The 787 Dreamliner program is Boeing's (NYSE:BA) most ambitious project in recent times, as for the first time, carbon composite parts have been used to build an aircraft. Carbon composites help lower the plane's weight and can save fuel worth millions for the airlines. Everyone expected airline companies to lap up these birds, and Boeing to earn huge profits.
As things turned out, Dreamliners attracted commitment for more than 1,000 units, but the second expectation still remains elusive. The innumerable delays and cost overruns associated with the program have become a nightmare for investors. Boeing makes a loss each time it sells a 787. Management expects the program to break even by the latter half of the year. Here's an update on the Dreamliner program and whether Boeing can finally make money out of it.
Touching breakeven... finally
Boeing hopes to be cash positive on the 787 program later in 2015, which means the company would be able to match the incremental costs to build a 787 with the unit selling price of the plane. At the fourth-quarter earnings call in January, Boeing CFO Greg Smith noted that the unit cost of the 787-8 and 787-9 have fallen 30% and 20% since the initial delivery.
Cash breakeven doesn't mean the program becomes profitable as a whole. It's going to take a while before actual revenue earned on the program exceeds the total costs incurred. As reported by Reuters, Richard Aboulafia of the Teal Group calculated that each 787 is selling at an approximate loss of $30 million, based on the third-quarter 2014 deferred cost of $25.2 billion. Deferred cost represents the difference between Boeing's actual cost to build each 787 and the average projected cost per unit for the initial 1,300 units.
However, Boeing is able to avoid recording actual losses on the Dreamliner program as it uses the program accounting method, under which it records profits by booking the average cost of the aircraft taken over the entire program period instead of the actual cost. Had Boeing booked the actual cost, it would have registered a loss of $122 million in the commercial airplane division instead of a pre-tax profit of $6.4 billion in 2014.
More than a year's wait before deferred costs decline
While investors are eagerly waiting for the 787's cash breakeven, it's coming at the cost of huge investments in productivity enhancements that have pushed up the deferred cost on the program.
Boeing had forecast that Dreamliner's deferred cost would rise to a maximum $25 billion before the company begins digging itself out of the hole in 2015. However, the deferred cost for the program surpassed the $25 billion mark in the third quarter of 2014, and finally piled up to $26.1 billion at the end of 2014.
Apart from spending on streamlining the process to enhance the program's productivity, Smith acknowledged that delay in contract renegotiation with suppliers and labor for the 787-9 Dreamliner cost the company more than expected. According to Flightglobal, Boeing is likely to spend another $2.5 billion over the next nine months, pushing up deferred costs to over $30 billion before the Dreamliner program attains cash breakeven.
According to Boeing's estimates, investors will have to wait till the company increases its production rate to 12 a month in 2016 before deferred costs start declining. Fortunately, the company has adequate backlogs to support the higher 787 production levels over the coming years. It had 836 pending orders for the 787 at the end of January, which means nearly seven years of work at the current production rate of 10 a month.
Investors wait for the cash boost
Boeing's erratic cash generation has troubled investors for some time. Despite record deliveries in the commercial aviation segment, the company's cash flow generation has dwindled. The Dreamliner had a big role to play in this, as Boeing is bleeding cash on each sale. Once that stops later in the year, and the program slowly starts contributing toward cash flows, we could see a better reflection of the soaring deliveries on cash flow numbers.
For 2015, Boeing has predicted cash flow of $6.2 billion, which, according to Reuters, is at the higher end of analysts' expectations. In 2014, Boeing generated $4.3 billion cash flows. JPMorgan analyst Joseph Nadol noted that "solid 2015 cash flow guidance suggests confidence on lower 787 unit costs." The situation could improve further once the deferred costs start leveling off in 2016.
For years, Boeing has invested in the troubled 787 program in hopes of turning it around. Finally, the company's efforts could begin bearing fruit as unit costs on producing the Dreamliner come down. The cash breakeven is definitely a big milestone, which could be followed by the burn off of deferred costs from 2016. When that happens, the 787 program will show profits not just in Boeing's books of accounts, but in actual terms, too.