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Dreamlining: Boeing earnings Q1 2013

by May 7, 2013

Newer Q2 2013 analysis for Boeing financials available at this link.

Dreamlining: Boeing earnings Q1 2013

Boeing 787 Dreamliner first flight

Boeing 787 Dreamliner first flight

Dreamliner issues heavily impact results
Cash flow down, and we expect large writedowns sometime

Latest Dreamliner grounding issue hit Boeing’s (NYSE:BA) Q1 2013 results, not too much however thanks to some Oz magic.
Huge inventory buildup, whose explanation we find unsatisfactory, let us believe a large “one-time inventory writedown” will happen at some point.
The huge pension and retiress’ health care liability is not encouraging either.
Let’s see, and be prepared.

Boeing (BA) sales decreased YoY, and gross margin decreased as well. Boeing explained the issue in Q1 2013 10Q report as follows: “Continued weakness in the air cargo market and lower-than-expected demand for large commercial passenger aircraft have resulted in pricing pressures and fewer 747 orders than anticipated. While we received additional orders for aircraft in the first quarter of 2013, we continue to have a number of unsold Freighter and Intercontinental production positions beyond 2013. If we are unable to obtain orders for multiple Freighter aircraft in 2013 consistent with our near-term production plans, we may be required to take actions including further reducing the production rate and/or building airplanes for which we have not received firm orders. If market and production risks cannot be mitigated, the program could face an additional reach-forward loss that may be material.
The cumulative impacts of production challenges, change incorporation, schedule delays and customer and supplier impacts have created significant pressure on 787 program profitability. If risks related to this program, including risks associated with change incorporation, the battery incidents and associated regulatory directives, planned production rate increases, or introducing the 787-9 derivative as scheduled cannot be mitigated, the program could face additional customer claims and/or supplier assertions, as well as a reach-forward loss that may be material.”

Not very encouraging indeed.

Boeing succeeded somehow to cut operating costs, to compensate for the reduced gross margin.
Note that Boeing’s management consider core operating earnings, core operating margin and core earnings per share a better proxy for purposes of evaluating and forecasting underlying business performance. Management believes these core earnings measures provide investors additional insights into operational performance as unallocated pension and post-retirement costs, primarily represent costs driven by market factors and costs not allocable to U.S. government contracts.

As a further result, operating result is a bit below the average of previous results.
Due to the complexity of allocating the costs for long-term development program, that operating result may be more or less artificial.

And here comes what we believe is the magic of tax optimization of Boeing earnings for Q1 2013 (and maybe some touch of creative accounting):
Net income is magically higher YoY and QoQ, despite all the Dreamliner grounding issue and the market weakness describer by management above.
Frankly, for us those earnings figures fly too high to be believable.

Nothing special in this cluttered chart, except for the research and development expense which is clearly going down, steadily, quarter by quarter. Part of the explanation for the Dreamliner failure may be here.
Note all the charts here are highly interactive, and you may fiddle with data series however you want for additional insight.

Current liabilities are steadily going up.
Long term liabilities are going up as well, albeit at a lower rate.
That does not compare favorably with the reduced sales.
We interpret this chart as a serious deterioration of the balance sheet. Further details below.

Current assets chart show a decreasing cash position over previous quarter. That’s not a major issue, but the ever-increasing inventories is very troublesome.
We strongly believe the inventory figure on the balance sheet is partly bogus. Inventory is more that double the quarterly sales, it increased about 50% within two years, and constantly drags the operating cash flow. While Boeing may carry such “virtual inventory” for many more quarters, at some point a large write-off shall crash from the skies. Beware!
We are not actually seeing here a repeat of Enron or Worldcom cases, but nevertheless that inventory makes us uneasy.

Greg Smith, EVP and CFO, motivated as: “Gross inventory for the Company included $28.8 billion related to the 787 program, an increase in the first quarter of approximately $3.3 billion driven by the planned increase in production rate on the program and fewer 787 deliveries in the quarter. Included in the work-in-process inventory are the deferred production costs. The deferred balance for the program was $17.1 billion at the end of the first quarter and includes approximately 61 airplanes still in process. The deferred production balance is still expected to peak at slightly over $20 billion and then decline after the program achieves the planned rate of 10 per month and stabilizes at that level.”
Source: Boeing earnings Q1 2013 conference call.
Unfortunately we just don’t see the reason to carry such a huge inventory (that may get obsolete by the time it gets used).

The advances from customers are encouraging signs that Boeing is still having bright prospects.

Note the clock is ticking on the pension bomb, that combined with retirees’ health care surpassed $27 billion. General Motors had a similar issue, and we very much suspect Boeing will have to deal with the unsustainable pension liability issue in a similar way to General Motors.

Note a potential inventory write-down will cut the equity as well.

Overall cash flow is not encouraging, and correlates with the inventory issue.

Operating cash flow is constantly dragged by the inventory build-up. It’s saved by the advances from the customers, however we are not very sure whether those advances shall be classified as operational.

We see nothing special here.

Dividends and bank loans are paid steadily, good sign.

Final comment: We see threats for the stock price coming from what we believe are excessive inventory and excessive pension liability, as described above. Boeing is likely to be bailed out anyway in case of any trouble. Otherwise situation is normal. Note this is not a recommendation to short or otherwise buy the stock, the report is provided only for informative purposes, and may contain factual errors despite checking.


My comment: