2012 a bright year for Boeing

- Boeing posts robust quarterly & yearly results
- 737 MAX to enjoy strong sales in 2012
- 737 MAX configuration continues to evolve
- Pent-up demand for 787 & 747-8 may be realised this year
- 787 production ramp-up key focus of the year
- Aspire Aviation changing estimate of 787-10X launch timing from 2012 to 2014
- 777X likely to be launched in 2013, eyed EIS in 2019 

2011 was more than a milestone year for Chicago-based aircraft manufacturer Boeing. Other than delivering the first 787 Dreamliner and 747-8F freighters, as well as launching the re-engined 737 MAX aircraft family and certifying the passenger variant of the revamped iconic 747 jumbo jet, the 747-8I Intercontinental, 2011 was a robust year for Boeing’s profitability.

The world’s largest aerospace company reported a 2011 fourth-quarter net profit of US$1.39 billion, or US$1.84 per share, handsomely beating the Wall Street consensus of US$1.01 per share even excluding a 52 US cents non-recurring gain from a favourable tax settlement. The 2011 fourth-quarter profit was a 20% rise over the US$1.16 billion profit recorded in the same period last year, or an 18% increase in earnings per share from the US$1.56 earning per share in the fourth quarter of 2010.

Revenues during the quarter were US$19.6 billion, an 18% increase from the US$16.6 billion recorded in the same period in the prior year, yet again beating the Wall Street consensus of US$19.38 billion figure nicely.

For the full-year, Boeing enjoyed a 21% increase in its full-year net profit of US$4.02 billion, or US$5.34 per share, up from US$3.3 billion, or US$4.45 a share, in the prior year. Revenues grew by 7% to US$68.7 billion from US$64.3 billion a year earlier, while operating cash flow (OCF) soaring by a staggering 36% from US$2.95 billion to US$4.02 billion as a result of higher deliveries in the commercial airplanes segment from 2010′s 462 airplanes to 477 airplanes. Free cash flow (FCF), in the meantime, increased by 26.4% from US$1.8 billion for full-year 2010 to US$2.3 billion for full-year 2011. By comparison, the operating cash flow for the final three months of 2011 increased massively by 163% from US$1.1 billion in 2010′s fourth quarter to this year’s US$2.9 billion, whereas free cash flow during the quarter more than doubled 2010 fourth quarter’s US$716 million figure to US$2.36 billion.

Operating margin for the full-year surged by 0.8 percentage point from 7.7% to 8.5%, whereas the operating margin increased by 1.5 percentage points to 8.2% in the 2011 fourth quarter.

At the Boeing Commercial Airplanes (BCA) unit, both the quarterly and yearly results paint of a robust picture despite ongoing economic uncertainties and an anaemic global economic recovery. Revenues for the quarter increased by 31% from US$8.18 billion in the same period a year ago to US$10.7 billion while revenue for full-year 2011 soared by 14% from US$31.8 billion in 2010 to US$36.1 billion this year. Operating margin for the quarter increased by 1.5 percentage points to 9.2% from 7.7% while the full-year operating margin only improved marginally by 0.3% to 9.7%, owing to the margin dilution by initial 747-8 and 787 deliveries.

However, the Boeing Defense, Space & Security (BDS) unit paints a more challenging and mixed picture. While the quarterly and yearly results posted by Boeing’s defence business were nevertheless solid, such as a 10% increase in the defence unit’s full-year revenues from US$2.88 billion in 2010 to US$3.16 billion in 2011, and an improved operating margin from 2010′s 9% to 2011′s 9.9%, mainly owing to higher revenues at the lucrative Boeing Military Aircraft (BMA) division, the full-year revenue was unchanged over the last year at US$31.9 billion.

Indeed, the backlog at Boeing’s defence unit gives a good indication of the global defence marketplace amid shrinking national defence budgets across the world. The backlog at BDS was only US$60 billion, or two years of its revenues, while the company backlog grew to US$356 billion at year-end 2011 from US$332 billion at the end of 2011 third-quarter, buoyed by 379 net orders valued at US$42 billion recorded at the commercial airplanes unit during the quarter.

An anticipated decline in the BDS revenue to US$30-30.5 billion in 2012, which subtracted 32 US cents from 2012′s earnings per share (EPS) figure, coupled with a higher pension cost as a result of a lower discount rate at 4.4% that subtracted another 83 cents from the figure, as well as 787 fleet support and a larger number of floating shares which further eroded 15 and 18 US cents, respectively; contributed to a 2012 earnings per share guidance of US$4.05-US$4.25, significantly lower than the Wall Street consensus of US$4.96 a share.

Revenues for 2012 are expected to be US$78-80 billion, with an operating cash flow of larger than US$5 billion and an operating margin of 8.5%-9% at the commercial airplanes unit. Boeing expects to deliver 585 to 600 airplanes in 2012, including 70 to 85 787 and 747-8 deliveries with the balance being 50/50 between these airplane programmes.

“Strong fourth-quarter operating performance, record revenue and backlog, and expanded earnings and cash flow capped a year of substantial progress for Boeing in 2011. We enter 2012 with renewed momentum, and proven business and product strategies. With a record backlog and intense focus on productivity, we are well positioned to deliver growth and increased competitiveness, even as we face constrained U.S. defence spending and pension headwinds. Our priorities for the year are to continue with disciplined increases in production rates for our commercial airplane customers, and to build on our strong position in defence, space and security with aggressive pursuit of growth in core, adjacent and international markets,” Boeing president, chairman and chief executive Jim McNerney commented.

Image Courtesy of Boeing

737 MAX to enjoy strong sales in 2012 while configuration remains evolving
Having garnered over 1,000 orders and commitments for the 737 MAX since its launch in August 2011, including Southwest Airlines’ launch order for 150 737 MAX 8s and Norwegian Air Shuttle’s firm order for 100 737 MAX 8s,  the 737 MAX is expected to enjoy a year of strong sales boosted by fundamentally strong industry demand for fuel efficient single-aisle aircraft, with these commitments being converted into firm orders over the course of the year.

“The rapid uptake on the [737] MAX since its August launch has validated our decision to address this important market segment with the solution our customers want, along with a timeline they need and an airplane that maintains a sizeable economic advantage over its competitors,” Boeing chief executive Jim McNerney said during a conference call discussing the company’s fourth-quarter and full-year results.

“Customer response to the 737 MAX accelerated rapidly through the fall, and orders and commitments now total more than 1,000 airplanes from 15 customers. We anticipate finalising most of these arrangements this year,” McNerney added.

As the sales momentum of the 737 MAX continues to pick up, the aircraft’s configuration will continue to evolve throughout the year, before settling on a firm configuration in mid-2013.

“We are on track with the development plan that we are working on now. And as you know, there’re minor modifications needed to the overall airplane. The engine is the big story and that’s going well,” McNerney reiterated.

The 737 MAX’s CFM Leap-1B engine with a 68-inch (173 cm) fan size and a more “squash-bottomed” engine nacelle will continue to be optimised and its 787-styled tail cone will now incorporate a relofted design with the elimination of vortex generators, in addition to a new design of the inlet door of the 737 MAX’s auxiliary power unit (APU) that features a “retractable intake door” found on other Boeing airplanes instead of the existing NACA APU inlet door design, Aspire Aviation‘s sources at the Chicago-based airframer revealed.

Along with the elimination of a structural body join, a partial fly-by-wire system on the its spoilers, as well as the 1% aerodynamic improvement brought by the 787-styled tail cone, these enhancements are meant to enable the 737 MAX to deliver a 10%-12% lower block fuel burn per seat than the 737-800 NG (Next-Generation).

Though not every Wall Street investment firm is convinced that the 737 MAX’s modifications will be minimal that could be easily accomplished.

“The re-engine is harder for Boeing than for Airbus, as the 737 has less ground clearance. The 737 MAX will have a smaller fan size, but the fit is still tight, which led Boeing to extend the nose gear (no extension to the main landing gear). The 737 engine requires less thrust (27,000 pounds) than does the A320 engine (30,000 pounds), which helps. But, we understand that with the engine’s close proximity to the wing, there were heightened concerns about a blade out potentially puncturing the fuel tank. Modifications were made to the fuel system and the pylon design. With a heavy engine positioned in front of the wing, the centre of gravity also shifts forward. This change, combined with the longer nose gear make the design more complex than that for the A320neo, which is mainly about strengthening the wing and wing join (necessary on the 737 MAX as well). We expect that development costs for the 737 MAX will be roughly double those for the A320neo,” New York-based Bernstein Research said in a 23rd January research note.

“Not surprisingly, Airbus and Boeing have different views of the relative performance of their re-engined airplanes. Today we see the 737 as roughly 4-5% more fuel efficient than the A320. But, the two airplanes split the market for narrowbodies, with Airbus making up the efficiency difference through pricing. We expect the neo [new engine option] to improve the A320′s performance position relative to the 737, which means that the net pricing impact will be modestly positive for Airbus and negative for Boeing (even under Boeing’s analysis of changes in performance). A320 improvement areas should be: 1.) Increase range for the A321 in order to handle some 757 routes (including US transcon[tinental routes]). The A321 currently has too short of a range to address some important longer routes. 2.) Provide an engine choice, given uncertainty about how the GTF and Leap will ultimately match up. Boeing was constrained to sole source with CFM based on its prior exclusivity agreement on the 737. 3.) Reduce the gap in fuel efficiency by 1-4% with the addition of Sharklets and slightly better engine performance, net of weight and drag,” Bernstein added.

Boeing was quick to dismiss the report, saying it was “inaccurate”, according to a flightglobal article.

“It’s a mistake to think that the differences in engine installation dictate significant developmental cost differences between the 737 MAX and A320neo. MAX development to date confirms earlier cost estimates and is well within our expectations when we launched the programme in August,” Boeing spokeswoman Karen Crabtree told flightglobal.

“Wing strengthening is needed on both airplanes. The neo is a significantly heavier aircraft and will likely require weight reduction changes that add complexity to that programme,” Crabtree elaborated.

Aspire Aviation‘s sources at Boeing said the structural reinforcements required to accommodate the larger and heavier CFM Leap-1B engine, such as the mid-body strengthening in Sections 43 and 44 reported by flightglobal, will add 2,000 kg (4,409 lbs) to the 737 MAX’s manufacturer’s empty weight (MEW), whereas the A320neo with a CFM Leap-1A engine weighs around 1,361 kg (3,000 lbs) more than an existing A320 (“Boeing 737 MAX sees a bright year ahead“, 20th Dec, 11).

Interestingly, Buckingham Research offered a contrary view on the 737 MAX’s complexities in a 27th January note to clients, saying “a positive development for the 737 MAX was the conversion of 737 MAX commitments to orders by Norwegian Air Shuttle. That indicates to us that BA [Boeing] is making positive progress defining the 737 MAX and narrowing performance guarantees”.

Meanwhile, apart from the modifications and aerodynamic improvements, Boeing will continue to study other concepts to further improve the 737 MAX’s performance, such as potentially increasing the maximum take-off weight (MTOW) of the 737 MAX 9 to make it a closer 757 replacement. For instance, Boeing will study the variable area fan nozzle (VAFN) concept which promises a fuel burn reduction of up to 2% and is going to be tested on board an American Airlines Boeing 737-800 in August or September 2012 as part of the US Federal Aviation Administration (FAA) continuous lower energy emissions noise (CLEEN) programme. A retrofittable hybrid laminar flow control (HLFC) is also understood to be studied by Boeing which could reduce 0.5%-1% of the 737 MAX’s drag, although any decisions on all these studies are not expected to be made until mid-2013.

Image Courtesy of Getty Images

787 production ramp-up a litmus test
During the 2011 fourth quarter, the gross inventory of US$18 billion and the deferred production balance of US$9.7 billion continued to grow to US$20 billion and US$10.8 billion at the end of the year, respectively, whereas the programme accounting block remains unchanged at 1,100 units. As the 787 production ramps up throughout 2012 and 2013, the deferred production balance is expected to climb correspondingly until the production rate has stabilised at 10 airplanes per month.

“Gross inventory for the company includes $20 billion related to the 787 programme an increase of approximately $6.9 billion during 2011. Gross inventory for the 787 programme is expected to increase approximately $4 billion in 2012 as we continued ramping up production rates. Included in the work in process inventory are deferred production costs. The deferred balance for the programme was $10.8 billion at the end of the fourth quarter. It includes almost 50 airplanes still in process,” Boeing chief financial officer-elect Greg Smith said.

“As we said in the third quarter the deferred production balance will continue to grow as we increased production rates and introduce the 787-9 derivative. We anticipate the deferred production cost to peak at slightly over $20 billion and then decline after the programme achieves the planned production rate of 10 per month and stabilises at that level,” Smith explained.

Meanwhile, Boeing officials have commented that the 787 production ramp-up plan from the current production rate of 2.5 aircraft per month, to 3.5 units per months in the second quarter of this year and then to 5 per month by the end of 2012 is manageable, and that the quality of parts arriving at Everett’s final assembly line (FAL) continues to improve steadily.

“The engineering change flow has slowed down to a trickle, pretty much done. As every day passes and we get closer to the goal and we pass other milestones, yes my confidence does increase, because we are executing to plan and the statement of work is better known without all the change flowing in, and so I think as each week passes, each month passes my confidence does grow, it’s something though that is these ramp-ups are always difficult and it has our attention,” Boeing chief executive Jim McNerney said.

“With the airplane design stabilised and out-of-sequence work being reduced as planned, we expect change incorporation requirements to decrease progressively with each airplane moving through production in the first half of the year. The first non-change incorporation airplane will be a line number in the mid-60s coming out of the factory the summer,” McNerney added.

According to a flightglobal report, the first 787 requiring no rework will be line number LN63. Boeing is expected to begin the final assembly of LN57 in late-January, the report said.

Boeing has taken a prudent step in projecting the number of 787 deliveries being 35 to 42 airplanes, which Aspire Aviation thinks is the right decision given around two-third of the 787s being delivered this year requires rework, an issue that is time-consuming and labour-intensive to make these airplanes deliverable. Nevertheless Wall Street investment banks generally have an upbeat tone on this year’s 787 deliveries, thinking the eventual outcome in this year’s 787 deliveries will beat the company’s conservative guidance.

“We’re above management guidance for 787 deliveries, projecting 55 planes this year, managemnt guides 35-42 but looks heavily cushioned. We took note that the 787 breakpoints (2.5/month currently to 3.5 by late 2Q, and 5 by year-end) seem on track. We are reiterating our estimate for 55 787 deliveries in 2012,” Morgan Stanley analysts wrote in a 25th January note to clients.

“BA [Boeing] also guided that 787 production aircraft in the mid-60s (rolled out this summer) will be the first “non-change incorporation” airplanes As such, slightly less than half of BA 2012 787 production, or 16-19 aircraft, should require no rework and should be ready for delivery in 2012. That is 3-6 planes higher than BA’s guidance for ~13 “non-change incorporation” airplanes. We’re assuming 45 787 deliveries in 2012,” Buckingham Research said in a 27th January report.

“We expect that the company is planning to exceed its full rate assumptions at both Everett (7/month) and Charleston (3/month) and see up to 12-15 787s a month in 2014-2015. We believe the company currently plans to deliver its first 787 out of its Charleston, SC, facility in April, ahead of its mid-year guidance, and is on pace to deliver between 12-15 of the aircraft in 1Q 12,” Wedbush Securities said in a 25th January research.

A noteworthy point is, Credit Suisse and Wells Fargo are the only investment banks assuming a number of 787 deliveries within the range of Boeing’s guidance at 37 and 40, respectively, whereas Bernstein Research assumed 47 787 deliveries this year.

Furthermore, Boeing officials hinted at a 787 production rate higher than 10 airplanes per month once the ramp-up target by the end of 2013 is met, which Aspire Aviation thinks bodes well for the 787 profitability, as well as the launch and introduction of a stretched 787-10X variant.

“The 787 programme continues to record a low single-digit gross margin, and we’re proactively working opportunity to offset risk and increase profitability,” Boeing chief financial officer-elect Greg Smith said.

“Some of those areas we’re addressing include leveraging our buying power by combining purchases on common commodities such as raw material and fasteners reducing costs for us and our suppliers, through lean and other initiatives we continue to look for opportunities to refine our assembly and fabrication methods and designs focusing on cost and flow-time reductions again in our factories and within our supply chain. We’re also looking at our production rates. Once we’ve demonstrated our ability to successfully execute the plan rate increases, we will consider rates above 10 per month,” Smith disclosed.

In doing so, not only can the deferred production cost be spread over the same block of airplanes at a faster burn down rate of the low-yield, high-cost early-built production examples, it could also improve the availability of delivery slots on the 787 programme which is currently only available in 2018 or 2019, thus making the 787 more attractive. In addition, any new 787 orders are expected to have a higher pricing and margin than those sold early in the programme, which could improve the 787 programme’s profitability over time.

On the other hand, Aspire Aviation changed the timing of a 787-10X launch from 2012 to 2014 despite the possibility of a programme launch this year indicated by industry sources. Given the significant challenges facing Boeing on the 787 production ramp-up to 10 per month by the end of 2013 while introducing improvements on the 787-8 to trim its weight to enable line number LN90 to meet its original airline-specific operating empty weight (OEW) and manufacturer’s empty weight (MEW) targets and the 787-9′s entry into service (EIS) in the first quarter of 2014 (“Boeing eyes 787 improvements along with production ramp-up“, 11th Jan, 12), Aspire Aviation thinks it is paramount for Boeing to demonstrate the readiness of the 787′s global supply chain before embarking on another 787 derivative programme or a further production ramp-up.

Aspire Aviation also brought its estimate of the entry into service (EIS) date of the 787-10X forward by one year from 2018 to 2017, since the most significant risk facing the 787 programme will have been retired once the end-2013 production ramp-up goal is successfully met and that most of the foundations for stretching the 787-9 variant further has already been laid and the engineering and financial resources required by a 787-10X development would be minimal.

Image Courtesy of Boeing

Outlook in 2012
Now that the 787-8 and 747-8F freighter have entered into service, and the first 747-8I Intercontinental as well as the first GEnx-equipped Boeing 787-8 are going to enter into service this quarter, the pent-up demand for the 787 and 747-8 may be realised this year at last. Boeing said it has several sales campaigns on the 747-8I Intercontinental that may bear fruit this year, and Aspire Aviation expects the commitments on the 747-8I by Air China and Hong Kong Airlines are likely to be turned into firm orders, in addition to a likely order from Hong Kong-based Cathay Pacific owing to the aircraft’s larger revenue cargo volume and its frequency-based network model (“Cathay Pacific stays on the course of expansion“, 2nd Jan, 12).

“The production is going well. And we have a pretty decent pipeline of planes [orders] that we’re working [on] right now. Most of which are decisionable in 2012, so we’re cautiously optimistic about good order news this year,” Boeing chief executive Jim McNerney commented.

“The freighters are very productive machines for these guys. The amount of money an operator makes versus what he’s been making is tremendous incentive, but it’s not only freighters we have a decent international, Intercontinental pipeline, and there’re some VIP airplanes that we are talking to people about. So a pretty decent pipeline.

“We’re in active discussions on the Atlas airplanes. And the flutter issue, look any issue that we have to address is an important issue. I would not characterise that as out of bounds in terms of normal issues we deal with new introductions, and we have a good degree of confidence that we’ll be able to work through that issue, as do we on placing the Atlas airplanes, and on executing a pipeline beyond the orders we have right now,” McNerney asserted, referring to the 3 early-built 747-8F freighters whose orders were cancelled by Atlas Air Worldwide Holdings due to performance shortfalls and the US Federal Aviation Administration’s (FAA) demands to lock out the tail fuel tank and seal fuel pipelines between the tail fuel tanks, which Boeing said will not affect airlines’ normal operations significantly since the use of the tail fuel tanks is prohibited when “non-fuel payload exceeds 60% of the aircraft’s maximum structural payload”, a flightglobal report stated.

The potential solution that addresses the flutter concern, coupled with an increase in the 747-8I’s maximum take-off weight (MTOW) from 442 tonnes (975,000 lbs) to 448 tonnes (987,000 lbs), according to a flightglobal article, as well as the significant weight saving opportunities identified in the 747-8′s wing structures, could improve the very large airplane’s attractiveness (“Initial 747-8 woes will not affect aircraft’s business case“, 18th Oct, 11).

Indeed, Boeing will have to make the 747-8I Intercontinental as attractive as possible to secure more orders, not least of the combined 747-8 family’s outstanding backlog of 97 aircraft as of the end of 2011 will require more orders to sustain the production rate of 2.5 airplanes per month from the current production rate of 1.5 airplanes per month beginning mid-2012, but also because of the emergence of a highly-efficient revamped 777 that will further undercut the 747-8I Intercontinental’s business case.

The proposed 777-9X, the successor of the highly popular 365-seat 777-300ER, will seat 380-390 passengers with a 10%-15% less block fuel per seat (“New Boeing 777X likely to be a highly efficient derivative“, 14th Sep, 11). With a request for proposal (RFP) having been issued to General Electric (GE), Rolls-Royce (RR) and Pratt & Whitney (P&W) for a 100,000 lbs engine, Boeing should design the 777-9X in a way such that any increasing internal competition with its VLA sibling, while inevitable, is minimised. Though the 747-8I Intercontinental holds an advantage over the revamped 777 aircraft in earlier availability, with the entry into service (EIS) of the 777-9X not expected until 2019 even with a launch in 2013, Aspire Aviation‘s sources say.

Looking ahead in 2012 from a financial perspective, Boeing is in a strong position with increasing cash flow and declining research and development (R&D) expense, leading to some Wall Street analysts characterising Boeing as a “cash flow story”.

Rather than issuing more dividends and cash payouts to shareholders, a pressure commonly faced by companies with a large cash pile from investors, Boeing will voluntarily contribute US$1.5 billion towards the pension plan of its employees in 2012, quelling concerns on more future special charges involving higher pension expense as a result of exceptionally low discount rates for an extended period of time. Aspire Aviation also deems this treatment of its strong operating cash flow of over US$5 billion in 2012 as prudent, as Boeing will have to reserve a certain amount of financial resources to handle the 737 MAX, 787-10X and 777X developments going forward.

“The fact that Boeing is contributing more than previously planned into the pension could all else remaining equal eliminate the pension contribution spike we had feared for the 2013-2015 timeframe,” JP Morgan said in a January 26th note to its clients.

In conclusion, 2012 will be an exciting year for Boeing, with a key focus on the 787 production ramp-up in addition to strong 737 MAX sales, and that 2012 is going to be a more robust and profitable year for Boeing financially, given its track record of consistently beating its conservative financial guidance, with the earnings per share (EPS) of Boeing in full-year 2011 of US$5.34 per share beating its initial 2011 EPS guidance of US$3.8-US$4 a share remarkably.

Read the key highlights of the Boeing full-year 2011 results conference >>