- Boeing Defense earnings will be more prominent in the earnings mix but that reflects weakness in the Commercial Airplanes business.
- Boeing Defense has had - and is having - its own program-specific challenges.
- Boeing likely to return to previous earnings mix levels as time passes.
- With Commercial Airplanes beaten down, shifting focus away from the ugly reality is not warranted.
- Boeing Commercial Airplanes will drive earnings up again.
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In recent reports, I had a look at Boeing’s (NYSE:BA) Commercial Airplanes monthly order overviews and the pressures on demand for commercial aircraft. Although the order and delivery overviews have been part of my coverage for years, some readers have now perceived that as me viewing Boeing as a “commercial aircraft only” company while ignoring the other business segments. That’s not quite accurate as we have been dealing with the defense and services segment sides as well. The fact remains that the biggest changes have been happening on Boeing Commercial Airplanes. In this analysis, I will explain why Defense indeed shouldn’t be ignored, or any of Boeing’s other segments for that matter, and why Defense is becoming more prominent but isn’t the solution to Boeing’s problems.
Source: Defense News
In this article we us some abbreviations:
Boeing Commercial Airplanes: BCA
Boeing Defense, Space & Security: BDS
Boeing Global Services: BGS
Boeing Commercial Airplanes: Bulk of the revenues
Figure 1: Revenue distribution Boeing segments
When looking at the distribution, we see clearly that commercial aircraft account for around 60% of the sales. In 2018, we saw an uptick in revenue share for Boeing Global Services and that further increased in 2019 due to the acquisition of KLX Aerospace. In 2019, the Boeing 737 MAX was largely absent from the delivery mix. To show this, we added back the scheduled Boeing 737 MAX deliveries as if there would be no crisis and added the Starliner charge on revenues back as well:
Figure 2: Revenue distribution Boeing segments with 737 MAX added back
What we see is that the distribution would be more or less stable and you could really ask yourself whether we should shift our focus away from Boeing Commercial Airplanes because this segment is not performing well at the moment, which results in higher revenue shares for Boeing Defense, Space & Security and Boeing Global Services.
Figure 3: Revenue development Boeing segments versus 2015
Boeing Commercial Airplanes revenues declined between 2015 and 2018 due to lower Boeing 777 deliveries while the offsetting production rate increases on the Boeing 737 and Boeing 787 programs were not realized until 2018. In the process, Boeing Commercial Airplanes maintained its share in the overall revenues and would even have expanded it if it weren’t for the Boeing 737 MAX crisis to hit Boeing.
For Boeing Global Services, the acquisition of KLX Aerospace was finalized in late 2018 and so we saw partial positive impact in the 2018 numbers and full impact of that acquisition in 2019. For Boeing, Defense, Space & Security what we see is lower revenues in 2016 due to lower C-17, F-15 and Chinook deliveries and lower satellite volume. The trend on lower planned deliveries continued in 2017 and didn’t revert until 2018 as defense spending increases found their way to Boeing’s topline. All in all, when measuring against 2015 revenue levels we see that the notion that Defense is carrying Boeing doesn’t quite hold. What we see is that depending on the year BDS did a billion worse or better in any given year. The biggest growth vehicle for Boeing has been their Global Services business which leans on BDS and BCA installed bases.
Table 1: Compounded revenue changes Boeing (Source: AeroAnalysis)
There of course is a difference between revenues, profits and cash but we see quite clearly that up until 2018 revenues for Boeing Commercial Airplanes declined $4.7B due to lower Boeing 777 deliveries. This wasn’t offset by Boeing Defense, Space & Security which saw compounded revenue declines vs. 2015 levels of $1.6B. The partial offset came from Boeing Global Services and in 2019 there was nothing that could offset the Boeing 737 MAX crisis.
We see that Boeing’s Defense business, revenue wise, has been a stable factor but certainly not an offsetting factor. In Q1 2020, adjusted revenues were $6.9B for BDS vs. $6B for BCA. These figures also include COVID-19 pressure as assembly lines were closed. Absent of this pressure, BCA and BGS likely would have posted similar revenues. Going forward, with production rates of 10 aircraft per month for the Boeing 787, revenues of BDS and BCA would be similar and at a rate of seven per month would be $1.4B higher for BDS.
So, clearly there's no reason to ignore BDS but also not to shift the focus away from the incredibly big changes that are happening at BCA now, because in any undisturbed year it's BCA that drives 60% of revenues. That's the normal that we are likely going to return to as demand for aircraft rebounds, but also the normal that's currently heavily disturbed leading to Boeing’s big falls in profitability.
Figure 4: Boeing segment earnings
What we see is that in any normal year BDS doesn’t come even close to the BCA profits. Exception to that rule seemingly is 2016, but that's also the year in which Boeing took an accounting charge on the Boeing 747 program, reclassified costs for two Boeing 787 aircraft to R&D and added a portion of the tanker cost growth to BCA operating costs.
To get a better reflection of earnings, we took the unit accounting profits instead of program accounting profits which due to realignment of business segments is only available since 2017.
Figure 5: Boeing segment earnings using unit accounting
Figure 5 really shows what we have been seeing in pretty much all figures and that is that BDS simply is not as big BCA and frankly not even as big as BGS. 2019 is of course the outlier and we expect the same for 2020-2022, but you can again really ask yourself whether we should try to construct a positive story on Boeing hinging on BDS because BCA is seeing big earnings declines.
You can of course counter by saying that over the years there have been charges that take down the segment earnings. I do believe that these “one off items” have been happening so often at BDS that stripping them off no longer provides a valid base for comparison but let’s do it anyways:
Figure 6: Boeing segment earnings excluding one-off items
What we see is that when we strip off the one-off items, even in absence of the Boeing 737 MAX deliveries, BDS is less profitable than BCA. Again, I don’t think we should strip off these items but we see again that BDS doesn’t provide any remarkable earnings growth.
In Q1 2020, BCA booked a $2B loss while BDS booked a $191 million loss. So, BDS currently indeed has the better profitability. Adjusted earnings would be around $150 million for BCA due to $137 million in costs for the COVID-19 induced production suspension, $336 million for the pickle fork issue on the Boeing 737 Next Generation, $797 million in abnormal costs related to the Boeing 737 MAX production suspension and hundreds of millions driven by changes to the Boeing 787 accounting quantity. Adjusted BDS earnings were $804 million driven by a $827 million charge on the KC-46A program and a charge on the VC-25B program due to COVID-19. So, BDS currently is the more profitable segment but we are not seeing the remarkable growth that would warrant shifting focus away from the big negative changes at BCA.
Everybody can probably find a timeframe to make a focus on Defense fitting. However, at this stage, it does seem that some readers want to shift focus away from the big negative changes on BCA to focus on the extremely small positives that BDS has been seeing in terms of order inflow. For Boeing’s cash profile BDS orders are a good sign. However, we haven’t seen remarkable growth at BDS which makes BCA less prominent. What we have seen is significant revenue and profit falls at BCA which make BDS look bigger and I don’t believe that provides solid base to keep pointing at BDS as if it is Boeing’s savior. In the end, all segments that Boeing operates are of importance but BCA is being hit extremely hard and that warrants some extra coverage but does not mean we don’t consider the company as a whole and in that full overview it remains that BDS is seeing significant engineering challenges that pressure its profits. So, yes, BDS is currently becoming more important to Boeing’s overall profit numbers but it shouldn’t be considered a sign of strength for the segment. It's in fact a sign of unprecedented weakness at BCA that deserves to be addressed and monitored, because going forward that's also going to be the biggest driver of profits.
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This article was written by
Dhierin-Perkash Bechai is an aerospace, defense and airline analyst.Dhierin runs the investing group The Aerospace Forum, whose goal is to discover investment opportunities in the aerospace, defense and airline industry. With a background in aerospace engineering, he provides analysis of a complex industry with significant growth prospects, and offers context to developments as they occur, describing how they might affect investment theses. His investing ideas are driven by data informed analysis. The investing group also provides direct access to data analytics monitors. Learn more.
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