Impact of Deferred Costs on Boeing’s 787 Profitability

How is the 787 doing in the market? The 787 program is key to Boeing’s financial success, and needs additional sales to enable recovery of the $29 billion in development costs over the life of the program. Boeing has a huge amount of its capital tied up in this program. A leading analyst estimates that Boeing must recover $36 million per 787 yet to be delivered to offset the $29bn development costs, never mind production costs and profit. That number is no small hurdle. Consider the 2016 current market value, per Collateral Verifications, for a 787-8 at $117 million and the 787-9 at $143 million. Take the $36 million off those values (787-8 at under $81 million and 787-9 under $107 million) and Boeing must build a 787 for less than the balance to earn a profit. Let’s look at the state of play. Using the Boeing O&D data through October we find the following. The 787-8 represents 35% of orders and 66% or deliveries. The 787-9 is at 52% or orders and 34% of deliveries. The 787-10 is at 12% of orders with no deliveries yet. The 787 has proven popular in East Asia (essentially Japan and China) where only 16% of orders have come from, but 26% of deliveries went. Orders often come from US or Irish lessors while their deliveries may be anywhere on the globe. For Boeing to move into a stronger profit on the 787 it must cut production costs. Ray Conner is quoted as saying this was coming in 2016. It is crucial Boeing gets this right. The next table shows how orders and deliveries have stacked up to date. Some orders placed many years ago, and have yet to be delivered. Payments made in 2005 are less valuable today only making the accounting and costs more difficult. For example the original Northwest Airlines 787 order for 18 which now rests with Delta was made in 2005. Korean Air also ordered 10 in 2005 and none have been delivered. Backlog aging is something one has to think about. Supporting Mr Conner’s hopes, Boeing seems to have worked its way down the learning curve. This may be a glimpse of how Boeing is working on reducing production costs. It seems clear that Boeing has made production progress. Recently Bloomberg reported that Boeing has cut its 787 costs by $4m per aircraft. This is good news. Now that Boeing can apparently make the 787 more efficiently, how much flexibility does this provide to price aggressively and still cover that R&D cost overhang? A guide to that is obviously orders. And we can see orders are not coming at the same rate as they once were. In Boeing's 2015-2035 CMO it projects a demand for 6,060 small widebodies by 2035. Airbus forecasts 8,060 twin-aisle aircraft in service in 2035. The 787 and A330 fit this definition. But the question remains, are customers going to take delivery of the aircraft currently on order? What if some, like Delta, are going to keep pushing deliveries back? Earlier in the year analysts made the case that Boeing could not fully recover its 787 development costs. Competition will hamper Boeing’s plans to achieve the desired level of productivity and hence profitability for the 787. Airbus is soon going to start producing the A330neo, the first of which left the FAL last week. Airbus can, and will, price the A330neo to ensure they hobble any 787 competition they encounter. If the 787 program R&D overhang is currently $27.5 billion (as reported in the Bloomberg link) and the backlog is 723, the per-aircraft R&D hurdle is $38 million. The 787-9 retails at $264.6 million and the A330-900 retails at $287.7 million. Discount these prices by 50% and the 787-9 comes in at $132.3 million compared to $143.9m for the A330-900. The 787-9 has 621 orders while the A330-900 has 176. Might this indicate that Boeing has been too aggressive in pricing? Given the R&D overhang, Boeing might be able to increase its prices and still hold on to much of the segment. Looking at the 787 program numbers we have, we see the picture differently. The program appears to us to have an R&D overhang of about $24 million per ordered aircraft through end of October 2016. If we average Boeing's and Airbus 2035 market projections, and assume Boeing gets 50% share, then the R&D overhang drops to $8 million per aircraft by 2035. This implies a big growth in the accounting block from the current 1,300. Since 2035 is a long way off, even if we limit the block size to 2,000, the R&D overhang drops considerably to only $14.5 million per aircraft. Bottom Line: Where does this leave Boeing? The 787 program costs are clearly a problem. How many more 787s will Boeing sell? Despite a higher list price, Airbus can and will sell the A330-900 at a lower price, as there isn’t much cost to recover and still maintain acceptable margins. This will hamper Boeing. This hampering could limit Boeing's market responses to new Airbus aircraft in the single aisle market or an MoM.

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