Earlier this year Boeing (NYSE:BA) shares tanked quite a bit on a disappointing delivery forecast for 2016. The rate cut on the Boeing 777 program added to the bad news. Simultaneously Boeing announced it will be increasing production rates on the Boeing 737 program. In this article I will explain why the rate decrease on the Boeing 777 and the rate increase on the Boeing 737 program are coupled.
To smooth the transition from the Boeing 777 Classic production to the Boeing 777X, Boeing has decreased its production rate from 100 aircraft per year to 84 per year in 2017. Although Boeing states this rate cut is necessary for a smooth transition, the fact is that Boeing did not sell enough Boeing 777 Classics to fill the production gap. So in some ways the transition is not smooth at all.
The lower production of course has some impact on revenues and earnings. Currently the list price for a Boeing 777-300ER is $339.6 mln, up $9.6 mln from a year ago. In 2015 a heavily-discounted Boeing 777-300ER sold for about $130 mln, a 60.6% discount. Boeing said the higher list price for Boeing has to do with higher associated costs for production, parts, materials and services.
I expect discounts for the Boeing 777-300ER to have risen to roughly 62%, still selling for around $130 million per aircraft. The underlying profit margin likely contracted from 23% to 16%.
In terms of revenue a decrease of 16 units annually means a decrease in revenue of $2.08B. As for earnings, it is quite hard to estimate. Boeing cites higher costs as the main reason for this, but it is unknown how much of those costs it really has to absorb. So I will be using an estimate of 15.7% and 20% to estimate the loss in earnings. On a unit basis the loss in earnings is between $20.4 mln and $26 mln. So the total loss in earnings related to the cut will be between $326.4 mln and $416 mln for 2017.
Table 1: Impact of lower Boeing 777 production on revenue and profit
For the coming 3 years I expect production to be lower by 84 units compared to today's production rate. According to my estimates this will lead to revenue being $10.9B lower and a negative impact of $1.7B-$2.2B on earnings.
While Boeing announced it will be cutting rates on the Boeing 777 program it increased production rates for the Boeing 737 to 57 per month from 2019. The company had already announced a rate increase to 47 per month in 2017 and 52 per month in 2018.
For the Boeing 737 program there is no ramp up pattern available, which makes mapping a production mix that will consist of 7 types of aircraft rather difficult. To simplify the calculations, I have assumed that the rate increases will be used to increase the production rates for the MAX, 2017 will be a combination of increases for the NG and MAX. Additionally, I have assumed that most aircraft will be MAX 8 aircraft (85%) and Max 9 aircraft (15%). The assumed profit margins are 15% and 20%.
Table 2: Impact of higher Boeing 737 production on revenue and profit
What can be seen is that the increase in production rates for the Boeing 737 more than compensates for a lower revenue and profit on the Boeing 777 program. Over a timeframe of 3 years the accumulates missed revenue on the Boeing 777 of $10.9B is fully offset by a $18.5B gain from production increases on the 737 MAX program. Even the most conservative margin assumption of 15% will result in a net improvement of earnings of $600 million to $1B. Using the profit margin of 20% the net improvement is $1.5B to $2.0B.
The most important thing to realize here is that although it is good to zoom in on aircraft programs separately and analyze them, at all times you should also keep in mind the bigger picture.
In a previous article I concluded that high production rates on the Boeing 777 were not sustainable, but did make sense when the highly dilutive impact of the Boeing 787 program was taken into account.
A similar thing is happening now: Boeing is throttling back production on the troubled 777 program and is boosting 737 production to cover up any loss in revenue and profit. The healthy backlog of the Boeing 737 even allows Boeing to further grow revenues and profits by boosting production. Additionally, the Boeing 787 will be contributing to Boeing's financial results as well.
If you would like to receive updates for my upcoming articles, please click the "Follow" text at the top of this page next to my profile.
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.