Boeing posted strong Q4 earnings but weak guidance last week. Photo: Boeing.
Boeing (BA +2.47%) shares slumped 9% on Wednesday, following the company's earnings report. While Boeing's Q4 earnings came in well ahead of analysts' estimates, the aerospace giant issued a weak forecast for revenue, aircraft deliveries, and earnings for 2016.
However, the projected declines in these metrics during 2016 are not as bad as they might appear on the surface. During Boeing's earnings call on Wednesday afternoon, management explained why 2016 should be just a blip in the company's long-term growth story. Here are five points they emphasized.
777 backlog is healthy
In terms of production slots, we are sold out on the 777 in 2016. At the seven per month rate in 2017, we are approximately 80% sold out and feel good about customer demand to fill the remaining slots given the airplane's unique and recognized value proposition.
-- Boeing CEO Dennis Muilenberg
During the earnings call, Boeing CEO Dennis Muilenberg announced that the company will cut production of the 777 widebody jet to seven per month in 2017, from 8.3 per month today. This cut was widely expected, especially after Muilenberg hinted at a possible reduction to seven per month on the October earnings call.
Some investors and analysts have warned that Boeing might need to cut 777 production further prior to the introduction of the next-gen 777X in 2020. However, Boeing is already sold out for 2016, and it now appears to have fewer than 20 777s left to sell for 2017. There are still many open slots for 2018 and 2019, but Boeing has plenty of time left to line up orders.
The Dreamliner is finally producing cash
Consistent with our expectations, the 787 program also became cash positive in the fourth quarter. 787 deferred production increased $201 million to $28.5 billion in the fourth quarter, reflecting ongoing unit cost reductions.
-- Boeing CFO Greg Smith
The Boeing 787 is finally turning cash-positive. Photo: Boeing.
Many investors have also been concerned about rising deferred production costs for the 787 program. Up until recently, Boeing has been bringing in less revenue for each 787 than the cost of production. These deferred production costs have been approaching $30 billion in total, leading some analysts to speculate that Boeing will never recover its costs.
However, production costs are declining steadily, and Boeing reached a major milestone last quarter as the 787 program finally started to generate cash. Cash flow from the 787 program is likely to rise dramatically over the next five years, allowing Boeing to eventually turn a solid profit on the program.
Production increases will also boost cash flow
The drivers behind our long-term year-over-year cash flow story are unchanged. We continue to expect strong core operating performance, improved 787 productivity, working capital efficiencies, and increasing production over the remainder of the decade.
-- Greg Smith
The improving cash profitability of the 787 Dreamliner will be the biggest driver of cash flow growth at Boeing for the next several years. However, Boeing will also benefit from significant production increases over that time frame.
In 2016, Boeing expects a modest decline in commercial airplane deliveries. That's due to lower production of the 747, fewer 767 deliveries -- that production line will be building some KC-46 military tankers that won't be handed over to the U.S. military until 2017 -- and a slowdown in 737 deliveries as Boeing will produce some 737 MAX test models this year.
However, Boeing has one or two production increases scheduled in every year from now through 2019. Over that time period, 737 production will rise 36% from today, 787 production will increase by 40%, and 767 production will grow 67%. This will drive steady growth in revenue and cash flow beginning in 2017, despite the impact of lower 747 and 777 production.
Aircraft demand remains strong
And the value proposition of our airplanes is compelling whether you're looking at replacement of old assets or the need to satisfy passenger growth. ... The Southwest Airlines (LUV +4.51%) announcement that was made just a week ago refers to both passenger growth as well as the compelling value proposition of fleet modernization.
-- Dennis Muilenberg
In recent years, Boeing has profited from strong replacement demand as airlines looked to boost the fuel efficiency of their fleets. As a result, some analysts have suggested that low oil prices could sap demand for Boeing's planes. Muilenberg countered this notion by pointing to Southwest Airlines' recent order for 33 more 737-800s.
Southwest Airlines recently ordered another 33 Boeing 737s.
These planes certainly offer big fuel-efficiency gains over the older 737s that Southwest is replacing. But they also have a higher seating capacity, allowing the carrier to grow and make more efficient use of scarce (and expensive) pilot labor. Southwest Airlines will also benefit from maintenance savings. Even with low fuel prices, there are plenty of reasons to replace older aircraft.
Driving long-term margin growth
As we've mentioned before, we are driving fundamental productivity with a target of increasing our operating margins to get into that mid-teen range. And that remains our aspirational target. I think it's a challenging but reasonable expectation.
-- Dennis Muilenberg
In recent years, Boeing's commercial-airplanes segment has produced operating margins around 10%, excluding special charges. For 2016, Boeing has forecast a modest decline in the segment margin to around 9%.
Nevertheless, management still believes it will be feasible for the commercial airplanes segment to reach mid-teens margins eventually. Boeing has a number of cost-reduction programs under way, and the scheduled production increases over the next few years should also help margins.
Most importantly, as 787 costs come down and orders increase, the profit margin for that aircraft program should rise significantly from the very low rate being recognized today. It's just one more way that Boeing's near-term results don't truly reflect its strong long-term prospects.
