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Boeing Co.'s Earnings Growth Is a Lot Stronger Than It Appears

By Adam Levine-Weinberg - May 13, 2016 at 10:25AM

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A look at Boeing's unit-cost accounting shows that earnings are on a strong upward trajectory in the commercial jet segment after hitting a rough patch a few years ago.

Boeing (BA 0.71%) has forecast that core earnings per share will reach $8.15 to $8.35 this year, up from $5.79 five years earlier. The midpoint of the guidance range represents a compound annual EPS growth rate of 7.3% -- solid but not spectacular.

Investors had expected faster earnings growth at Boeing. That's a big reason why the stock has performed poorly over the past year. However, Boeing's underlying earnings trend is actually a lot better than it seems on the surface.

Program costs vs. unit costs

Boeing uses a technique called program accounting to measure its profit (or loss) from each of its long-term aircraft programs. The idea behind Boeing's use of program accounting is that production costs for an airplane model fall over the course of a long production run -- quite dramatically in the first few years. As a result, early units in the production run are typically sold at a loss, while later units are highly profitable.

Program accounting allows Boeing to smooth out its reported earnings. For each aircraft program, it estimates the total number of planes it will sell and the average profit margin it will earn on those sales. It then books a profit for each sale based on the estimated average profitability of the entire aircraft program.

Recently, program accounting has become a controversial topic. Boeing has lost huge sums of money on production of the 787 Dreamliner product family in the past few years, yet program accounting procedures have allowed it to report (tiny) profits on its 787 sales. As a result, it has accrued nearly $29 billion in deferred costs for the 787 program.

Costs for building the first few hundred Dreamliners were a nightmare. Image source: Boeing.

Some analysts doubt that Boeing will ever recover these costs. These concerns have led to an SEC investigation into Boeing's use of program accounting and a shareholder lawsuit regarding the same issue.

Boeing isn't hiding anything

It's true that Boeing has racked up big losses producing the 787 over the past few years. But the company doesn't try to hide it. In fact, Boeing maintains a page for investors detailing just how much money it would have made (or lost) if it calculated its earnings based on the profit earned on each period's aircraft deliveries.

As it turns out, over the 2012 to 2015 period, Boeing recorded a cumulative profit of more than $22 billion for its commercial aircraft segment using program accounting. However, under unit-cost accounting, it would have had to report a loss.

This glass is half-full

A fair number of analysts and stock market pundits have written extensively about the gap between Boeing's program accounting results and its unit-cost accounting results. Most of them have interpreted it as a big negative for Boeing.

Indeed, Boeing's unit-cost accounting statistics reveal that the company wasn't doing as well as the "official" numbers showed a few years ago. However, this is a backward-looking perspective. What really matters for investors is how Boeing is performing now and how it will do in the future. That will determine how much money Boeing will have to reward shareholders with dividends and buybacks.

From this perspective, the unit-cost accounting statistics tell a great story for Boeing investors. On a unit-cost accounting basis, Boeing's commercial airplanes segment profit has improved by at least $1.5 billion a year every single year since 2012, swinging from a $3.7 billion loss to a $2.7 billion profit. Over the same period, profit barely grew on a program accounting basis.

Falling costs and a better 787 product mix are driving rising unit profitability. Image source: Boeing.

In Q1, Boeing's commercial airplanes business remained on its upward trajectory, as unit-cost accounting profit soared from $167 million to $1 billion. This puts Boeing on track to deliver another multibillion-dollar improvement in unit-cost accounting profit for the full year.

Huge profit and cash flow growth potential here

Now that the 787 program is turning profitable, the gap between program accounting profit and unit-cost accounting profit at Boeing is poised to swing in the other direction. Over the next several years, the Dreamliner should become quite profitable on a unit-cost accounting basis, yet Dreamliner sales will still be booked at a very low profit margin to make up for the big losses on the first few hundred deliveries.

However, in the long run, the profit trend in unit-cost accounting terms is the key driver of both program accounting profit and cash flow. As Dreamliner profitability surges and 737 production increases over the next five years, all three metrics are poised to rise dramatically.

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