Bloomberg News

Boeing May Peg 787 Profit Benchmark to Output of 1,100 Planes

October 25, 2011

Oct. 26 (Bloomberg) -- Boeing Co. is poised to give investors the first glimpse into the average profit from each 787 Dreamliner today, with analysts estimating the company will spread the initial costs over 1,100 planes.

That’s the average of 18 estimates compiled by Bloomberg for Boeing’s so-called accounting block for the 787. Chicago- based Boeing uses a practice known as program accounting to determine average profitability rather than posting a loss on early output because of high startup expenses.

All Nippon Airways Co. makes the first flight today with paying passengers on the composite-plastic jet, Boeing’s fastest-selling model ever. Setting the initial quantity will show how quickly the company expects to widen profit margins on the 787. The analysts’ estimates spanned 900 to 1,300 planes.

A Boeing figure lower than that range “might send a signal that they’re incredibly confident about profitability over a shorter period of time than Wall Street assumed,” said Carter Copeland, a Barclays Capital analyst in New York. A larger number “arguably would shake Wall Street’s confidence about the longer-term profitability profile of the program.”

Boeing plans a fivefold jump in monthly 787 production to 10 by the end of 2013, a record for a wide-body jet. Meeting that goal would mean that Boeing would need just over a decade to deliver 1,100 planes. About 800 have been ordered so far.

’Day One’

The 787 “will be profitable on Day One” under program- accounting rules, Chief Executive Officer Jim McNerney said Sept. 26, when the first Dreamliner was turned over to All Nippon.

Boeing determined the block size in the third quarter and will include it with today’s earnings report. Analysts expect profit of $1.10 a share, based on the average of 24 estimates compiled by Bloomberg.

The twin-engine 787 is Boeing’s most closely watched aircraft program, partly because the plane has racked up billions in extra costs during more than three years of delays. Before today, the stock dropped 37 percent since October 2007, when the first of seven setbacks was revealed, compared with 21 percent for the broader Standard & Poor’s 500 Index.

Boeing fell 1.6 percent to $63.72 yesterday in New York.

Amortized costs on the 787 won’t include research and development expenses or the undisclosed amount Boeing spent to buy out a couple of struggling suppliers. The block size is based on the number of initial sales, airlines’ options, orders Boeing is confident it will win in the near term and the planned production rate.

Quantity, Profit

“The accounting quantity is determined independently of the profitability calculation,” Boeing said in a statement. “It is bounded by our ability to make reasonably dependable estimates of both revenue and cost.”

CEO McNerney’s declaration of the 787 as being profitable from the outset means that the accounting block Boeing calculated is big enough to absorb all of the costs. Putting more jets in the initial block would lower profit margins for a longer period of time, while starting with a smaller block and expanding it later would boost margins for the additional planes more quickly.

The smaller the block, the more confident the company is in its ability to estimate the cost, said Barclays’s Copeland, who recommends buying Boeing shares. In the 787’s case, the record level of initial orders may boost visibility, he said.

Evaluating the reasons behind Boeing’s calculations will be pivotal to judging what the block size means, he said.

‘Intensely Focused’

“The Street is intensely focused on the block size,” Copeland said. “The reason it’s so intriguing is because there aren’t a lot of metrics that are publicly disclosed that allow you to get a sense of the profit profile of the program.”

Boeing doesn’t disclose the discounts given to customers. The 787 has a list price of $193.5 million to $227.8 million, depending on the model.

Developing a new plane costs billions of dollars, so Boeing generally introduces just one each decade, along with a few derivatives of existing models. It has five commercial programs now: the 737, 747, 767, 777 and 787.

Boeing chose an initial accounting quantity of 400 units for the 747 in 1969. The company used the same amount for the 757 and 767 models in 1982, and again for the 777 in 1995. The planemaker analyzes the figures quarterly and often boosts them. With the new 737NG family introduced in 1998, for example, the block was doubled to 800 by the end of the year.

According to the 1995 annual filing when the 777 quantity was disclosed, Boeing had 250 orders for that model, along with options for 138 more, and was building two of the jets a month.

By last quarter, the block size had more than tripled to 1,250, output had risen to seven a month, and Boeing had sold 1,233 of the twin-engine, long-haul jets.

Deferred Production

Boeing’s earnings report will also include deferred production differential, the cost overrun on the early jets that will be spread over the program block. Copeland estimated that Boeing may list a differential of $10 billion that will rise in a few years to $15 billion to $20 billion. That compares with a peak of $2.5 billion for the 777 in the mid-1990s.

McNerney said last month that the 787 program will achieve a positive cash flow later this decade. That means Boeing will have burned off the initial production costs and be making money with each delivery.

The company’s assumed learning curve is a key component in getting past that differential, David Strauss, an analyst with UBS Securities LLC in New York, wrote in a note last week.

Reducing Costs

Boeing will need to reduce the 787’s manufacturing costs 50 percent to 60 percent faster than on the 777, “despite having less control of production,” Strauss wrote. Suppliers build 65 percent of the Dreamliner, compared with 50 percent of the 777.

Production expense for each plane will need to drop to about $100 million, from as much as $300 million now, to reach Boeing’s goal of burning off that higher cost balance by the time it reaches full production in 2014, he wrote.

That would mean a 25 percent reduction in expense with each doubling of the output rate, wrote Strauss, who estimated that so far, the drop has been a percentage in the low- to mid-teens.

If the learning curve reaches only the 16 percent cut in costs on the 777, Boeing would have to spread its expenses over a block of 3,000 planes in order to not be in a loss position, according to Strauss. He has a neutral rating on the stock.

At that rate, it would take until early next decade before Dreamliners were being built for less than the average revenue estimate of $113 million each, Strauss said.

Negative Margin

Douglas Harned, an analyst with Sanford C. Bernstein & Co. in New York who has a market-perform rating on Boeing stock, said even his “optimistic assumptions” lead to an initial accounting quantity of 1,000 jets with a negative gross margin.

“For Boeing to estimate a positive gross margin over the block, we believe that the company must be making assumptions that significant changes in the aircraft design or manufacturing processes are possible that would materially lower the production cost,” Harned wrote in an Oct. 24 note.

“Despite a tough initial period for the 787, this program could eventually deliver profitability comparable to other programs” such as the 777, he said.

--With assistance from John Lear in Chicago. Editors: Ed Dufner, Donna Alvarado

To contact the reporter on this story: Susanna Ray in Seattle at sray7@bloomberg.net

To contact the editor responsible for this story: Ed Dufner at edufner@bloomberg.net


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