Analyst cautious on Boeing free cash flow
When Boeing Co. (NYSE: BA) reported earnings in January, some analysts were surprised at the huge boost the company reported in its free cash flow (FCF). In the third quarter of 2014, Boeing’s FCF totaled just $317 mln, and in the fourth quarter FCF rose by a factor of nearly 14 to $4.33 bln. How did that happen?
According to aerospace analyst David Strauss at UBS, Boeing was able to pull forward advances and progress payments for new airplanes due to the “very strong order cycle and increasing production rates over the last several years driving large customer prepayments.”
Here is how the aircraft maker gets paid for a new airplane, according to Strauss, as cited by Leeham News & Comment: “When a customer places an order, assuming an order is for further out than 18-24 months, Boeing collects a small down payment at ~2% of the purchase price (1% of list), which is recorded as an advance (liability) on its balance sheet. Then roughly 18-24 months prior to delivery, the customer begins making additional payments to Boeing, with roughly 40% of the purchase price (20% of list) in total due prior to delivery. Initially, these prepayments are also recorded as advances.
“Once Boeing begins aircraft production, it re-classifies advances as progress payments, which is a contra asset within its inventory account. The customer pays the remaining ~60% balance at the time of delivery.”
UBS says that its model for estimating Boeing’s advances and prepayments has “correlated well with actual prepayments other than during 2014.” Strauss also notes that total prepayments are forecast to average around $2 bln for 2015 to 2017, about $2 bln to $3 bln less than the average for 2011 to 2014. Boeing’s average FCF for the four years from 2011 to 2014 is $5.2 bln, according to data compiled by MarketWatch.
Strauss outlines UBS’s forecast for Boeing ahead of the company’s scheduled April 22 earnings announcement: “We think cash generation will come through below expectations as 787 cash costs improve at a continued slow pace, while tougher pricing in the backlog, pension and cash taxes are headwinds. We continue to see risk to the large aircraft production cycle, as deliveries as a percentage of the installed base are well above normal levels, while higher interest rates have the potential to limit further growth and cheap fuel makes older aircraft more attractive relative to new.”
The headwinds that UBS outlines could be magnified by the loss of loan guarantees if the U.S. Export-Import Bank’s charter is not renewed in June. That could force the company to provide the loan guarantees itself and add to its FCF difficulties. Other headwinds include orders for the current version of the 777 and deferred production charges that could continue to rise for the next quarter or two.
Boeing shares were down fractionally Tuesday morning, at $152.78 in a 52-week range of $116.32 to $158.83.