Boeing: Pay Attention To Those Write-Offs

| About: The Boeing (BA)

Summary

Boeing wrote down $2.1B against its 747, 747-8, and KC-46A programs last week.

The write-off didn't move the needle, but we wouldn't be surprised if there were more write-downs in the near future.

It is helpful to understand how write-offs impact financials.

Last week Boeing (NYSE:BA) wrote of $2.1 billion against its 747, 747-8, and KC-46A programs, but the analyst community dismissed it as a non-event and the stock price quickly recovered. Boeing has been dealing with production-related issues with each of these programs for a while, and most investors expected the impairments. The magnitude of the write-offs did not surprise investors either; only the Dreamliner charge had an element of uncertainty to it, and the write-off paled in comparison to the value of deferred production costs. The charges were largely the result of program delays that investors were well aware of rather than a change in demand forecasts, and this seemed to reassure investors. But with demand slowing, there may be more impairments on the horizon. It is important to consider what these write-offs represent, and the impact they could have on BA's financials going forward.

Management stated that the asset impairments (non-cash charges that Boeing will recognize on the income statement but add back to net income on the cash flow statement) would not impact its 2016 revenue and cash flow forecasts. But it is important to look beyond 2016 and consider what these impairments represent. Companies write off assets whose carrying values overstate the present value of the future cash flows they are expected to generate. Due to design problems, production delays and program cutbacks, Boeing anticipates that it will not realize the full economic benefits it originally expected when it capitalized the assets. In other words, the company will sell fewer planes. Many analysts and investors believe the charges were long overdue. The problem is that write-offs have become a recurring theme for Boeing, and it's getting harder to categorize these charges as one-time items. As Buckingham Research explains,

"Looking back, in Jan 2016, BA guided 2016 EPS $1.10 below street estimates due to the 737 MAX introduction. BA also announced a 747 charge associated with reducing rate to 0.5/mo from 1/mo (and previously from 1.3/mo). In April 2016, BA took a KC-46 and another 747 charge. In May 2016 at its investor day, BA reduced 777 output to 5.5/mo due to the 777-X introduction and reduced 787 output to flat y/y in 2017. Finally, ahead of 2Q16, BA announced after-tax charges on the KC-46/747/787 of $393M/$814M/$847M or $0.60/$1.23/ $1.28 (based on 663M shares)".

The aircraft cycle, at least in the US, is approaching a peak. Demand for new orders is slowing down, and this will increase the pressure on Boeing to introduce new technologies. We believe the race to get new, innovative products to market is largely responsible for the production difficulties and program delays that led to the write-offs, and we wouldn't be surprised to see more write-offs in the near future.

Aerospace manufacturing is a capital-intensive business, and these write-downs could have an important impact on Boeing's financials, especially if they persist. If you are a current or prospective Boeing investor who uses ratios to analyze stocks, it helps to be aware of how these impairments might affect future financial ratios (holding all else equal). First, profitability ratios could improve as a result of lower depreciation expenses. If profit margins expand in the coming quarters, it will likely reflect lower depreciation rather than higher pricing or productivity gains. Second, Boeing may appear more efficient: lower asset values on the balance sheet will boost fixed asset turnover. The combination of a higher profit margin and asset turnover would boost ROA (ROA = net profit margin * asset turnover), and an investor might conclude that Boeing made meaningful strides in its return-generation ability. Finally, BA's financial health may appear to have worsened. The D/E ratio would increase without the firm adding more debt.

Conclusion:

Boeing's write-offs did not impact the stock price because they were expected, and they reflected issues that investors were well aware of. But we've noticed a trend developing, and we think it is likely that BA will continue to record impairments as aircraft demand moderates. Investors should be aware of how these write-offs impact financial ratios so they can properly assess the company's fundamentals.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.