May 2, 2016, © Leeham Co.: To say that the order from Delta Air Lines last Thursday for 75+50 CS100s with conversion rights to the CS300s was welcome news for Bombardier is an understatement.
Bombardier has a superb airplane in the C Series. The passenger seats are the most comfortable coach seats of any manufacturers, better than the Airbus A320 and way more comfortable than the Boeing 737. With apologies to Embraer, the C Series is even marginally better than the Embraer E-Jet, which is very good.
The C Series economics are far superior to the Airbus A319ceo and Boeing 737-700 and even better than the A319neo and 737-7, according to our analysis. (We
have yet to run an analysis of the prospective 737-7X against the C Series.)
BBD had a 14-month drought in orders, until Air Canada placed one for 45+30 CS300s in January. But even this blue-chip customer didn’t remove clouds of doubt over the airplane. A suspicion remained that the Canadian government pressured Air Canada to buy the airplane. Air Canada and Bombardier deny it.
An order from another blue chip customer was needed to instill confidence in doubters. United Airlines was highly anticipated, but it was not to be. Boeing came in with a deal BBD couldn’t possibly match or beat, and UAL ultimately purchased 65 737-700s at a price that substantially undercut the Canadian competitor.
Eyes then turned to Delta. Having seen so many deals fade away, LNC expressed caution even after Jon Ostrower of The Wall Street Journal wrote that a major deal was near. The tea leaves certainly supported Jon’s story. But too many times, defeat was snatched from the jaws of victory to be confident Bombardier would land this deal.
Taking a charge
Concurrent with the Delta order, BBD announced it will take a $500m charge against the 127 recent firm orders obtained from Air Canada, Air Baltic and Delta, or an average of $4m per plane. The blogosphere immediately erupted that Bombardier “dropped its pants” for these deals and sold under cost.
Bombardier follows accounting rules that require unit cost accounting. It’s well known that early production airplanes cost more to build than later models, once the learning curve it achieved. BBD said last year that it would be five years (to 2020) before the program achieved break-even. This charge is in line with unit cost accounting and BBD’s previous statements.
Contrast this to Boeing, which uses program accounting. As LNC has written recently several Wall Street analysts believe Boeing will never recoup its $29bn of deferred production costs (plus another $3bn in deferred tooling costs) on the 1,300 airplane accounting block for the 787. (Boeing claims otherwise.) It’s been acknowledged by Boeing and the subject of endless analyst reports and news reporting (including LNC) that until very recently, none of the 787s delivered recovered the cost to build them. If Boeing used unit accounting instead of program accounting, the company’s quarterly and annual financial results would have been much poorer, and in some years, a net loss would have been recorded.
Bombardier, and Airbus, write off costs as they are incurred. This reduces the profit margin. Boeing’s program accounting allows it to report profits and higher margins. The practice is accepted under the Financial Account Standards Board Generally Accepted Accounting Practices, but it masks the true financial results. To its credit, Boeing publishes non-GAAP financial results that present a truer picture, but few read these numbers and fewer still pay them any heed.
Setback for Embraer
With the C Series order, Delta also announced that it will not induct into service the 20 Embraer E190-E1s it contracted to purchase from Boeing Capital Corp. Boeing is taking these airplanes in on trade from Air Canada, part of a deal for AC’s 737 MAX order. Delta will assume ownership but resell the airplanes.
Embraer touted Delta as a new customer for the E-Jet (albeit, for used airplanes). The Power Point presentations will have to be revised.