July 25, 2016, © Leeham Co.: Boeing July 21 announced it is taking an after tax charge of more than $800m against the 747-8 program. It also canceled plans to increase production of the 747-8F from the current 0.5/mo to 1/mo in 2019 on the long-held belief demand for the 8F would recover as 747-400Fs age.
In an email to LNC, a Boeing Commercial Airplanes spokesman wrote, “We have consistently said that while there is a cargo market recovery – it is not as robust as we had expected. Our new long term forecast projects cargo traffic to grow at 4.2% per year over the next two decades. But in the short term, the cargo market continues to struggle.
“The 747-8 is closely tied to the cargo market. There is an opportunity starting around 2019 when many 747-400 Freighters will be retired. Some of that replacement could go to the 747-8F, some to 777F, but some of those airplanes won’t be replaced at all. The decision we announced reduces future risk for the program and the company– and allows us to see how that replacement cycle plays out.”
With that, years of forecasts of a solid recovery for the 747-8F that ran counter to many outside Boeing was softened considerably.
Boeing’s action and conclusion is a shift in its long-held position about the 747-8F. Many Wall Street analysts, industry observers and others said for years there is a permanent shift in main-deck freighter demand to increasing use of belly capacity in the Airbus A330-300 and Boeing 777-300ER. The additions of the Airbus A350 and Boeing 787 added to this capacity and exacerbate this shift. I’ve been in this camp as well.
Boeing steadfastly resisted this view. At the Farnborough Air Show, just a week before Boeing’s announcement of charges, the company revealed its 20-year cargo forecast and reiterated its long-standing view of the market, including the long-stated prediction the 747-8F market will recover in 2019.
Boeing’s move doesn’t bode well for the future of the 747-8 program.
We’ve long predicted the demise of the 747-8 program, after 40 years of a successful run and after becoming an iconic aircraft in commercial aviation history. There hasn’t been an order for the 747-8I since December 2013. Orders for the 747-8F have been few and far between, with recent ones taking up white tails until Volga Dnepr’s firming of the MOUs announced a year ago at the Paris Air Show.
In addition to the 747-8 charge, Boeing announced a $400m charge against the KC-46A tanker and more than $800m in charges for two more of the initial six 787 test aircraft. All in, the charges totaled nearly $2.1bn after tax.
Here are some excerpts of analyst noted issued immediately following the charges:
None of these three charges affect our overall outlook for Boeing. Our 787 and 747-8 delivery outlooks and cash contributions are unaffected by these announcements. The tanker charge has a slight effect on cash but was previously expected and is one-time in nature. We rate Boeing outperform, target $176. We expect strong cash flow growth, with the 787 a key driver. Narrowbody demand remains strong, but our estimates are revised down slightly due to widebody weakness. Defense sales should be roughly flat with upside potential.
BA noted a recovering freight market at last week’s Farnborough Airshow and we’re surprised by a 747- 8 charge due to anticipated air cargo weakness. Speaking with BA, the company notes that the 747 program is in a tough market that they no longer think will recover. The charge reflects BA’s expectations that it will not raise production rates to 1/mo in 2019.
BA’s pattern of lowering numbers this year is concerning to us. Looking back, in Jan 2016, BA guided 2016 EPS $1.10 below street estimates due to the 737 MAX introduction. BA also announced a 747 charge associated with reducing rate to 0.5/mo from 1/mo (and previously from 1.3/mo). In April 2016, BA took a KC-46 and another 747 charge. In May 2016 at its investor day, BA reduced 777 output to 5.5/mo due to the 777-X introduction and reduced 787 output to flat y/y in 2017. Finally, ahead of 2Q16, BA announced after-tax charges on the KC-46/747/787 of $393M/$814M/$847M or $0.60/$1.23/ $1.28 (based on 663M shares). BA reaffirmed its revenue and cash guidance for the year.
Investor expectations for a substantial charge on the 787 have been increasing, and speculation that Boeing will in fact limit 787 production to 12/month have also been increasing. We continue to believe BA will hit 14/month on the 787, but confidence in the near-term success of the program is weaker. However, these aircraft had 6,700 ground and flight test hours, and BA determined that the cost to modify these aircraft in order to sell them was not justified. Taking these two units (line units #4 and #5) out of the production block is in fact a slight benefit to margins.
The 747 charge ($814M after-tax, or $1.28 per share) reflects the reality of the cargo markets, and the lack of meaningful orders for the aircraft. Boeing now expects to maintain its .5/month rate on the 747, and we continue to expect that this line will shut within the next 3-5 years. BA has just 21 unfilled 747 orders. Boeing did recently pass the final test necessary for the Air Force to award a final production contract on the KC-46, so ideally this charge represents a significant milestone in de-risking the program moving forward. BA still plans to deliver 18 KC-46 tankers to the Air Force between August 2017 and June 2018, which is not risk-free.
Boeing no longer expects production rate to return to 1/month in 2019. This supports our contention that 747 likely winds down in the 2020s, something we
wrote when BA announced the initial rate cut in January. Recent sales attempts likely convinced them that the cargo replacement market wasn’t coming back to
support higher rates. This results in an $814m after-tax charge ($1.28 per share) to reflect lower deliveries/sales in the accounting block, writing off the deferred
production. There are still empty delivery slots so it’s a watch-item with $377m of unamortized tooling; a portion of which will be written off if/when they shut the line .
747 future rate limit ($1.28/share): On 747, the charge reflects a decision to hold rate indefinitely at 0.5 per month rather than increase to 1.0 per month in 2019 as announced in January when the previous charge and rate cut was announced. We think many investors saw a future uptick in rate as unlikely. We continue to believe the program will be cancelled once the current backlog plus any orders for Air Force One are delivered. Should Boeing terminate the program at that point, and assuming all white tails are sold, we would estimate remaining liability to include the $370M in unamortized tooling and any remaining supplier termination liabilities, which would likely be negotiated.
747 rate to remain at 0.5/month. Recognizing continued weakness in the cargo market, Boeing no longer plans to raise the 747-8 production rate to 1/mo in 2019 and will take an ~$815 mn ($1.28) after-tax charge on the program. We had not modeled a return to 1/mo in our forecast, nor an explicit recovery of the cash remaining in the deferred balance. The surprise here is that Boeing had seemed committed to the cargo market in recent months and the move raises questions about just how long Boeing will continue building 747s beyond the Air Force
On 747, combined with the prior large Q4 charge ($885M pre-tax), we estimate that BA has now written off its entire deferred production balance, implying roughly
breakeven cash from here across the remainder of its block (~35 aircraft). We think this is optimistic given that more than half of its remaining block is unsold.