Boeing: When will there
be good news? November 2019

The 737 MAX fleet remains parked, the return to service date is uncertain, deliveries this year are half those of 2018, Boeing is being assailed by lawsuits, attacked by Congressmen, key customers are losing patience. But maybe Boeing has touched the nadir and has positioned itself for a recovery over the next two years.

The net result for the first nine months of 2019 was a profit of $374m in contrast to $7.0bn in the same period of 2018. Total revenues fell to $58.6bn from $72.8bn, approximately $5.6bn of the $14.2 decline being due to a charge in respect of expected 737 MAX liabilities. Boeing’s deliveries totalled just 302 aircraft in the first nine months of 2019, down 47% on the same period in 2018; it should be noted that aircraft sales are only accounted for as revenue when the aircraft is completed and accepted by the customer.

The commercial airline segment actually reported a $3.8bn loss at the operating level, equivalent to a margin of -15.3%. The overall result was rescued by strong performances in Defense and Global Services, which both maintained double digit operating profit margins.

As for the 2019 full-year, Boeing is, understandably, not offering any guidance. Indeed, the Q3 presentation by Dennis Muilenburg, the CEO but no longer the Chairman, that role having been transferred to Dave Calhoun, formerly of GE, Caterpillar and Blackstone, contained just four slides, the first two of which referenced the victims of the Lionair and Ethiopian Airlines crashes and focused on “strengthening the culture of safety at Boeing and Boeing and industry-wide”.

We think that the most useful way of looking at the OEM’s financials is through the cashflow reports (see Aviation Strategy, April 2019); Boeing’s is summarised in the table.

Focusing on the latest nine months cashflow, as mentioned above, the net result fell to $0.4bn from $7.0bn but the even more serious development was the collapse in operating cashflow (ie, the P&L adjusted for non-cash items like depreciation and changes in assets/liabilities) to a negative — ($0.2bn) from a strongly positive $12.4bn in 2018.

The main reason was the huge additional amount of cash — $9.5bn — used to build up inventories; Boeing cut production of the 737 MAX to 42 a month from 52 before the grounding in March but it has mostly maintained its global supply chain running at the previous rate so it can ramp up quickly after the MAX returns to service. Cash in from Pre Delivery Payments (PDPs) fell by over $1bn compared with 2018; management has admitted that advance payments from customers for MAXes on order have all but dried up, and this effect in likely to show even more clearly in the Q4 results. Incidentally, operating cashflow also contains $5.5bn in accrued liabilities as a positive adjustment — this is money allocated for MAX compensation, but which has not yet been paid out.

Subtracting Capex/investments from Operating Cashflow gets us to Free Cashflow, which for Boeing this year was negative, ($2.3bn), in contrast to a positive $10.2bn in 2018. The basic question for corporations is: what to do with free cash? Which proportions to return to shareholders or pay down debt or add to reserves? Since 2014 Boeing’s answer has been to be very generous to shareholders both through dividend payments and a share-buy-back programme, and it has not changed that policy despite Free Cashflow turning negative, maintaining dividends and continuing to repurchase shares, albeit at a reduced rate, throughout 2019.

Dividends and share buy-backs together totalled $6.4bn in the first nine months of 2019 compared to $11.7bn in the same period of 2018. The $10.7bn increase in debt incurred by Boeing was partly necessary to cover these payments and to provide a relatively modest increase in cash,

Put another way, over the 12 months to end September 2019 Boeing increased borrowing by a net $10.7bn but only $2bn of this has gone to build up cash reserves while $2.3bn went to cover the Free Cashflow deficit and a remarkable $6.4bn was used to support the share price through dividend payments and share buybacks.

Cash and near-cash stood at $9.8bn at the end of September. Although this sum is $2bn above the 2018 equivalent, it is identical to the average end-period cash balance held by Boeing during the period 2012-18. Moreover, Boeing doesn’t need additional cash just for the MAX crisis, as mentioned in the Q3 presentation, a large part of this year’s debt build-up is intended for the purchase of Embraer.

Contradicting the 737 MAX narrative, the share price (as at end November) was only 10% down from its early 2019 peak. Looking at the longer-term trend — a 1,200% increase over the past ten years (see chart) — the MAX crisis appears to have scarcely disturbed investors’ valuation of the company. Most stockmarket analysts have focused on the maintenance of dividends and on news flow, retaining buy recommendations on the stock at least until this summer when some leading analysts downgraded to hold.

But the build-up of long-term debt, doubling to $24bn over the past year, has undermined Boeing’s balance sheet. According to Boeing’s filed accounts, liabilities of $136.4bn exceeded assets of $132.6bn as at the end of September. This is quite difficult to absorb: Boeing, probably the US’s most prestigious industrial corporation, has a negative net worth of ($3.8bn) according to its own Form 10-Q filing yet the stockmarket is saying that it is worth $207bn.

In normal circumstances the net asset value might be regarded as an accounting technicality as the liability side of the balance sheet contains $53.2bn of advances and PDPs — in effect progress payments made before aircraft are delivered to the customer, a source of working capital and also an insurance against the cost of an airline cancelling its order. But if the manufacturer cannot deliver the orders, then these PDPs become as real liability as customers reclaim their money.

A broader explanation is that the balance sheet deficit hugely underestimates Boeing’s brand value. This seems to be the view of the equity analysts who have queued up to reassure investors that the balance sheet is nothing to be concerned about, while the chairman has stated in television interviews that the “strength” of Boeing’s balance sheet (by which he probably means the capability of the company to continue to borrow at low interest rates) will get it through the MAX crisis.

S&P, along with the other credit rating agencies, has maintained Boeing’s investment A grade though in the summer it downgraded its outlook to negative from stable, warning about the company’s ability to generate operating cashflow to sufficiently cover debt repayments, “absent a more conservative financial policy”.

There may be light at the end of the tunnel for Boeing. Once the MAX is returned to service Boeing’s cash inflows should recover rapidly as PDPs and deposits from customers resume and production rates can be geared up using the inventories that that have been built up and already paid for over the past year. This might turn cashflow around quite rapidly. And as a sign of resilience, Boeing was able to announce new commitments for 60 MAXes at the recent Dubai Air Show.

On the other hand, cash outflow for compensation related to the two crashes and to airlines who have had to park aircraft and have not received scheduled deliveries can only be roughly estimated at the moment. As at the end of September Boeing had allocated over $5bn to cover liabilities, but this figure could double, according to industry analysts. Note that the $5bn is not a cash reserve — it is an amount that Boeing has committed to pay out of cashflow.

Boeing does seem to have acknowledged that it cannot continue to be as generous to shareholders. CFO Greg Smith confirmed at the Q3 results presentation that the share buy-back programme has been paused (until 2021?). Share buy-backs accounted for $2.9bn in the nine months to September, well down from $8.7bn in the same period of 2018, but still, according to our analysis, unjustifiable in the context of the MAX crisis, putting unnecessary stress on cashflow. It appears at the moment that Boeing intends to maintain its dividend payments.

So cashflow in the short/medium term is delicately balanced, with another major round of borrowing very probable, and dependent on a smooth return to service for the MAX.

Just how critical the 737 MAX is to Boeing is illustrated by the pie chart; the MAX accounts in value terms (estimated actual prices rather than list prices) for 58% of Boeing’s firm commercial backlog, almost three times as much as the 787 Dreamliner. So what is the likely timescale for restoring the MAX to operational status?

In October Boeing completed its redesign of the MCAS and delivered the software package to the FAA along with a manual of safety improvements. The Technical Advisory Board (TAB), a body of experts from the DoT, NASA, and the USAF, tasked with reviewing Boeing’s actions, has approved the redesign in a preliminary report to the FAA.

The next step is ongoing simulator training in the US under the auspices of the FAA’s Flight Standards Board (FSB) as well as in all countries where the MAX will operate. The International Joint Operational Evaluation Board, representing European, Canadian and Brazilian regulatory bodies, will also submit its recommendations to the FSB.

Furthermore, the FAA has decided that it will certify each individual MAX being returned to service or delivered to customers. This reverses the policy of allowing Boeing to self-certify its own aircraft, a policy that was justified on the grounds that Boeing had better resources and technical expertise. This change will presumably slow the process of returning the full fleet to service. EASA has further complicated the situation by stating that it will no longer automatically follow FAA decisions on Boeing aircraft licensing but will perform its all independent certifications.

A key certification flight is scheduled for December. Boeing has stated that a dry-run of the test was successful.

The FAA can only recertify the MAX until after the test flight and pilot training recommendations are finalised. EASA will run a parallel process to roughly the same timetable as the FAA, aiming for competition by the end of January. Other regulators will follow their own schedules, and there is no guarantee that all these bodies will recertify at the same time as the FAA, or indeed recertify at all. How CAAC will act is a major uncertainty.

Then the operating airlines have to install the new MCAS software, recommission the parked MAXes, agree processes with the pilots unions and complete pilot training — two months at minimum.

So it would appear that the earliest that the MAX would back in service would be late March, a year after the grounding. The two most important MAX customers, in terms of achieving credibility for the type — Southwest and Ryanair — were tentatively scheduling early March for a restart but this now looks optimistic.

Ryanair, currently with no MAXes in its fleet but 135 on order, had been planning for 20 operational MAXes in the summer of 2020 but in a recent briefing to pilots this was downgraded to 10. Still, the airline is trying to secure at least 50 delivery positions for Max jets for 2021. Southwest has 34 parked MAXes and 310 on order; its aim is to get about 76 units operational by summer 2020. These two airlines are critical to restoring confidence in the type in Europe and North America.

Meanwhile at Airbus

A fundamental reason for investors’ resolute support for Boeing might be attributed to the fact that it has only one competitor and there are no other viable alternatives for the foreseeable future. And Airbus simply does not have the capability to ramp up production to take advantage of any shortfall from Boeing.

Airbus’s own target was for 890 deliveries this but by the end of the third quarter this year had been downgraded to 860. Airbus has had its own production issues, though on a different scale to Boeing’s: the A380 production line is being wound down with the cancellation of this programme and the A320/321 neo ACF (Airbus Cabin Flex) ramp-up, in Airbus’s own words, “remains challenging”.

In the first nine months of 2019 total revenues increased by 14% to €46.2bn compared to the same period in 2018. At the net level Airbus reported a €2.2bn profit, up from €1.5bn in 2018. Almost all this profit was generated in the Commercial division with Defence and Helicopters making marginal contributions. For 2019 as a whole, guidance is for a 15% profit increase to about €2.6bn. This will be the first time that Airbus has outperformed Boeing financially — during 2012-18 Boeing’s net profit margin, 6.8%, was over twice Airbus’s 3.3%.

However, operating cashflow was strongly negative at (€3.9bn), as it was in the first three quarters of 2018, although the full year showed a positive effect. Airbus’ does not provide as much detail as Boeing on these cash items, but it did highlight a large negative change in working capital of ($8.2bn), presumably caused by a slowdown in PDPs and/or a speed-up in Airbus’s payments to suppliers.

Free Cashflow was also strongly negative at (€5.5bn). Nevertheless, Airbus improved its dividend to €1.3bn. With net borrowing increasing by €1.9bn, its cash balance was reduced to €4.6bn from €9.4bn over the 12-month period from September 2018.

In effect, Airbus has been duplicating Boeing’s financial strategy, talking advantage of ultra-low interest rates to borrow money to help fund dividends and share back-backs. Indeed, Airbus has been the more aggressive in this regard: during 2012-18 its dividends exceeded Free Cashflow by 15.6% while Boeing’s outflow on dividends and share repurchases was in total 6.8 % above the amount generated by its Free Cashflow.

The graph clearly shows Airbus’s share price closely tracking Boeing’s. It is remarkable that the MAX crisis has hardly differentiated the trendlines.

It appears that both OEMs have been returning cash to shareholders at close to their limit to do so. It could be argued that the duopoly has not produced super-normal profits, but it has created super-normal shareholder return. Whether this strategy is sustainable — or desirable given the controversy about revamping existing families rather than embarking on new designs — is a valid question for the OEMs.