1. Analysis – Lengthy 787 Probe, Fixing Problem, May Cost
Boeing Dear
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SEATTLE (Reuters) – The slow progress of investigations into battery problems on Boeing Co
‘s 787 Dreamliner jets suggest the new plane could be grounded for months, raising fears that
the financial hit to Boeing will be greater than had been initially predicted.
Wall Street had been working on the assumption that safety inspectors would find the root
cause of two battery incidents in the United States and Japan within weeks and Boeing would
implement a speedy fix costing no more than a few hundred million dollars.
But on Thursday, the head of the U.S. National Transportation Safety Board said it was only
“early” in its investigation of a fire on a Japan Airlines Co Ltd jet in Boston on January 7, while
Japanese aviation authorities appear no closer to resolving a battery problem that caused an
emergency landing of a domestic All Nippon Airways Co Ltd flight last week.
“Saying we are in the early stages of the investigation sent a resounding message to those
who thought this was a quick fix,” said Carter Leake, aerospace analyst at BB&T Capital
Markets.
“If it comes out that ultimately it’s a six-month issue or a nine-month issue, everything
changes. All of this optimism and all of this costing assumption, starts to become bigger
numbers. Once you get past six months, you have to consider cancellations.”
Investors do not appear to be in a panic yet. Boeing shares are down only about 2.5 percent
since the 787 was grounded worldwide following the emergency landing in Japan on January
16.
“Wall Street reaction shows confidence in Boeing’s ability to solve the 787 problem,” said
Michel Merluzeau, managing partner at G2 Solutions, an aerospace and defense consulting firm
in Kirkland, Washington.
Boeing does make four other kinds of jets, including the best-selling 737, and the company
earns 40 percent of its revenue from its defense arm.
Still, the world’s biggest planemaker is producing 787s, but not delivering any, a situation that
could stretch the company financially and test investors’ faith.
“One of our big concerns is that this investigation continues to drag on, and it looks like it may
be more than just the battery overheating itself,” said Russell Solomon, an analyst at Moody’s
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2. Investors Service. “You start getting into three, six months out and it has a bigger impact and
my guess is that they (Boeing) would have to potentially cut the production rate.”
BREAKING DOWN THE COST
Besides the actual cost of fixing the 50 787s in service, plus another 50 or so in production or
waiting for delivery, Boeing will have to compensate carriers unable to use 787s as planned and
pay penalties for late deliveries, most likely in the form of discounts on future purchases.
It also is not clear whether any fix – particularly if the probes lead to the identification of a
major design fault – would also be costly.
At the same time, it will be starved of the cash it was expecting for delivering 787s it is still
producing at the current rate of five per month, which could add up to $300 million per month,
analysts estimate.
And the longer the planes are grounded, the more Boeing is exposed, as airlines may start to
reconsider orders and – in extreme cases – cancel some, especially if the battery fix adds
weight to the plane and reduces its vaunted fuel efficiency.
Boeing, which is expected to report a drop in fourth-quarter earnings next Wednesday, is not
talking specifically about costs of the 787 issue yet.
“It’s too early to know the financial effects,” said Boeing spokesman Charles Bickers. “We’re
focused on working through the process, getting to a resolution and returning the airplanes to
service.”
Douglas Harned, an analyst at Bernstein Research, puts the cost of a fix at no more than $350
million, or about 30 cents per Boeing share, in a worst-case scenario. Howard Rubel at Jefferies
estimates the cost at somewhere between $250 million to $625 million, but notes that some of
the cost may be borne by suppliers.
“There’s still the hope of a relatively easy fix followed by a return to service within a week or
two, but there’s also the strong and growing risk that they’ll need to redesign the battery
system, which could mean another six to nine months,” said Richard Aboulafia, an analyst at
aerospace research firm Teal Group.
PRODUCTION DELAY LOOMS
More important is the effect on Boeing’s production rate, which is scheduled to jump to 10 a
month by the end of this year, from five now.
That jump is crucial to Boeing’s plans to eventually make a profit on the 787. Most of the
investment in a new plane occurs early in the program, which means earlier planes cost more to
build than later ones.
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3. The quicker Boeing can refine the process and ramp up numbers of planes produced, the
quicker it will reach the target of 1,100 planes, where it calculates it will break even on the
program. At planned production rates that would take about a decade.
If Boeing makes fewer planes than it has budgeted for and is not getting cash in the door for
deliveries, that could add up to more than $1 billion per month in “incremental working capital
spend,” according to Solomon at Moody’s.
With $6 billion of cash on its balance sheet at the end of the third quarter, Boeing looks strong
enough to deal with that, but the longer it goes on, the more the worries mount, said Solomon.
“If a billion to a billion and a half of incremental working capital consumption is the right
number in terms of cash burn every month, you start getting into three, six months out and it
has a bigger impact,” he said. “My guess is that they would have to potentially cut the
production rate if that were the case.”
Cutting production of 787s, or halting it altogether, would be a huge blow for a plane program
that is already three years behind schedule.
“The market really only cares about one thing right now and that is, will production change?”
said Leake at BB&T. “I believe it will not, Boeing can’t afford to do that. It’s too expensive to
ramp down and ramp up again.”
Production delays would ripple down the supply chain, could cost jobs and could even mean
the loss of future orders if airlines lose patience with Boeing.
Rubel at Jefferies said this is unlikely, but in the worst case scenario could result in a $5 billion
write-off for Boeing, if it loses orders it was counting on to offset expenses it has already laid out
in building the 787.
That would take its toll on earnings and likely mean taking a provision against those losses.
“It will impact equity investors,” said Solomon at Moody’s. “The company will grow much
more slowly if they can’t ramp to 10 a month and the program is not successful.”
(Additional reporting by Tim Hepher in Paris, Alwyn Scott in New York, Jim Wolf in
Washington; Editing by Martin Howell and Andre Grenon)
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