 learning curve, analysts pointed out that up to LN90 it was the same as the 777 (an achievement in itself) not better. I don’t think Boeing has released any solid info since, which might be regarded as suspicious in itself, so I can’t see when the 787 will turn a profit, maybe by the newer 1300 aircraft block? From the little solid information we have, LN200 still more expensive than the aircraft can be sold for, and that sale price in itself seems to be higher than the market will except, judging by recent lack of 787 sales. I’ve said before that I have trouble believing Boeing program accounting, at the time I was not meaning to criticize Boeing but rather the opaque nature of the system, but now I suspect that uncertainty is worrying the stock market. 77W sales couldn’t last forever, it was always obvious that 787 needed to be on track by now, but is it? 737 could never last forever either, hence discounting worries. Does anybody really see anything surprising in this news?

    • “Programme accounting” makes sense as accounting for a programme and nothing more.
      The problem in the shareholder arena is dumb investors and not the “loose some money for later profits” aka investment pardigm.
      Instead of fixing that the ruleset for evaluation of commercial entities is “finetuned” to make those dumb investors ( more like vultures *) happy. Exposure of real risk and
      present value is lost under thick layers of cosmetics.

      * buying shares on the reseller market is imho not a “real” investment.

    • MartinA

      “Originally the learning curve was to be 40% better than the 777 learning curve, analysts pointed out that up to LN90 it was the same as the 777 (an achievement in itself) not better. ”

      Why should Boeing expect the the 787’s learning curve to be better than the 777’s? They have less control of the 787 program because a greater % is performed by outside contractors and some are struggling – see Spirit Aero latest filing.

      • Cost develeopment at the risk sharing partners doesn’t hit Boeing directly.
        Boeing probably expected that FAL work alone was easier to “learn”, the “Lego Bricks Plane”. The previously observed to be more demanding part of the curriculum was outsourced. Voila, without anything improved you look much better. ( And as I noticed before, initial cost per frame was in relation to targets proportionally higher than on the 777. 777 developement was 100% over budget. Not much is known about initial production cost excesses. ( Is the 777 really that profitable or only by way of project accounting? 777 + 737 profits are not sufficient to compensate for the 787 and 747 drain.)

  5. If the execution of the program (whatever it might be) is done and the amount of money that it was projected to make is made, then there should not be any problem with program accounting. Are there any issues with it? Sure, every business by definition has it risks associated with it. What program account does best is spread the cost of such program over a determine amount of goods or services and charge it accordingly. If you can sell your product, then it does not matter what accounting system you use.

    • Well, you make it sound simple but it’s a tricky business. You are trying to spread one time expenses made to develop the product over its life time, but no one has a perfect crystal ball to predict how many you’ll make. Boeing was over-optimistic with 747-8 and is already admitting that the development costs will never be recouped. With 787 it’s hard to believe that would be the case, but given the tremendous extra costs it had with it these costs are already spread over (for some) uncomfortably many frames. Boeing has to do it in order to show not too many loses from 787 programme. I really wonder whether they shouldn’t have taken massive one time loss at some point and be done with it as Airbus has done with 380. Yes, the investors will scream bloody hell and will try to crucify you but they’ll get over it and you’ll have many happier quarters instead in the future.

      • Too bad Boeing doesn’t do accounting like Airbus, did with the A380. Just write the whole cost of the program off.
        POOF! Instant profitability (oh, except it still costs more to build an A380 than they sell for).

        And those unrealistic sales projections? Just move the goal posts. POOF! You’re suddenly exceeding expectations and the sales forecast is spot on!

        • “Just write the whole cost of the program off.
          POOF! Instant profitability (oh, except it still costs more to build an A380 than they sell for).”

          – Same for the 787. Production break even on the 787 is still years away. The A380 is expected to achieve it next year, according to Airbus.

        • You are mixing up truthfull bookkeeping with PR and outlook projection.
          Then, if early losses make things so much easier as you pronounce
          why doesn’t Boeing proceed similarly.?
          Is it a case of “Quod licet Iovi, non licet bovi” ( and who is the ox here 😉 or just hurt jingoism?

  6. I am surprised that the analysts are moving only now!
    BOEING shares have been defying gravity for years.
    It has been highly visible that huge floods of red ink were being swept under the carpet, with the help of this “programme accounting” gimmick.
    Serious independent auditors should never sign creative accounting on such a scale.
    I personally blew the whistle on several occasions more than two years ago in “the SEATTLE TIMES” for example.
    If Boeing had been registering the 787 losses while they happened as AIRBUS has always done (not only for the 380), it would have been making losses for three years.
    Instead, Mr McNerney has been laughing all the way to the bank, with huge bonuses in his pockets!
    Clever indeed, especially knowing that in a few quarters, everybody will have acknowledged that his management has been a tragedy.

  7. Is history repeating itself? – remember the role “managed earnings (AKA project accounting)” played in the demise of Douglas Aircraft company in the mid 1960s. Below are extracts from T.A. Heppenheimer’s book ‘A Brief History of Flight’:-

    “For decades Douglas Aircraft had followed the conservative practice of writing off development costs of new aircraft as they were incurred, accounting for them as expenses charged against current receipts. In 1963, amid the company’s reforms , it acquired a new financial offier, A. V. Leslie. He took the view that this standard practice produced big cuts in profits during development phases, along with artificially inflated jumps once cash from sales began to roll in. Managed Earning, by contrast, would delay reporting these expenses. It would treat them instead as part of the production costs, charging them pro rata against each DC9 to come of the line.

    The downside was that if the company reported a loss, the true loss might be considerably worse. Soon Lesie’s new practice, combined with stubbornly high labour costs, brought bad news. McGowen (Douglas CEO) had planned for an average loss of $1.15 million on each of the first twenty aircraft. This was normal: he expected the first planes would be quite costly to build but that manufacturing costs would drop as the program advanced down the learning curve. After twenty airplanes, the loss would drop to $400,000 on each plane, and prosperity would be just around the corner.It didn’t happen, Losses on the first twenty produced $10 million more red ink than McGowen had anticipated. And even after delivering more than fifty planes, each new one was bringing a further loss of $600,000. This meant that profitability lay somewhere off in the distant future. It would be very difficult to bring down costs, through the learning curve, to where the company could recoup its losses by means of sales volume.”

    To me the above ‘Douglas Story’ extract has many parallelisms to the Boeing situation today.
    In a previous blog I made the following comments, which I believe just as relevant to the topic in hand:-
    1) By adopting program accounting Boeing is effectively mortgaging its future development. Boeing is a $US90B company but to have $US30B outstanding in deferred B787 costs is going to hurt.

    2) The B787 program has not only hurt Boeing but also its key suppliers. Check out the Spirit Aerosystems SEC filings. Like Boeing Spirit also use program accounting but they are now in a forward loss situation with their B787 program.

    3) Since the Global Finiance Crisis I have ceased to pay too much attention to Wall Street’s finiancial analysis – remembering AAA mortgage bonds, Enron and the fact they voted Ken Lay CEO of the year!!!!!

    4) An interesting question is “If Spirit Aerosystems find themselves in a forward loss situation regarding the B787 will Boeing and how would that affect their future?

    While I believe Boeing today is in a much healthier state (current and projected cash flows) than Douglas Aircraft was in the mid sixties I am still surprised by bullish sentiment expressed by so many on Wall Street.

  8. I wonder why all comments are directed towards the Buckingham “sell” when 26 other analysts are hold/buy/strong buy? Not very balanced and just allows Keesje to chip in with his usual anti-Boeing tirade. A bit of balance and perspective please.

    • we shall see what the other 26 will do
      But we often see that these type of people have a strong herd mentality: one moves, and others tend to follow quickly…
      and there are strong reasons for them to move!

    • he,
      “leaving the ship” always starts with the first rat. initiating a rush to shore 😉

    • You are right. But I doubt that many analysts are taking much effort in really analyzing the data. Further, there are only a few that really understand the industry. Even the regular readers of this blog are sometimes puzzled by what happens in the industry. For example, we know (due to this blog and other) that Boeing has given an average of more than 40% discount on list prices for aircraft delivered in 2013 (Airbus will have similar discounts). Such number is rarely cited in professional media.
      I think only few analysts have really understood the barrel of dynamite the B787 program still represents for Boeing, likewise how the A380 program continues to worry Airbus financially (while Airbus apparently didn’t play tricks to produce virtual profits … probably because these things aren’t allowed in other accounting rules).

    • Longreach, I think there has been a lot of lack of perspective and balance. Quaterly shiny figures and forecasts are welcomed by shareholders, customers, politicians and taxpayers.

      Stating aviation will grow and copy in a few Randy lines is good enough. Deffered costs and perspective are a pain in the butt for everyone. http://www.forbes.com/sites/greatspeculations/2014/09/02/solid-long-term-demand-for-commercial-airplanes-will-drive-boeings-results/

      Boeing management are paid based on stock value. Literary. You get what you pay for. http://seattletimes.com/html/businesstechnology/2011354850_boeing16.html

      I’m not stating Airbus or anyones steering principles are better, but personally I feel this isn’t helping Boeing long term. McNerney’s successsor will probably agree.

    • Longreach, that this is the first Sell on Boeing since 2008 (or 2009 in some media follow-up reports) is news. But it’s not the first downgrade, as we noted.

      As for the snipe at Keesje, knock it off. That violates Reader Comment rules and in any event, Keesje is taking a break from Leeham because of his own violations.

      Hamilton

    • These days a “sell” rating is very rare. I personally consider a “hold” to be pretty close to a “sell”.

  9. “In 2013, Boeing’s stock rose about 82%, compared with a rise of 28% in the DJIA and about 32% in the S&P 500.”

    It would be surprising Boeing stock if didn’t underperform the market after increasing over 80% in 2013. I’m surprised more analysts haven’t made the call.

  10. 286 firm orders for the 777x and now it’s time to sell? However much production drops on the 777-300, Boeing can make up that revenue on the 787 lines. If they can ramp up to 18 or 20 a month by 2020, that will be the new cash cow.

    The 777x has made the A380 a gamble. Light CFRP wing vs. aluminum, more efficient span to weight ratio, less engines to maintain, far less gas robbing frontal area. Boeing will have the definitive value at the top end of the market with the 777x wing, once it goes into production. Although the A350-K wing will be close enough in size to get a good portion of the large aircraft market.

    • “Boeing can make up that revenue on the 787 lines. If they can ramp up to 18 or 20 a month by 2020, that will be the new cash cow.”

      There are a couple of problems with that picture – Boeing is still struggling to deliver 10 787s per month and they are still adding to the 787s deferred costs (remaining -10 development and certification will need to be added too).

      • Boeing would have to introduce some hefty changes in production methodology and subsystems to make significant progress in that direction. See, a good learning rate won’t do all that much for a process that is characterized by excess expense across all fronts. ( Compare a learning curve that starts at 100% and decreases at A%/a versus one that starts at 200% and decreases at A+n%/a with n <<A )
        Production of barrels will stay more expensive than panels. It just is not that "duhh, simple" as the PowerPointRangers once thought.
        Things like watercooling for early gen power electronics are very expensive and high maintainance.
        increasing production on a still too expensive line is just another way of further balooning deferred cost.

      • I don’t get why you would say Boeing is struggling to deliver 10 787’s per month. Over the last 6 months, Boeing delivered 61 (10.16/month ave) and over the last 8 months, 69 (8.63/month ave). This was achieved while dealing with a wing crack issue and the production ramp-up and certification of a new derivative.

        As far as the deferred costs go, any aircraft program under program accounting rules will see the deferred costs increasing until the program reaches break-even on a per-frame basis. Boeing says early 2015 but UBS says later (didn’t say how much later). Reality is probably somewhere between.

        Boeing is now in the process of increasing the rate in Charleston and the main line in Everett and eliminating the surge line in Everett. This will reduce costs. The additional cost due to -10 development (plus the rate increases above 10/month) has already been accounted for by increasing the accounting block from 1100 to 1300.

        • “and over the last 8 months, 69 (8.63/month ave)”

          I hadn’t seen August’s deliveries when I commented. Through July, deliveries were 56 (or 8 a month).

          Thanks for the clarification on the change to accounting block.

  11. It’s been asked before, but worth repeating: heavy discounting of a market leading new product (ie. B787) in a duopoly? What were Boeing thinking of…?

    • TC,
      Re “The 777x has made the A380 a gamble”.

      The A380 and B777x are very different aircraft. There is no chance of Emirates, Singapore, Qatar substituting their A380s for B777xs – the B777xs just don’t have the capacity to fufil the pax demand, or internal space available to deliver the comfort levels provided by the A380. Much of these carriers business model is now built around the A380. I guess what I am saying is the B777x cannot be viewed as an A380 competitor so the above comment to me is rather pointless.

      • What is the potential for leveraging the A380’s inherent strength, maximum floor area? A stretch, new state of the art engines, are folding wing tips possible for a 90m in flight wingspan?

        • TC,
          The current A380’s wing was designed for the dash 900 and can, without the need of folding tips, using its present engines take of fully laden 380 to an economic 41,000 ft cruise altitude.
          A stretched A380-900 with new engines would offer a CASM and levels of passenger appeal that could not be matched by any other aircraftng – something I believe Singapore, Emirates, BA, Qatar are well aware of.

    • People today forget that in 2004, following the December 2003 launch, Boeing only sold 54 787s (50 to ANA). Initially it was a very slow seller.

  12. Has anyone actually calculated the cost to be recovered on a per 787 frame basis to account for the $30 billion over-run?
    I do not understand what is allowed and what is not in US accounting rules, but in very basic terms it looks like a huge impost before trying to make a profit.

      • The trouble is the size of the bill makes it a long term expense, so you need to add ten years interest, so you can call it $40M/aircraft.

  13. In my ‘shoot from the hip’-estimation, Boeing will likely have to absorb a $10-$15 billion one-time cost at the end of the 1,300 unit accounting block of the 787 program. By itself, it’s no threat to the Boeing Company; the company is modestly leveraged at a 5:1 liabilities-to-equity ratio, and a $15 billion hit would only move that ratio to 6:1. Although Boeing would then be in a slightly worse position to absorb other unforeseen costs that may arise, and it could marginally affect its appetite for launching new programs.

    Over the life of the 787 program, though, I find it highly likely that Boeing will eventually find a way to produce 787s very efficiently, and the dynamics of increasing demand and duopoly-limited supply in the market for small widebodies will over the long term be tremendously beneficial, in my view. Boeing predicts a market for 4,520 small widebodies over the next twenty years, corresponding to about 19 per month on average, and the 787 assembly lines will likely be open for at least an additional decade beyond that forecast horizon.

  14. Pingback: Odds and Ends: 737 rate hike on cash flow; How the Chicago ATC fire impact unfolded; New PW engine chief | Leeham News and Comment

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