The grounding of the Boeing (BA 2.25%) 737 MAX is set to drag on for longer than anyone had initially anticipated. New potential safety issues discovered last month have forced Boeing to design yet another software update for its troubled jet, which will probably keep the 737 MAX out of the sky until at least November.
With deliveries of its biggest cash-cow product halted until further notice, Boeing's earnings results suffered in Q2, the first full quarter following the grounding order. A big one-time charge to cover some of the costs of the grounding made the quarterly earnings report look even worse.
Earnings turn negative due to a big one-time charge
On Wednesday, Boeing began to total up the damage caused by the 737 MAX design flaws and the ongoing grounding. Boeing's results deteriorated substantially on a year-over-year basis across every major business metric.
| Metric |
Q2 2019 |
Q2 2018 |
Change |
|---|---|---|---|
|
Revenue |
$15.8 billion |
$24.3 billion |
(35.1%) |
|
Commercial airplane deliveries |
90 |
194 |
(54%) |
|
Core operating margin |
(23.8%) |
9.9% |
N/A |
|
Free cash flow |
($1 billion) |
$4.3 billion |
(123%) |
|
Core EPS |
($5.82) |
$3.33 |
(275%) |
|
Total order backlog |
$474 billion |
$488 billion |
(2.9%) |
Data source: Boeing Q2 earnings releases.
Earlier this month, Boeing revealed that it delivered just 90 commercial jets in the second quarter, down more than 50% year over year. Additionally, the aerospace giant took a $5.6 billion pre-tax charge against revenue in its commercial airplanes segment to account for the compensation it will have to provide to customers in the future.
This pre-tax charge accounted for nearly two-thirds of the 35% revenue decline Boeing reported for the second quarter. It also caused the company's operating margin and core earnings per share (which adjusts for volatile pension costs) to plunge deep into negative territory.
Excluding this one-time charge, Boeing's core operating margin would have been a little less than 9%. The charge reduced EPS by $8.74, so core EPS would have been $2.92 otherwise. That compares to core EPS of $4.11 in the year-ago period, excluding two relatively small one-time charges recorded during the second quarter of 2018. Analysts had expected adjusted EPS of just $1.87.
Cash flow also plunges into negative territory
Aside from the $5.6 billion one-time charge, Boeing's operating margin and core EPS were surprisingly good, all things considered. A one-time gain on a property sale helped matters, but Boeing also delivered solid revenue and earnings growth in its defense and services businesses. By contrast, the 737 MAX grounding is having a bigger impact on cash flow.
The 737 MAX grounding caused Boeing's cash flow to plunge last quarter. Image source: Boeing.
The cash flow pressure stems from Boeing's decision to continue churning out 737 jets at a pace of 42 per month. Since Boeing gets most of the purchase price from customers upon delivery, every additional 737 MAX that is produced but not delivered reduces its cash flow. Indeed, inventory has ballooned by nearly $6 billion year to date.
Thus, it wasn't surprising to see Boeing burn $1 billion of cash last quarter after producing $4.3 billion of free cash flow in the prior-year period. The company also pays nearly $1.2 billion in dividends each quarter.
As a result, Boeing is quickly burning through the $5 billion in additional liquidity that it raised last quarter. This may explain why CEO Dennis Muilenburg stated during the earnings call that Boeing could halt 737 MAX production entirely if its return to service keeps getting delayed.
The 737 MAX isn't the only headwind for Boeing right now
While the 737 MAX grounding is by far the biggest problem dragging Boeing's results down right now, delays to its 777X jet program represent yet another risk for investors. Until recently, Boeing had planned to begin test flights this year so that it could start delivering the 777X to customers in 2020.
Unfortunately, General Electric has been forced to redesign an engine part for the new GE9X engines that will power the 777X due to premature wear on that part. On Wednesday, Boeing acknowledged that it won't be able to begin test flights until early 2020 -- assuming no further delays. It's still possible that Boeing will be able to begin 777X deliveries at the very end of 2020, but that's an aggressive timeline that isn't likely to hold up.
This may lead to Boeing building a handful of 777X jets in 2020 that it won't be able to deliver until 2021. That would create a cash-flow headwind in the same way as the 737 MAX grounding, albeit on a smaller scale.
Over time, Boeing should be able to sort through the issues weighing on its earnings and cash flow and return to growth. But it will be left with a bunch of extra debt and other liabilities, as well as a weakened brand that could reduce its pricing power. With Boeing stock still trading less than 20% below its all-time high, investors should probably steer clear of the company for now.
