Will 787 program ever show an overall profit? Analysts grow more skeptical

More than 300 Boeing 787 Dreamliner jets now crisscross the world’s skies daily, their gracefully up-curved composite plastic wings testifying to the innovative technology that is cutting fuel costs and saving money for airlines.

Almost a dozen years after the jet was launched, however, the prospect of the 787 ever making an overall profit for Boeing remains doubtful.

After losing about $25 million on each jet it delivered in the second quarter, Boeing projects a watershed moment for the plane by year-end: It expects to finally roll out a Dreamliner that brought in more money than it cost to build.

That’s when Boeing begins the slow climb out of a deep financial hole that already totals just shy of $32 billion and will increase further when Boeing reports quarterly financial results Wednesday.

While Boeing asserts this 787 hole can be filled in just over six years by churning out hundreds of Dreamliners at a profit, even bullish Wall Street analysts have grown nervous over the staggering size of the accumulated losses, already $10 billion higher than Boeing projected just two years ago.

Less optimistic observers see no prospect of Boeing ever making an overall profit on this jet.

“No way,” said Bjorn Fehrm, an aviation and business analyst with Leeham.net who has run detailed models on 787 costs and revenue. “They need to recover far too much money per airplane. They will never do that.”

Company estimate

In Boeing’s accounting, it smooths out the 787’s sky-high early costs by deferring into the future the losses accumulated since production began more than four years ago.

Due to investments it’s making for a rate increase and the introduction of a new model, the 787-10, the total will continue to rise even after that watershed rollout later this year.

The company’s own projections indicate that total deferred costs will peak late next year at around $33 billion. To recoup those costs, Boeing’s accounting assumes it will quickly reverse its current per-plane loss, and build another 900 Dreamliners at an average profit of more than $35 million apiece.

That’s the scale of the turnaround Boeing must achieve to avoid a multibillion-dollar write-off.

For accounting purposes, Boeing has taken the 1,100 firm orders for the 787, added a couple hundred more it can reasonably expect to sell, and projected that it can recover its costs, plus make a little profit it has already booked, over that block of 1,300 planes.

Like Fehrm, Wall Street analyst David Strauss, of UBS, says that’s not possible.

“I can’t get the math to work. It seems very tough to bridge,” said Strauss. “You need a much, much, much bigger block than 1,300.”

Ted Piepenbrock, an academic affiliated with the University of Oxford and MIT who heads the International Institute for Strategic Leadership (IISL), has taken the math a step further and calculated at what point beyond the 1,300 Dreamliners Boeing might reach that goal.

His answer: Never.

Piepenbrock, who does business-management consulting and research, worked with Boeing’s executive team in the mid-2000s to analyze the 787 program. Since then, it has become his prime case study in how not to run a business.

A detailed IISL financial model, updated each quarter with Boeing’s latest results, projects decreasing but continued losses on every Dreamliner through at least the first 700 airplanes, with no prospect of fully recovering the cumulative deferred costs — which the model forecasts peaking beyond $34 billion.

The most conservative of IISL’s models, the one most favorable to Boeing, projects that after delivering 2,000 Dreamliners, the jet-maker will still have “a total program loss of approximately $5 billion.”

Worse, the above IISL, Wall Street and Leeham analyses of 787 costs don’t include Boeing’s original investment to develop the jet, estimated by most analysts at a further $20 billion or more.

Piepenbrock’s team, which includes a former strategic analyst at Boeing, concludes the company will never recoup that, either.

Boeing: We can do it

In an email, Boeing investor-relations spokesman Chaz Bickers acknowledged that recovering the accumulated 787 losses assumes a very aggressive increase in profits per airplane.

Myles Walton, of Deutsche Bank, highlights a detail deep in Boeing’s financial filings disclosing the portion of the deferred 787 costs to be covered by the final 205 airplanes in the accounting block, which should be delivered starting in 2020.

To recoup the $33 billion, and earn the “low single digit” overall profit margin Boeing says it is booking, requires making an average profit of more than $50 million on those later jets, a profit margin of more than 30 percent.

Yet the financial filings imply that even the mature 737 and 777 programs have profit margins of only 20 to 25 percent.

Shown a similar set of numbers, Bickers wrote that “The math you present is essentially correct.”

He said Boeing thinks it can reach the projected profits through lower production costs and higher jet prices in the years ahead.

The cost reductions will come from the expected improvement in manufacturing operations as more planes are built, both “within our factories and our supply chain,” Bickers said.

Better pricing will come from delivering a much higher proportion of the larger 787-9s and later 787-10s.

“The model mix shifts to higher priced 787-9s and 787-10s as we move forward,” Bickers wrote. “Investments we have made in reliability and producibility are expected to drive the unit cost of these aircraft down towards the same level as the 787-8. So you have higher revenue aircraft with not a whole lot of incremental cost.”

Walton said he expects the two larger 787 models to cost only 5 to 10 percent more than the original 787-8, but to bring in 20 to 40 percent more revenue.

Though he doesn’t see that expected price improvement generating enough profit to fill the $33 billion earnings hole over 1,300 jets, he said it should result in a lower-level but still healthy per-airplane profitability.

Too optimistic?

Other analysts think that outlook may be too rosy.

Adam Pilarski, a leading industry analyst with aviation consultancy Avitas and former chief economist at Douglas Aircraft, said 787 manufacturing costs from here on may not come down as rapidly as Boeing needs.

He said that because Boeing has two 787 assembly sites on opposite coasts, in Everett and in North Charleston, S.C., the operational skills and productivity improvements that come from building the jets are split between the two.

“You are getting less learning than if you had it all on one assembly line,” he said.

Boeing insiders say the original 787 business case assumed that costs would come down at a faster clip than on previous programs. So far, that hasn’t happened.

As for the supply-chain costs, the globally outsourced 787 manufacturing model means Boeing’s major partners control much of that.

For example, Spirit AeroSystems of Wichita, Kan., has yet to agree what it will charge Boeing for its sections of the 787-9 and -10 models.

As the exclusive supplier of the entire forward fuselage, Spirit has strong leverage in those ongoing negotiations.

Analysts are also skeptical of Boeing’s hopes for a big lift in 787 pricing.

With Airbus producing both the A330neo and the A350 to go against the 787, said Strauss, of UBS, he believes the widebody jet market is now “significantly oversupplied,” which will depress prices.

Fehrm, of Leeham.net, said Airbus’ launch of the rival A330neo — a jet with a new 787-style engine but otherwise an established and much cheaper airframe — has already put strong pressure on 787 pricing.

Does it matter?

If Boeing management at some point finally has to acknowledge that it cannot achieve the set accounting goal and that 787 profitability will be lower than projected, what’s the consequence?

A multibillion-dollar accounting write-off, known as a forward loss, is a definite possibility.

Yet Wall Street analysts, concerned only about the future stock price, care less than you might think.

Strauss, who has a neutral rating on Boeing stock, said that all the money the company has poured down the 787 drain in past years is irrelevant.

“Most of this is sunk costs. It doesn’t matter,” Strauss said. “It’s all about how they improve from here.”

He sees the 787 generating significant cash between now and 2020, though less than Boeing projects.

Walton, of Deutsche Bank, who rates the stock a buy, estimates the 787 could bring Boeing about $5 billion a year in cash by 2020.

“The stock price reflects already that Boeing screwed up massively” on the 787, he said, so recovering the previously sunk costs is not an issue for Wall Street.

In a broader, historical context, things look different, he conceded.

“Would you have made an adequate return on capital versus your initial investment?” Walton said. “That’s a whole other story.”

Almost a dozen years after the 787 launched, the answer to that question appears clear.

An overall profit on the entire investment including development costs seems way out of reach. And Boeing will struggle to generate enough cash to cover the huge production costs.

Fehrm said the only reason Boeing’s finances have not suffered more from the 787 debacle before now is that “the 737 and 777 programs produced cash like mad.”

Unlike Canada’s Bombardier, which is facing possible cancellation of its new CSeries jet because it doesn’t have cash to keep financing it, Boeing’s overall earnings have barely faltered since the 787 launched.

“It’s an extraordinarily strong Boeing Co. that has coped with the disaster that is the 787 without running out of cash,” Fehrm said.

Now though, both the 737 and 777 are under intense pricing pressure from Airbus rivals, and the 777 production rate seems likely to be cut.

In an odd twist, Boeing will depend on turning the corner dramatically on 787 profitability between now and 2020 to offset reduced profits from the former cash cow programs.

“It’s going to be a tough five years for Boeing,” Fehrm said.