Tuesday, September 2, 2008

The Dreamliner's Cost to Boeing

The Dreamliner's Cost to Boeing

By the time Boeing (BA) puts its first new 787 into the air this fall, after delaying the so-called Dreamliner for more than a year, the company will have racked up extra costs that may top $2 billion. That hit comes with deferred sales worth at least $3.5 billion, and a roughly 40% slide in its stock market value.

Such dismal numbers—and the possibility of even further delay—pressured Boeing at the contract bargaining table since it can ill afford a work disruption. On Aug. 28 the company presented a final offer to machinists and dropped proposals to end some retiree medical benefits and scrap a traditional pension program—terms the International Association of Machinists had said were deal-breakers. The contract offers wage hikes of 5%, 3%, and 3% for each year of the pact. In addition, Boeing will pay $2,500 to each machinist if more than half vote for the contract on Sept. 3.

Boeing negotiator Doug Kight called the offer "the best contract offer in America this year" and said it will be the best offer for the next two years, too. Union officials said they would review the offer line by line. Fears of rising costs spurred by additional Dreamliner delays make Boeing executives especially wary of a strike. The $2 billion-plus estimate, toted up by American Technology Research analyst Peter Arment, is twice the figure analysts broached last fall when Boeing announced its first six-month delay. The company followed that delay in January with a three-month holdup and another six-month delay last April. "It's been a strain financially and from a credibility standpoint," says Arment. The tab includes penalties Boeing owes customers for delayed orders and additional research charges, as well as payments to suppliers. Boeing customers, ranging from Biman Bangladesh Airlines to Etihad Airways of the United Arab Emirates, have been keenly awaiting the new plane. In some cases, Boeing will have to cover the costs of the equipment the carriers must use while they wait, Arment says.

Hits to Earnings

A Boeing spokesman declined to comment on the new estimate, but said the company has taken delay costs into account in guiding analysts about earnings this year. In July, Boeing stood by its long-standing estimate for 2008 earnings, predicting them to come in between $5.70 and $5.85 a share, although some analysts trimmed their own expectations after the company said its margins on commercial planes had slipped. Revenues grew just 2%, to $32.95 billion, in the first half of this year for Boeing, while net income inched up 7%, to $2.06 billion. In the second quarter, with the costs of the delays hitting hardest, revenues were flat at $16.96 billion, while net income plunged 19%, to $852 million. The biggest hit to earnings in the quarter was a charge for problems in an airborne early-warning and control system the company is producing.

So far, only one carrier—Azerbaijan Airlines—has canceled an order for a Dreamliner. Boeing says 58 customers have ordered nearly 900 of the $165 million planes, making it the most anticipated commercial jet (BusinessWeek.com, 4/4/07) in history. Etihad alone this year has ordered 35. Boeing's backlog of orders will take it well into the middle of the next decade.

More Hurdles Ahead

The Chicago-based planemaker now expects the first 787 flight by yearend and some observers are expecting it as soon as November. While Boeing expects to make deliveries to customers in the third quarter of next year, it faces still more hurdles to ensure the new jet passes flight testing and is cleared to fly.

"This is an enormously complex program and that comes with a lot of risks," says Arment. "They've spent more than four years modeling and testing and developing the systems for this aircraft, but this is still an all-new composite frame and all-new electronic system architecture. There are many different systems." Boeing marked a major milestone in June with its so-called "power on" sequence. The company turned on the switch to power up its electrical systems, monitoring to make sure the proper levels of power were reached. In July the 787 cleared tests on a key part, a stabilizer, made in Italy.

The plane has been plagued by delays partly because some suppliers have let Boeing down. The company has complained of parts shortages, slow completion of work from suppliers, and unexpected rework. The delays, coupled with uncertainties about a battle Boeing is in with the Northrop Grumman (NOC)/EADS alliance to build $35 billion worth of airborne refueling tankers for the U.S. Air Force, have slammed the company's stock. Boeing now trades at about 66 a share, down from a high of 107 last fall.

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