Last quarter, Boeing (BA 0.01%) missed analysts' earnings estimates for the first time in five years as it absorbed another charge on its KC-46 military tanker development program. Yet the company's underlying financial performance was quite strong, and Boeing expects to make up for the Q1 earnings shortfall over the course of the year.
On Boeing's earnings call last Wednesday, the management team provided more details on why it is so confident about the company's trajectory. Here are five key points it highlighted:
Fundamental trends support strong aircraft demand
Over the past three years, we've seen passenger traffic growth consistently outpace global GDP and airline capacity growth, a key indicator that the supply and demand dynamic remains positive. Additionally, global airline load factors are at record levels of about 80% and daily airplane utilization at an all-time high of nine hours.
-- Boeing CEO Dennis Muilenberg
Airline passenger traffic trends remain very strong. Image source: Boeing.
As oil prices have cratered over the past two years, many investors have become worried that airlines would stop ordering new planes. The rationale was that airlines would feel less of an urge to replace older, less fuel-efficient planes with the newest and greatest technology.
That may be true, to some extent. However, nearly 60% of aircraft demand comes from market growth, rather than replacement. With lower fuel prices, airlines can make more money at lower fares, stimulating demand. Low oil prices have accelerated global passenger traffic growth to the highest levels since the Great Recession. As a result, demand for growth-related aircraft should offset the impact of lower replacement demand.
Airlines want the planes they have ordered
As a matter of fact, in the past year deferrals, accelerations, debookings, and cancellations combined for about 1% of our backlog. That is well below the 6% average over the last 15 years.
-- Muilenberg
A second, related concern among many investors is that airlines will try to defer or cancel their orders for new aircraft as lower fuel prices make it feasible to keep older planes in service. The risk of outright cancellations is mitigated by the fact that airlines would forfeit their deposits, which can be substantial.
But even requests for order deferrals have been relatively few and far between. Boeing has routinely stated in recent years that requests for deferrals and cancellations were below historical levels. Last week, the company finally put numbers on this claim. In the past year, just 1% of the company's backlog has been subject to change requests that could impact production.
Dreamliner costs continue to decline
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.
-- Boeing CFO Greg Smith
Stubbornly high production costs for Boeing's revolutionary 787 Dreamliner have been a big drag on the company's cash flow for the past few years. Many pundits have speculated that Boeing will need to record a "reach-forward loss", which would indicate that it no longer expected to fully recover its $28.7 billion in deferred production costs.
However, while Boeing is still building Dreamliners at a loss, those losses have shrunk to almost nothing. The deferred production balance only rose $141 million last quarter and should start to decline by the middle of this year, when Boeing begins to deliver Dreamliners at a faster rate.
Boeing has made great progress in reducing 787 production costs.
Continued cost reductions and an improving product mix within the 787 family should lead to strong cash flow growth for the Dreamliner program over the next few years. This will allow Boeing to finally generate some kind of return on its massive investment.
Parts and services are a big long-term opportunity
As we mentioned before, growing our services business across the Boeing enterprise is one of our top priorities going forward. We do see a significant opportunity there. If you look across commercial and defense sectors over the next 20 years, it's about a $4 trillion market space, and we have significant opportunities to grow within that existing market space.
-- Muilenberg
Late last month, The Wall Street Journal reported that Boeing was starting to sell more spare parts to airlines, squeezing suppliers that have historically earned fat margins on spare parts. Muilenberg confirmed the company's interest in the spare parts and services markets on the earnings call last week.
However, he argued that the market for parts and services is growing rapidly. That means Boeing could potentially turn the commercial parts and services market into a source of long-term, high-margin growth without undermining its suppliers' business models.
The KC-46 tanker is on track despite another charge
We are about 80% complete on the flight testing that's required for milestone C and we are moving toward completion of that milestone and approval around the end of the second quarter. ... The next major milestone beyond that will be delivery of the first 18 tankers and we remain on schedule to do that August of 2017.
-- Muilenberg
Boeing took its third charge on the KC-46 tanker program last quarter. This will cover the cost of reworking the first few aircraft to incorporate late design changes.
However, Boeing's management remains confident about the KC-46 program's trajectory despite the history of delays and cost overruns. The company expects to get the go-ahead to start low-rate production within the next few months. And Boeing still thinks it can meet the Aug. 2017 deadline for delivering 18 working tankers, notwithstanding the Pentagon's doubts.
Muilenberg also urged investors to think about the big picture. Boeing expects to build up to 400 KC-46 tankers over time, bringing in as much as $80 billion of revenue. These planes will then need decades of support. As a result, the KC-46 program should still be highly profitable when all is said and done.
