Boeing (BA 0.84%) continues to be a battleground stock, as investors debate whether the aircraft market is peaking -- and whether the company's profit goals are realistic.
On balance, Mr. Market seemed satisfied with Boeing's Q3 results, sending the stock up nearly 5% following the earnings report. Boeing executives' confident tone during the Q3 earnings call probably helped in that respect. Here are five key points that they emphasized related to the company's outlook for the next few years.
Robust demand for the 737
We remain on track to raise the 737 production rate from the current 42 per month to 47 in the third quarter of 2017, followed by 52 per month in 2018 and then 57 per month in 2019. And importantly, even at the 57 per month rate, we continue to be oversold.
-- Boeing CEO Dennis Muilenberg
The workhorse 737 jet remains Boeing's most important sales and profit driver right now. The explosion of low-cost airlines across the world has created huge demand for relatively affordable narrowbody jets. As a result, Boeing has accumulated a backlog of more than 4,300 orders for 737 jets.
The Boeing 737 has a backlog stretching beyond 2020. Image source: Boeing.
Nevertheless, a number of pundits have questioned whether Boeing can support a production rate increase to 57 per month by 2019, from 42 per month today. Muilenberg noted that the Boeing 737 is oversold to the end of the decade even at a rate of 57 per month. That provides a cushion in case poor market conditions force some airlines to defer or cancel orders.
A 777 rate decision is coming soon
If [another 777 production cut] were to occur, implementation would begin in late 2017 or early 2018. On the other end of the spectrum, should we see success on ongoing campaigns, we may not need to adjust our existing production plans at all.
-- Muilenberg
Demand for the 777 widebody family is much shakier. Boeing fell short of its order goal in 2015, and it is less than halfway to meeting its 2016 order target with just two months left in the year. Still, Boeing reeled in 11 net orders for the 777 last month, compared to just six net firm orders in the first nine months of 2016.
Boeing is already in the midst of cutting 777 production from 8.3 per month to seven. By 2018, actual deliveries are scheduled to fall to 5.5 per month, as Boeing starts to build 777X test aircraft. And if order activity remains slow, the company may need to cut output by another one or two units per month.
That said, Boeing has a few more ongoing 777 sales campaigns. Depending on its success, it may be able to avoid further production cuts. In any case, it will have to make a decision on future 777 production rates in the next few months.
Dreamliner profitability is turning the corner
On the 787 program, the deferred production balance declined by $151 million in the quarter. This decrease was driven by delivery mix, internal productivity efforts and suppliers step-down pricing.
-- Boeing CFO Greg Smith
Arguably the best piece of news in Boeing's earnings report was that the 787 deferred production balance has started to decline. In other words, after years of incurring huge cash losses from selling Dreamliners below the cost of production, Boeing is starting to turn a profit on each 787 it turns out due to a combination of favorable mix, higher prices, and lower production costs.
Dreamliner profitability is on a steady upward trajectory. Image source: Boeing.
Right now, the cash profit margin on each 787 Boeing builds remains modest. However, the trends of improving mix, better pricing, and lower production costs (particularly driven by contractual price reductions from suppliers) will continue. This should allow Boeing to recoup its $27.5 billion in accumulated losses over the next six or seven years.
Expect rising cash flow in any scenario
... [E]ven if we have to moderate our widebody production plans in the future, we continue to expect commercial aircraft deliveries to grow beyond 900 airplanes per year through the end of this decade, supporting our expectation that we will continue to grow cash flow year-over-year throughout this time period.
-- Muilenberg
Clearly, Boeing's 737 and 787 aircraft families are on pace to churn out more and more cash in the coming years. On the other hand, the 777 -- one of Boeing's most reliable cash cows in recent years -- is facing a rough stretch.
Investors have struggled to estimate the net impact of these trends. However, Boeing's management gave very clear guidance last week. Even in a worst-case scenario for the 777, where orders slow to a trickle for the next few years, Boeing expects its cash flow to continue rising steadily between now and the end of the decade.
Services growth will boost margins
... [A]s we continue to invest in growing our services business, generally services will be accretive to our margins...
-- Muilenberg
Boeing has set a goal of expanding its pre-tax margin from high-single-digit territory in recent years to mid-teen levels by the end of the decade. Analysts are understandably skeptical of this extremely aggressive margin target. A lot of things need to go right for Boeing to improve its profit margin that much.
However, Muilenberg noted that Boeing's increased focus on selling services will support profitability. Aftermarket services contracts generally carry higher margins than airplane sales. This strategy shift is still in the early innings, but Boeing is already gaining traction, signing some big services contracts at the 2016 Farnborough Airshow. As Boeing expands its services portfolio, it could continue gaining momentum in this lucrative ancillary business.
