No doubt about it: Boeing (NYSE:BA) has had a tough 2009 so far. The bad news is: It's about to get tougher. Because according to The Wall Street Journal, a movement's afoot to get Boeing to foot more of the bill for the planes it builds.
As the Journal reports, British Airways (BA) is leading the charge to shift the cost of building an airplane off of its own balance sheet and onto those of plane builders like Boeing, Airbus, and Embraer (NYSE:ERJ).
Briefly, it works like this. When an airline like BA, Delta (NYSE:DAL), or Continental (NYSE:CAL) rings up its Boeing sales rep and says "I'd like to buy a 787," the airline is asked to pay an upfront fee of about 1% of the sticker price on said plane. But that's only the beginning.
Once Boeing starts work on the plane, it requires predelivery payments (PDPs) to finance its purchases of parts and services from subcontractors. Such PDPs can amount to 30% of the agreed price, paid over the course of the two years preceding actual delivery of the plane. (Then the balance is paid upon delivery.)
It's a fair system, one that's familiar to any homeowner who's ever had a basement remodeled or a roof replaced. But in the midst of the economic downturn, British Air is finding it increasingly difficult to make millions of dollars of advance payments on planes that won't even begin generating revenue for at least two years. Banks like Citigroup (NYSE:C) and JP Morgan Chase (NYSE:JPM), which used to be willing to lend money to help BA make PDPs, are closing their wallets. One Deutsche Bank rep says its PDP financing business is down to "virtually nothing now." And in the absence of banker support, BA wants Boeing and its peers to step up and fill the gap by delaying cash payments, essentially forcing Boeing to bear more of the financing burden.
How likely is this to happen?
Pretty likely, I'd say. By its own actions, Boeing seems to be preparing for this latest financial hardship, launching a $2 billion debt offering last week. And even before BA threw down the gauntlet, we saw United Airlines (NYSE:UAUA) make the provision of favorable financing terms a key requirement of its invitation for Boeing and Airbus to bid on a $10 billion, 150-airplane deal.
Worse still for the airplane manufacturers' chances, they've handed their customers a proverbial "silver platter" argument for vendor financing. After all, PDPs are supposed to be provided over the two years preceding airplane delivery, right? So what's an airline supposed to do when the manufacturer is two years late (and counting) on making delivery?
Um, wait patiently?
To paraphrase British Air: Not bloody likely.
So what does all of this mean for Boeing investors? If BA's effort succeeds -- and perhaps even gains imitators among peer airlines -- this means that airplane manufacturers are going to need a lot more cash to run their businesses going forward. They won't be able to depend on prepayments from customers to pay their suppliers. Who's best placed to profit from such a trend? See for yourself:
|
Stock |
Cash and Short-Term Investments |
Total Debt |
P/E |
|---|---|---|---|
|
EADS* |
$13.9 billion |
$6.1 billion |
7.4 |
|
Boeing |
$4.8 billion |
$9.1 billion |
14.2 |
|
Embraer |
$2.1 billion |
$2.6 billion |
20.0 |
Cash and debt data provided by Capital IQ, a division of Standard & Poor's. *European Aeronautic Defence and Space Company is the parent company of Airbus.
Foolish takeaway
From where I sit, it looks like Boeing is the odd man out on this chart. It's got the lowest level of cash reserves relative to its debt load, while archrival EADS has the highest, at more than twice the amount of cash as it carries in debt. Tiny Embraer may have the least cash as an absolute dollar value, but (a) it also has the least debt, and (b) its planes don't cost a lot, which mitigates the cost of financing their construction. Also, Standard & Poor's recently dropped Boeing's rating a notch -- further borrowing to fund plane production could put pressure on Boeing's balance sheet, increasing borrowing costs.
Which is a long-winded way of saying that over the coming years, Boeing shareholders are going to see a combination of:
- higher debt loads as Boeing floats more bonds to beef up its cash stash;
- greater share dilution, should Boeing elect to issue equity rather than debt to raise cash;
- and lower profits -- whether via dilution of the value of their shares, or compressed margins as interest costs eat into profit.
Any way you look at it, this is bad news for Boeing.
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