Will Boeing Manage To Recoup 787 Development Costs?

  • Worries that Boeing might ultimately be forced to take a huge accounting writedown on its 787 program have refused to go away.
  • But looking at the trend for 787 deferred production costs shows that the increase in accumulated losses has moderated significantly.
  • A huge accounting write-down for 787 is not a very likely outcome.

The debacle surrounding the massive sunk costs into the Boeing Co. (NYSE:BA) 787 Dreamliner program has been ongoing for years and never seems to peter out. Fears that Boeing might one day be forced to record a reach-forward loss as an admission that it will never be able to fully recover the more than $28B costs for the program are still rampant on Wall Street and, of course, amongst Boeing investors. In fact, these concerns are partly to blame for keeping Boeing stock depressed over the last year.

BofA Merrill Lynch analyst Ron Epstein is one such analyst, and he recently gave a Sell recommendation for Boeing saying that the company stands little chance of recovering 787 development costs. According to Epstein's math, Boeing is likely to realize $14B as cash flow from 787 by 2022 and not the $29B Boeing has assumed in its outlook. What's worse, the analyst reckons that Boeing will need to generate $30M profit on the Dreamliners it sells between now and then, something he sees as ''unachievable.'' Epstein figures that Boeing is more likely to realize $16M, or only half of Boeing's projections, from each Dreamliner sold. The only way out would be for Boeing to take a charge or increase its projection for the number (1300 units) it's been using to estimate future profits.

These sentiments by Epstein are real concerns because if Boeing is unable to completely recover sunk costs for the 787, it could likely lead to a huge write-off and drag the company's profits for years. This could have very serious negative implications for the stock. Analysts estimated that Boeing was losing ~$25M on each 787 sold. But looking at the trends for 787's deferred production costs, we can surmise that Boeing is pretty close to breakeven point on the 787 program. The slower 787 deferred production costs grow, the sooner Boeing is going to break even and eventually make a profit. During the last quarter, deferred production costs grew just $141M sequentially to reach $28.7B, the slowest growth since 2013. During the company's recent earnings call, Boeing CFO Greg Smith said:

787 deferred production was better than planned and increased $141 million to $28.7 billion in the first quarter, reflecting the favorable mix toward more 787-9s as well as continued unit cost reductions.

In fact, 787 deferred production costs have slowed down quite dramatically over the last three-quarters as shown in the chart below:

Boeing 787 Deferred Production Costs

1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16
787
Deferred Production Cost 17,095 18,733 20,189 21,620 23,123 24,242 25,189 26,149 26,942 27,732 28,309 28,510 28,651
Unamortized Tooling and Other Non-Recurring Cost 2,508 2,620 2,862 3,377 3,453 3,442 3,565 3,801 3,913 3,906 3,908 3,890 3,767
Source: Boeing

Boeing plans to ramp up 787 delivery rate from the second half of the current year. This coupled with aggressive cost cutting and a more favorable product mix (bigger 787s sport much better-selling prices than smaller ones but with only a marginal increase in production costs and thus have much higher margins) should allow cash flows from the program to increase significantly.

So the assumption that Boeing will have to take a reach-forward loss is rather pessimistic. 787 sales are likely to far exceed the 1,300 accounting figure over the lifetime of the program. In fact, Boeing has already booked 1,100 Dreamliner orders to take it till 2020. Even if the company falls short of breakeven by the first 1,300, it's likely to recover these costs over the next couple of hundred shipped units. Yes, this means that profits from the program could be further away than earlier projected but it also means that a huge accounting write-down is not a very likely outcome.

Investor Takeaway

Investors can be forgiven for fearing the worst when it comes to Boeing's Dreamliner program. After all, Boeing has already taken multiple writedowns on the 747-8 program, though these have amounted to less than $2B. A writedown on 787 would be of a much higher magnitude, but this does not appear to be a very likely outcome. The more likely outcome is that Boeing might be forced to increase its estimate for the number of 787's it has to build to turn a profit from the current figure of 1,300. But even in such an event, profitability on the program would only be delayed for maybe two or three more years before the profits start coming in. Boeing currently estimates that the 787 program will become profitable in 2022. Extending that period by another two or so years really should be no cause for major worries.

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