Ahead of its official quarterly earnings release this week, Boeing on Thursday bit the bullet and announced a huge $4.9 billion after-tax accounting charge due to the financial impact of the 737 Max grounding.
This big cut to earnings will produce Boeing’s first quarterly loss in ten years. Prior to the announcement, S&P Capital IQ had projected a second-quarter profit of $1.3 billion, which will now turn into a loss of around $3.6 billion, the largest loss in Boeing history.
The last time Boeing recorded a net loss was the third quarter of 2009, when it lost $1.6 billion after writing off three flight test 787 Dreamliners and taking a charge for delays on the 747-8.
The charge was recognized in expectation that penalties for late deliveries and other costs will continue over a number of years, even assuming that regulators clear the Max to fly again in early fall.
In addition to that one-time charge, Boeing also increased its estimated costs to produce the 737 by $1.7 billion in the second quarter, primarily due to the reduced production rate.
That means that this amount will be added to the cost of manufacturing the 737, spread out over the assumed number of 737s remaining to be built, which for accounting purposes is just over 3,000 aircraft.
Boeing similarly added $1 billion to the 737 production costs last quarter because of the reduced production. The combined $2.7 billion addition to the costs will reduce the profit margin on each future 737 delivery and cut the cash flow per aircraft delivered by $900,000.
Boeing said that the charge to earnings will cut its quarterly revenue and pre-tax 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 the financial liability Boeing will incur as a result of 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, in a statement, said, “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 further assumed a gradual increase in the 737 production rate from the current reduced rate of 42 jets per month up to 57 jets per month in 2020, and that airplanes produced during the grounding will be delivered over several quarters following 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 errant 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 earlier this month, Ron Epstein, aerospace analyst with Bank of America Merrill Lynch, cited “a growing consensus that deliveries may not start again until the early 2020s” and added that “investors may need to adjust their expectations for 2020 and that 2021 or 2022 may be a more significant recovery years for the 737 Max program.”
In an interview Thursday, Epstein said that 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 pre-tax 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 charges, Boeing shares had slipped during market trading Thursday by $8.41 or 2.3 percent. 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.