The development of deferred costs has been the subject of some of my previous articles. Besides the quarterly updates, I also have looked at some common mistakes regarding the deferred costs on the Boeing (NYSE:BA) 787 program completely being zeroed out. In this article, I will have a look at whether Boeing's accounting block of 1,300 aircraft is big enough. If that is not the case, I will try to determine what is a more realistic block size.
Before reading this article, I would recommend reading the following articles if you have not done so already:
- An article about the disruptive use of wrong data analysis tools to predict the development of deferred costs.
- An article about the average revenue per aircraft.
- An article including the latest sanity check in simple form.
The articles above serve as a base for this article and make sure you have enough knowledge to understand this article and also prevent me from repeating myself too much.
What do we know?
Some key figures and milestones to keep in mind.
Currently, the size of the accounting block is 1,300 units. Accumulated deferred costs excluding unamortized tooling costs and other non-recurring costs are $28.51bn at the start of the year. Year over year, deferred costs are expected to be flat. 363 airframes have been delivered by the end of 2015, leaving 937 airframes in the accounting block. Expected deliveries for 2016 are 139 units.
With these points in mind, it is already possible to draw a curve of the accumulated costs and the projection of cost development this year.
Figure 1: Development deferred costs (Source: AeroAnalysis)
One of the most important things that can be seen is that the peak of the deferred costs will be approximately $28.7bn. At that time, the jet maker will likely have delivered 429 aircraft, a mix of Boeing 787-8 and Boeing 787-9 aircraft.
The peak in deferred costs is expected to be reached at 429 units or a third of the block of 1,300 units.
Explaining my method
The method I use is based on a couple of assumptions:
- A certain ramp up in profits.
- A certain production cost per airframe.
- A certain revenue per airframe.
- Ramp up of the Boeing 787-10 production.
To refine the calculations, I am taking into account that the average sales prices and production costs will increase after the launch of the Boeing 787-10, scheduled in 2018.
Boeing needed 429 airframes to reach the peak in deferred costs. For this analysis, I will assume it will need another 436 units to ramp up profits. This leaves 435 units on which the jet maker can make "full" profits. So, I am assuming that each phase (building deferred costs, ramping up profit and production on full profit) equals roughly a third of the total block size. In future analyses, I will have a look at the impact of different ramp-up patterns, but I think this pattern is a good one to start off with.
Revenue and cost assumptions
An important element of the estimate of the deferred cost development is the assumption for the revenue and cost per airframe.
For revenue, it is important to note that in the long term, the sales price will balance around a 50% discount.
Table 2: Estimated value in millions for the Boeing 787 members
For the second half of 2016, 2017 and half of 2018, I am not expecting any Boeing 787-10 deliveries. In those years, I expect a total of 287 Dreamliner deliveries with an average sales price of $127.2 million and cost of production of $100 million per airframe.
For the 436 aircraft that are used to ramp up profits, the average revenue per airframe is $128.4 million with average costs of $100.5 million per airframe. These values will be used for the ramp up model.
For the 435 airframes that follow after the ramp-up, a revenue per airframe of $132.5 million and cost per airframe of $102.7 million are used. What can be seen is that the introduction of the Boeing 787-10 will positively impact the profit per airframe.
If we take Figure 1 and implement all the assumptions made, we obtain the following graph:
Figure 2: Projected development deferred costs Boeing 787 Program (Source: AeroAnalysis)
My model shows that Boeing, as many analysts also expect, will not be able to recoup costs within the current accounting block. The AeroAnalysis model shows that at 1,300 deliveries, there is $9.7bn in deferred costs left to be covered, and Boeing will not be able to zero out the deferred cost balance until the 1,625th delivery.
My model indeed produces results similar to that of analysts and confirms earlier back-of-the-envelope calculations that it will be a major challenge for Boeing to recoup costs within the accounting block.
Analysts have been quick to say that Boeing almost certainly will have to take a charge. In my view, that is not necessarily the case. Boeing could increase the block size stating that it is expecting to sell more Boeing 787 airframes than it had anticipated earlier. This would justify the airline spreading costs over more airframes. Additionally, Boeing is actively and aggressively negotiating with suppliers to lower the cost of parts. If successful, this could drastically increase Boeing's profit per airframe. Also, in this view, I differ from analysts who expect the profitability to be driven by the learning curve.
What is also important to note is that the number of units required to zero out the costs is within the total number of aircraft that will be needed in the next 20 years. Earlier analyses expected Boeing not to be able to zero out costs until the 2,700th delivery and this analysis has been cited by many analysts and aerospace news portals.
Even if the charge comes, I think investors should not worry. Boeing is active in a cash intensive industry and its cash flow forecasts are looking good and are what attract most investors. A charge will only shake out the earnings-focused investors, offering a nice opportunity for investors who invest in Boeing for its cash flows.
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Disclosure: I am/we are long BA.
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.