Insight Friday 7 August 2020: Is Boeing too big to fail?

News:

Boeing has now formally informed the world that it may now be in a “forward loss position” on the Boeing 787 and Boeing 777X aircraft programs. Let’s translate that into English from accountant-speak.  What it really means is that the company will likely never make a profit on those two aircraft programs.

This was expected for the 787

, which incurred massive development costs during a three-year delay, followed by a safety grounding after entry into service. The 777X simply hasn’t sold well, and while Boeing has not yet established a formal accounting block for the program, it is clearly costing much more money than planned. With an anticipated low production rate of two per month, the demand for 777X is substantially lower than what Boeing initially expected.

With the likely consolidation of 787 production facilities from Everett into Charleston, that leaves the 777X, 767F, and KC-46 in Everett. That would mean additional facilities overhead would need to be absorbed by the 777X once the 787 line in Everett closes, exacerbating the issue.

Combing today’s warnings with prior disclosures of “forward loss positions” for the 747-8 and KC-46 tanker, the only remaining profitable civil programs are the 737 MAX and 767 Freighters.

With the MAX maintaining a substantial backlog (despite more than 800 cancellations this year) the program technically may not be in a forward loss position as yet. However, with high grounding costs and a prolonged recovery from the pandemic, Boeing is unlikely to deliver its entire backlog for this program. With slower production rates and lower margins, a future adjustment to a “forward loss position” has a high likelihood.

Analysis

Let’s look at the programs that remain active at Boeing.

Program	Status	Forward Loss Status
KC-46	multiple performance issues and delays	Yes
747-8	delays and poor order book	Yes
767F	still in production	No
777X	program delayed and few orders	Yes
787	high costs from delays and grounding	Yes
737 MAX	high losses after crashes and grounding	No, but probable

 With the exception of the 767 Freighters, every program is in trouble of one sort or another. The 737MAX has had another 20 cancellations this month, and the program is likely to to see its accounting block shrink and possibly join the other programs in a forward loss position after the billions spent during the safety grounding of the aircraft in the wake of two fatal crashes.

While Boeing expects to have the modifications completed and regulatory approvals for re-entry into service before year-end, the future market for this aircraft remains uncertain. The backlog for the MAX, minus adjustments per Accounting Standard ASC606, stands at 3,595 aircraft. With cancelations in excess of 800 aircraft this year, the MAX program is becoming more tenuous financially.

Having produced additional MAX aircraft during the grounding, Boeing must sell these 450 aircraft before it can ramp-up production substantially and will likely produce aircraft at very low levels over the next two years since the market cannot absorb new aircraft.  We have already seen several airline bankruptcies, and without additional government support, will see more this year.  The outlook for Boeing’s customers remains uncertain at best to dismal at worst.

The global pandemic hit Boeing’s customers hard, and the result will be the inability for airlines to take on new aircraft. In the case of the 737 MAX, contractual provisions enable airlines to walk away from orders, placing them in a position of relative strength in negotiating with Boeing. This will likely also result in lower margins for MAX aircraft that are delivered, impacting the financial performance of the program. We believe that the MAX will also fall into the “forward loss” column before the program is completed.

Insight

At Boeing, massive losses are not recognized immediately, as accounting blocks can be used to amortize expenses over several accounting years. The 787 programs which had a massive cost overrun on the order of $20 billion, which everyone recognized would be difficult for Boeing to overcome a decade ago, has finally hit the “forward loss” barrier from an accounting perspective.

Yet almost every industry analyst we spoke with indicated that the 787 would never become profitable after its massive cost overruns during development, followed by additional costs incurred during a safety grounding shortly after entry into service. Sales of the 787 would have needed to continue at record levels for a number of years, and given that airlines are a cyclical industry, that was unlikely to happen. The recognition of the obvious has arrived 9 years after the fact.

The 747-8, which hit the market just at the time four-engined aircraft were falling out of favor, has limited sales, led by the freighter version. But since the 777F carried nearly the same payload load with substantially lower costs, that model also became economically obsolete. Without adequate orders, the accounting block needed to be adjusted downward to reality and the forward loss position recognized, also years later than analyst projections.

We believe the 737 MAX is in the same position, and will not recover adequate sales nor margins to overcome the high costs from the safety grounding. Boeing has a massive task ahead of it to return more than 800 aircraft currently grounded to service, including the 370 plus delivered to airlines and the 450 produced by the company during the grounding that could not be delivered.