Girding to compensate its worldwide airline customers for delayed deliveries and disrupted schedules, Boeing on Thursday bit the bullet and announced a $4.9 billion after-tax accounting charge for the ongoing grounding of the 737 MAX jet.
This huge hit to earnings will produce the biggest quarterly loss in Boeing’s history when it reports its financial results next week.
Before the announcement, S&P Capital IQ had projected a second-quarter profit of $1.3 billion. The charge of $4.9 billion will turn that into a loss of around $3.6 billion.
In 2009, Boeing reported a loss of $1.6 billion, after writing off the first three flight test 787 Dreamliners and taking a charge for delays on the 747-8. The only other red ink in the last ten years came in 2016, when it lost $234 million after writing off two later 787 flight test planes, took another charge on the 747-8 and and added another write-off for the KC-46 tanker program.
Boeing said the charge reflects penalties for late deliveries and other costs that will continue over a number of years, even assuming that regulators clear the MAX to fly again in early fall.
In addition, Boeing acknowledged that the mounting costs will make the 737 less profitable. It increased its estimated costs to produce the 737 by $1.7 billion in the second quarter, primarily due to the reduced production rate. It had added $1 billion to the 737 production costs last quarter.
Those amounts will be added to the manufacturing cost that’s spread out over the entire 737 remaining production run, which for accounting purposes is assumed to be just over 3,000 aircraft.
The combined $2.7 billion addition to the costs will reduce the profit margin on each future 737 delivery, and will cut the cash flow per aircraft delivered by $900,000.
Boeing said that Thursday’s charge to earnings will cut its quarterly revenue and pretax profits by $5.6 billion.
It added that although this charge is being taken now, the potential concessions to customers or penalties paid will be provided over a number of years. That means most of the impact on cash flow will occur in the future.
And some of that may not be in direct cash payments. For example, an airline could potentially choose to take a big discount on a future order, or free maintenance support, rather than upfront money.
The charge focuses on the impact of the grounding and does not include any estimate of Boeing’s financial liability in the two 737 MAX crashes that killed 346 people, which potentially could be in the region of $3 billion, though much of that may be paid by insurers.
Boeing Chairman and Chief Executive Dennis Muilenburg said in a statement that “the MAX grounding presents significant headwinds and the financial impact recognized this quarter reflects the current challenges and helps to address future financial risks.”
In arriving at the multibillion-dollar charge figure, Boeing said it “assumed approval of 737 MAX return to service in the U.S. and other jurisdictions begins early in the fourth quarter 2019. This assumption reflects the company’s best estimate at this time, but actual timing of return to service could differ from this estimate.”
Boeing said it assumed a gradual increase in the 737 production rate from the current level of 42 jets per month, past the pre-grounding rate of 52 per month, and up to 57 jets per month next year. Airplanes produced during the grounding, which have been piling up around Renton and other local airports, will be delivered over several quarters after they return to service.
“Any changes to these assumptions could result in additional financial impact,” Boeing cautioned.
In fact, the MAX returning to service in early fall is the most optimistic scenario possible, since Boeing now says it is hoping to submit only in September its finalized software update for the problematic MCAS flight control system and other fixes, along with a pilot training proposal. And even if that happens, ramping up from 42 a month to 57 a month by next year is also optimistic.
In a note to investors last week, Ron Epstein, aerospace analyst with Bank of America Merrill Lynch, cited “a growing consensus that deliveries may not start again until the early 2020s.” He added that “2021 or 2022 may be a more significant recovery years for the 737 MAX program.”
In an interview Thursday, Epstein said Boeing’s assumption that the MAX returns to service “early in the fourth quarter,” which is a six-month grounding, means it’s projecting roughly $1 billion per month in pretax penalties paid to customers and about $1.7 billion per quarter added to the 737 cost basis.
So if the return to service slips into January, Epstein said that could add another $3 billion charge and an additional $1.7 billion to the cost basis for 737 accounting.
Before the announcement of the charge, Boeing shares had slipped during market trading Thursday by $8.41, or 2.3%. After the announcement, in after-hours trading, investors contrarily reacted to the news by buying Boeing stock and three hours later the shares had recovered $6.67 of that loss in value.
Epstein said that’s because some investors will see Boeing’s announcement as taking a big charge to cover the worst case scenario. “They’ll say, this is it, this is as bad as it will be. Now we know the risk.”
He said that because additional delay in returning the MAX to service is possible, it’s unclear if this is in fact as bad as it will be for Boeing.
Furthermore, he said, these charges take no account of potential longer-term consequences, such as whether Boeing will lose market share to Airbus in the single-aisle jet market.
Correction: An earlier version of this story incorrectly stated that a loss in the second quarter would be Boeing’s first since 2009. It had a smaller quarterly loss in 2016.