Tag Archives: A380

A380 sales compared to 747 sales at program start (update 2013)

In the previous post I briefly discussed aviation analyst Richard Aboulafia’s assertion “Airbus will be paying the price for the A380 for many years to come” (see original article) from a purely financial and accounting point of view. In this post I wanted to look at it from the market point of view. To do that I will update with 2013 figures a couple of tables and graphics I built last year comparing A380 and 747 orders at each programme start (see last year’s post here).

First see in the graphic below A380 orders since the programme launch (2001) in comparison to those of the 747 (1966):

A380 and 747 orders referenced to the year of launch of each programme (up to 2013).

A380 and 747 orders referenced to the year of launch of each programme (up to 2013).

Both programmes show an initial sales rush at the time of programme launch. In both cases the rhythm of sales slowed down after the second year. In the first 13 years of program, each had managed:

  • 747: 433 orders.
  • A380: 304 orders (30% less).

Thus, we can see that the Boeing 747 was selling better already from the beginning of the programme.

I include again yet another comparison: aircraft orders taking as reference the year of first delivery, having heard so often the industry mantra that some potential customers would wait to see the aircraft in operation before placing orders. See below this second comparison:

A380 and 747 orders referenced to the year the 1st aircraft delivery of each programme (up to 2013).

A380 and 747 orders referenced to the year the 1st aircraft delivery of each programme (up to 2013).

In this case, and due to the shorter time to develop the Boeing 747 since program launch (1966), the difference in sales is narrowed:

  •  747: 301 orders.
  • A380: 304 orders (about the same).

You can see that, 6 years after the 1st delivery of each aircraft (2007 for the A380 and 1969 for the 747) the A380 and the 747 have sold about the same number of aircraft (thanks, no doubt, to the large recurring order placed at the fall by Emirates).

Boeing 747. The Boeing 747 was the first wide-body in commercial aircraft history and still is the twin-aisle with the highest amount of aircraft sold (1,537 a/c as of today, probably to be soon overtaken by the 777) and delivered (1,482 a/c as of today). However, it has taken over 40 years to reach those numbers. The 1,000th unit sold was reached after 25 years of sales in 1990. The 1,000th unit delivered was also reached after 25 years of aircraft deliveries, in 1993.

Thus, in my opinion, when we want to measure the success of the A380 we cannot be distracted by the figures of other commercial aviation segments (single-aisle and small / intermediate twin-aisle) but we have to check what the 20-year forecasts for the Very Large Aircraft say:

  • ~1,300 aircraft according to Airbus GMF,
  • ~600 aircraft according to Boeing CMO,

and then see what could be expected market share for the A380 against those forecasts and whether it is getting the orders to reach it or not.

Finally, as a reader (Matt B.) of the blog pointed in the comment section in last year’s post:  wide-body market has evolved from the 1970s till today, when there are several competitors and other programmes such as the A330 or the 777 deliver close to 100 airplanes per year.

You can find orders and deliveries figures in both manufacturers websites or summarized here: A380 and 747.

1 Comment

Filed under Aerospace & Defence

A380: “one-off items” versus “accounting block”

Aviation analyst Richard Aboulafia recently published an opinion article at Aviation Week & Space Technology magazine, Airbus Twin-Aisles—Big Needs, Limited Means, in which he discussed strategic product portfolio options for Airbus. He was particularly critical to the A380. Let me bring a couple of passages from the article:

Historically, Airbus has spent more than Boeing on development as a percent of sales than. But during the past 15 years, the bulk of this heavy spending was squandered on the A380. Today, development spending is set to fall in line with the company’s new direction. Last year, it fell below 6% for the first time since the company was established (see graph). Given the requirements of funding the A350XWB and A320neo, Airbus isn’t likely to have the resources to fund both an A330neo and A380neo and a new large twin, too. Tough choices will need to be made. […]

In short, Airbus will be paying the price for the A380 for many years to come.

From these 2 paragraphs, the first assertions are factual: Airbus spends more on research and development than Boeing Commercial Airplanes and during the last years most of that spending was dedicated to the A380. In my opinion the last sentence overstates the issue of the current burden of A380 over the company’s future. If the A380 did not derail EADS during 2006-2010 it will not do so in the coming years. As numbers show and top management has indicated at investors events the A380 programme is expected “to emerge from the red by 2015“.

A380 MSN4 (credit: A. Doumenjou).

Today the A380 is a recurring cost issue, not more. The situation would be entirely different had Airbus (or rather EADS, now Airbus Group) applied the same accounting system that Boeing does (since the merger with McDonnell Douglas). EADS has passed in the profit and loss accounts in the previous years several one-off items related to the A380 valued in billions of euros (refer to yearly financial reports). What is left are R&D (mainly D) expenses to bring down unitary recurring costs and producing enough numbers of aircraft so that learning curve effects can be benefited from.

On the other hand, Boeing accounting system spreads the capital expenditures and research and development costs along what they refer to as an accounting block, which for example for the 787 now takes 1,300 airplanes to amortize those costs (previously were 1,100, see here a post on the 787 break even).

2 Comments

Filed under Aerospace & Defence

A380 sales compared to 747 sales at program start

Some weeks ago, in a discussion with a colleague we tried to put into context whether the A380 sales were such a dismal or not.

My colleague first plotted A380 orders since the program launch (2001) in comparison to those of the 747 (1966). I show below the result:

A380 and 747 orders referenced to the year of launch of each program.

A380 and 747 orders referenced to the year of launch of each program.

Both programs show an initial sales rush at the time of program launch. In both cases the rhythm of sales slowed down after the second year. In the first 11 years of program, each had managed:

  • A380: 262 orders.
  • 747: 357 orders.

Thus, we can see that the Boeing 747 was selling better already from the beginning of the program.

However, I wanted to make yet another comparison: aircraft orders taking as reference the year of first delivery, having heard so often the industry mantra that some potential customers would want to wait to see the aircraft in operation before placing orders. See below this second comparison:

A380 and 747 orders referenced to the year the 1st aircraft delivery of each program.

A380 and 747 orders referenced to the year the 1st aircraft delivery of each program.

In this case, and due to the shorter time to develop the Boeing 747 since program launch (1966), the difference in sales is narrowed:

  •  A380: 262 orders.
  • 747: 281 orders.

You can see that still, 5 years after the 1st delivery of each aircraft (2007 for the A380 and 1969 for the 747) Boeing had sold more aircraft, but with this reference the margin is lower, 19 aircraft.

Boeing 747. The Boeing 747 was the first wide-body in commercial aircraft history and still is the twin-aisle with the highest amount of aircraft sold (1,528 a/c as of today, probably to be soon overtaken by the 777) and delivered (1,464 a/c as of today). However, it has taken over 40 years to reach those numbers. The 1,000th unit sold was reached after 25 years of sales in 1990. The 1,000th unit delivered was also reached after 25 years of aircraft deliveries, in 1993.

Thus, in my opinion, when we want to measure the success of the A380 we cannot be distracted by the figures of other commercial aviation segments (single-aisle and small / intermediate twin-aisle) but we have to check what the 20-year forecasts for the Very Large Aircraft say:

  • ~1,300 aircraft according to Airbus GMF,
  • ~600 aircraft according to Boeing CMO,

and then see what could be expected market share for the A380 against those forecasts and whether it is getting the orders to reach it or not.

You can find orders and deliveries figures in both manufacturers websites or summarized here: A380 and 747.

5 Comments

Filed under Aerospace & Defence

Twin-aisle aircraft deliveries 20-year forecast

I read in the following article “Airbus seeks to increase Washington State supply business; aims for 13 A350s/mo” (from Leeham News) how from a presentation of a A350 supplier (ElectroImpact) at an aerospace suppliers event in Washington State, it was concluded that the Airbus aimed at building 13 A350s per month, as the mentioned supplier had built its factory with capacity to extend production rates up to those 13 aircraft.

This would be news because in its presentations Airbus talks about a production ramp-up up to 10 a/c per month (as does Boeing for the 787, which 10 aircraft/month should be reached by the end of 2013).

Having analyzed several times Airbus’ Global Market Forecast (GMF) and Boeing’s Current Market Outlook (CMO), I believe that those production rates of above 10 aircraft per month should be expected by industry followers just by seeing the numbers included in those forecasts.

In 2012, the GMF forecasted about 6,500 twin-aisle to be delivered in the next 20 years. The CMO indicated 7,210 aircraft. In 2013, Boeing CMO slightly reduced the figure to 7,130 a/c.

Comparison of Airbus GMF and Boeing CMO 2012-2031.

Thus, both companies expect between 6,500 to 7,200 twin-aisle passenger aircraft to be delivered in the following 20 years (excluding freighters, 747 and A380 – these 2 considered as Very Large Aircraft in the studies).

1st approach. If we were to take the mid-point of both forecasts, about 6,850 a/c, and simply divided by 20 years, we would reach to an average figure of 343 twin-aisle aircraft to be delivered per year between the 2 manufacturers, or 28 a/c per month. If Airbus wanted to maintain the long-term 50% market share, it would have to aim at delivering 14 a/c per month between all its twin-aisle products, which soon will be A330 and A350.

2nd approach. However, current twin-aisle production levels are in no way close to those 343 a/c per year. In 2012 there were 258 deliveries thanks to the introduction of 787s, but in the previous decade the average was about ~165 a/c per year. Thus, manufacturers must have a deliveries’ ramp up to accommodate those 6,850 in the next 20 years. Not knowing what that ramp-up is, I just linearized from where we are today and what is to be delivered.

I plotted in the graphic below all the deliveries of twin-aisle (excluding Very Large Aircraft) from the 1970s to 2012, and then what a forecast could be departing from 2012 deliveries’ figure to accommodate ~6,850 a/c in the next 20 years.

Taking a look at the graphic, one can already understand that if we take the GMF and CMO forecasts as good ones, the manufacturing rhythm will have to accelerate in the following years, especially in the second decade. In the late 2020s, over 400 twin-aisle would have to be delivered per year (over 33 per month), thus manufacturers will have to churn above 16 a/c per month each, that is the double of what they produced during the last decade.

Twin-aisle deliveries: historic series (1970s-2012) and forecast (excludes VLA -A380  & 747).

Twin-aisle deliveries: historic series (1970s-2012) and forecast (excludes VLA -A380 & 747).

Market shares. One could wonder whether this growth will favour more one company or the other. I compared market shares (excluding VLA):

  • in 2012: Boeing delivered 155 twin-aisle (26 767s, 83 777s, 46 787s) vs. Airbus 103 a/c (101 A330s, 2 A340s)… 60% / 40%.
  • in 2003-2012: Boeing delivered 839 twin aisle (148 767s, 642 777s, 49 787s) vs. Airbus 880 a/c (44 A300s, 687 A330s, 149 A340s)… 48% / 51%.
  • in 1993-2012: Boeing delivered 1,687 twin aisle (572 767s, 1,066 777s, 49 787s) vs. Airbus 1,521 a/c (175 A300s, 31 A310s, 938 A330s, 377 A340s)… 50% / 45%.

[The shares in the past decades include marginal deliveries from Ilyushin models and McDonnell Douglas models, which share I kept out of Boeing even after the merger in august 1997, these are ~30 a/c to be added to the 1,687]

Seeing that market shares have been fluctuating but always around 40-60% for each company, they could expect to have to at least deliver 40% of those 6,850 a/c in 20 years, or of those above 400 a/c in the late 2020s.

Backlog. Finally, just to see how the twin-aisle mix for each company is going to be, let’s look at the aircraft on order (backlog) that each company has as of today (end June 2013):

  • Airbus (43%):
    • A330: 260 a/c to be delivered.
    • A350: 678 a/c to be delivered.
  • Boeing (57%):
    • 767: 56 a/c to be delivered.
    • 777: 339 a/c to be delivered.
    • 787: 864 a/c to be delivered.

Thus, of the 6,850 twin-aisle to be delivered in the next 20 years, about 2,200 are already contracted as of today (plus the above 130 a/c delivered within the first half of 2013), thus 33% of those 6,850 a/c is more or less secured and among those the split is 57 / 43 for Boeing.

2 Comments

Filed under Aerospace & Defence

A380 & Patrouille de France in Blagnac for the Tour de France

Yesterday (July 20th 2012) the Tour de France departed from Blagnac, the village close to Toulouse which hosts Airbus HQ. In a place wich such an aeronautical tradition what better way to start the race than with an aerial exhibition: the A380 in formation flight with the Patrouille de France (Dassault/Dornier Alpha Jet).

This post is just to share the short video I took from the office (comments in French by my colleague Sylvain):

Leave a comment

Filed under Aerospace & Defence

Le Bal des Ambitions

Le Bal des Ambitions, 2009.

I learnt about the book “Le Bal des  Ambitions” in 2009, when a former colleague mentioned it and asked me to buy it in one of my trips to Paris. By then, I did not know French so as to read it, but some months ago I found it again in the aerospace boutique in Blagnac and grabbed it.

The book is written by two journalists, Véronique Guillermard and Yann le Galès, that in my opinion give an image history of EADS and the main characters who shaped it a bit too much thriller-like. Nevertheless, I found it interesting as I could recall many of the names and chapters, even though most of the stories happened either when I was still a student or had recently joined the company.

Some of the topics covered in the book:

  • Who are the so-called Lagardère boys, the relationships among them and with J.L. Lagardère. (I got to know who from some of top managers came from Matra and who from Aérospatiale.
  • It describes the merger discussions between Aérospatiale–Matra, BAE and DASA.
  • You get a glimpse of the role played by the grandes écoles in French networks.
  • The case of insider trading affecting top management of EADS in 2006.
  • Some of the issues behind the delays of A380 in 2006.

I guess that for a French native the text hasn’t got much quality, but for me, being my second book in French language, it was just perfect.

1 Comment

Filed under Aerospace & Defence, Books

Will Boeing 787 ever break-even?

Boeing 787, the Dreamliner, made its first commercial flight with Japanese airline All Nippon Airways between Tokyo and Hong Kong. The event has been widely covered in general and specialized press. One of such articles, in Bloomberg, was the spark of a conversation with a colleague that led to the following question: will the 787 ever bring value to Boeing? Will the net present values of all the cash flows related to the programme ever be positive?

After a conversation, I decided to try to answer to those questions, using information found in different sources across the internet.

Lately there has been much discussion in the media about what would be the Boeing’s “accounting block” size (finally it was announced to be 1,100 aircraft units). This concept refers to the number of aircraft upon which Boeing is going to spread the amortization of the work in process now in the balance sheet (around 18bn$ at 2011 Q3, according to Boeing), excluding R&D costs (which were already accounted for in previous years’ income statements).

While the concept has raised much attention, it is irrelevant to appraise the 787 as a long-term investment project, for which yearly cash flows, accordingly discounted for (to take into account the time value of money), shall be calculated. This time including R&D costs.

Together with the previous concept, last days’ news have often discussed the concept of “learning curve”. This is a concept typically used in aerospace industry and which will be central to the discussion of whether the 787 will be or not a success as an investment project.

Learning or experience curve

Let me introduce the learning curve effect by quoting directly from the Wikipedia:

“The rule used for representing the learning curve effect states that the more times a task has been performed, the less time will be required on each subsequent iteration. This relationship was probably first quantified in 1936 at Wright-Patterson Air Force Base in the United States, where it was determined that every time total aircraft production doubled, the required labour time decreased by 10 to 15 percent.” […]

“Learning curve theory states that as the quantity of items produced doubles, costs decrease at a predictable rate.”

The press has stated that Boeing’s targeted learning curve for this programme will be 75%, despite of having less control over the supply chain in comparison with previous developments. That means that every time production units have doubled, the unit cost will have decreased in 25% (if unit 100th costs 100, unit 200th shall cost 75).

In the last new aircraft development, the 777, Boeing reportedly experienced a curve of 84% (costs decreasing 16% every time production units doubled). In this exercise I will make use of different values for the learning curve in order to see its influence (90%, 84% -as with 777-, 80% and 75% – Boeing’s target).

Discounted cash flows

Due to the time value of money, i.e. the interest that could be earned by a given amount of money, it is important to evaluate the present value of the cash flows of the 787 project along its life-cycle. As the Wikipedia states it:

“Net Present Value is a central tool in discounted cash flow (DCF) analysis, and is a standard method for using the time value of money to appraise long-term projects.”

This basic concept of finance theory is rarely covered by the press.

The then-assistant professor of Economics and Public Affairs at Princeton University, U.E. Reinhardt, in his paper “Break-even analysis for Lockheed’s TriStar: an application of financial theory” (PDF, 2001), analyzed comprehensively the project of the TriStar making use of information that became public at a moment when Lockheed officials took part in Congressional hearings over a loan-guarantee needed by the TriStar programme (1971).

Reinhardt found that the figures that appeared in the media led one to consider that the programme cash flows were not discounted either to the time at the beginning of the project  or to the time of the congressional hearings, as prices and market numbers would had only produced a positive net present value if the discount rate had been in fact around 0%, that is “only if one assumes that the company was prepared to advance the enormous sums required for that project without asking for any positive return on this investment”.

Typically the discount rate used to evaluate different projects is the cost of capital of the company. For this exercise I have used different rates to see its influence in the results (0%, 5%, 10% and 12%, being the last two typical figures used in industry).

As a side note: Reinhard used as learning coefficient 77.4%, close to the optimistic 75% targeted by Boeing and lower than the disclosed 84% of the 777 case.

Data gathering

In order to build the exercise, different sets of data need to be collected. I will discuss them below, indicating the sources used and explaining the assumptions taken.

Number of aircraft produced

According to news reports, this year Boeing will deliver between 15 – 20 787 and 747-8, being about two-thirds of the latter. From that information I took that about 6 787s will be delivered in 2011. From then on, the ramp I used tries to replicate what the media is reporting.

Boeing intends to reach a rate of 10 aircraft per month by end 2013, thus from 2014 I assumed Boeing will produce 120 787s every year (as Boeing factors down time into calculation of the monthly rate).

According to Seattle Times, this week Boeing is increasing its rate from 2 aircraft per month to 2.5. Since between 2012 and 2013 this rate has to increase from 2.5 to 10, I assumed an average of 3 aircraft/month for 2012 and 6 for 2013.

Number of aircraft sold

Boeing publishes in its website the number of aircraft ordered each year. For this exercise, I took into account the net orders in the year of order.

In the last conference call, Boeing stated that it sees an addressable market for the 787 in the next 20 years of 5,000 aircraft (this number of aircraft reflects deliveries). As of today, Boeing has close to 800 orders. This backlog covers the production until somewhere in 2019, in order to keep the production line with a steady production rate, I assumed Boeing will sell the necessary aircraft to allow a steady state production of 120 aircraft per year until the end of the exercise in 2034. That would mean Boeing would have delivered 2,634 aircraft, a bit over half of the 5,000 aircraft that represents the addressable market.

Since Boeing has already sold close to 800 of those 2,634 aircraft, I assumed the rest will be sold evenly every year, or at a rate of 82 aircraft per year from 2012.

List price of the 787

Boeing publishes in its website the list prices of all its models. The list price of the 787 today ranges from 193.5 to 227.8 million USD, or about 211 M$ on average.

At the end of 2010, Boeing raised its list prices 5.2% on average. The previous raise had taken place in 2008, 2.6% in relation to 2007 prices, when they had been raised another 5.6% after two years.

From those numbers, I made the assumption forward and backward that on average Boeing raises its list prices about 2.6% per year.

Price discounts

I have already published two different posts about average Boeing price discounts for 2009 and 2010. A recent article from Flight Global confirmed the order of magnitude for the case of the A380. The discount rate I used for the exercise is 38%.

Another confirmation of the order of the discounts specifically for the 787 comes from the following analysis by Jon Ostrower, from Flight Global, who reports prices of 787 to be around 76M$ in 2004-2006, excluding engines, which were about 20-30M$ (a total of 96-106M$).

Taking the list prices above for those years and using the 38% discount for that period of 2004-2006 the real prices given by my model are in the order of 101-104M$, in the same order that Jon’s information.

Down payment

Here I used for the exercise the same assumption I had used to calculate Boeing discounts in previous posts: a single 3% down payment taken from the AIAA paper “A Hierarchical Aircraft Life Cycle Cost Analysis Model” by William J. Marx et al.).

Regarding down payments, I once received another input in my blog from the analyst Scott Hamilton (Leeham), where he mentioned several progress payments of 3-5% of the price of the aircraft so that at the time of delivery 30% of the aircraft had already been paid for. Simulating these payments complicates the model, but, since early cash inflows may have an impact in the break even analysis, I have checked the variation with different sizes of down payment (3%, 20%).

Costs

These are the main inputs needed for the whole analysis. Most of the non-recurring cost (NRC) have already been incurred, thus, there is little room for manoeuvre in there. However, regarding the recurring costs (RC), those are where Boeing has the chance to make the programme profitable.

NRC: Research & Development (R&D) and capital expenditures (CAPEX)

Seattle Times provided a detailed description of the incurred costs that Boeing had through end September 2011. The account was split in different categories of non-recurring costs (R&D, CAPEX, buying out partners) totalling over 16bn$.

RC: Inventory, advances to suppliers

In the same article there was another explanation about the recurring costs (inventory –work in process, supplier advances and others) incurred so far: up to 16.3bn$ by September. This last figure has risen to 18bn$ according to the last conference call given by Boeing.

In order to build the cash flow profile, it is necessary to know the cash flow profile of the costs described above. Since we have only information regarding some of those (buyout of partners, CAPEX for Charleston FAL) I needed to make an assumption for the rest.

In this case, I used the same cash profile used by B. Esty and P. Ghemawat (both then at Harvard Business School) in their paper “Airbus vs. Boeing in Super Jumbos: A case of failed Preemption” [PDF], where they performed a valuation analysis for then known as A3XX (now A380).

You may see in the following graphic the cash profile used up to now:

Boeing 787 costs through 2011 profile.

Regarding the recurring costs, the main finding to be done is the recurring cost of the aircraft at a certain point. Once we have a reference, we can play with the learning curve to see how the costs will be in the future or were in the past.

Different sources quote figures as 250-300M$ or even 400M$, but they do not explain whether that is the cost of a unit right now (e.g. serial number 44) or whether it is the average cost up to now (they do not indicate how many aircraft are included in that average either if that was the case).

The approach I followed was different.

Boeing has disclosed it has 18bn$ as WIP related to the 787, and from local press we know what is the state of production right now, thus, we can try to estimate what is the average cost of the aircraft already produced.

The aircraft delivered to ANA needs to be discarded as its portion of WIP has already been included in the income statement of Q3. We know that at Seattle FAL there are now serial numbers 46 (to be completed according to press) to 50 (just arrived, according to Jon Ostrower). Thus, within WIP there must be about 44 aircraft almost completed and another 5 about 98% completed (FAL value added is around 4% of RC).

As we do not know how many other aircraft are in process and at which stage each one, we need to make further assumptions. From the same article of Seattle Times we learnt the following:

“The first 40 out of the Everett factory required massive and repeated rework, and the next 10 to 20 also need modifications because of design changes after flight testing.”

That means that at least about another 20 aircraft are being manufactured when other aircraft are at FAL. We can assume an average stage of completion of 50% of costs incurred in each one.  With these assumptions, we gather that the 18bn$ correspond to about 58 aircraft in different stages of work in process (WIP).

This gives us an average cost of about 310M$ apiece, close to the figures mentioned by some sources. The difference is that now we have a reference of cost and aircraft unit or units for that cost (1 delivered + 44 finished + 5 at FAL + 10-20 WIP ~ 60-70 aircraft).

With this average cost and using the learning curve formulas, we can deduct the unit cost of the first unit produced, which will be different for each learning curve we select, and from which all the costs of future units will be calculated.

Side note: Both 80% and 75% curves yield lower unit costs than the aircraft price (with the 38% discount) by the year 2015, in line with what was disclosed by Boeing CFO James Bell during the conference call:

“Bell projected that the cost to build each Dreamliner will drop below the price paid by the buyer around 2015, providing positive cash flow for the first time.”

Analysis

With all the data gathered above, and the required assumptions made, we can build a comprehensive valuation analysis.

Boeing 787 will not break even before 2034

The first graphic that is shown is what I believe will be the real scenario for the 787: it will not break even in the first 30 years of the programme, discounting cash flows. It won’t break even before 2034. In this case, I used the learning curve of 84%, that which was reported as the real one for the 777, and which is more conservative than the targeted one, 75%. As discount rate for the cash flows I used 10%, which could be even considered a bit low.

787 cash profile for a learning curve of 84 and discount rate of 10%.

When will then the 787 break even?

I continued the series for this set of reference parameters (84% curve and 10% discount rate) and break even would indeed happen, but not before 3650 units of the 787 have been delivered at the year ~2046. By then production rate would have had to slow down to about 6-7 aircraft per month as the backlog would have been already consumed, thus a new cost structure per unit produced could even make the mentioned date to be deferred even later.

Influence of the discount rate

The discount factor could be assimilated with the cost of capital. The reference I used was 10%, but let see how the previous graphic would look like in the case the factor was lower 5% and a bit higher 12%.

787 cash profile for a learning curve of 84% and discount rate as parameter.

We can see that if the cost of capital was as low as 5%, the 787 would reach break even by around 2028, but in the case of 12% it would never break even within 30 years as well.

Influence of the learning curve

The learning curve I used was the one I believe is more realistic as previous Boeing’s experience has shown, 84%. But let’s see how it influences the valuation, now fixing the discount rate at 10% and using the learning curve as a parameter:

787 cash profile for a discount rate of 10% and learning curve as parameter.

We can see that if the curve is the 90% the outlook is much darker, however, for 80% the programme would break even within the first 30 years, at around 2029. If the curve is the one Boeing targets, 75%, the programme may break even at around 2023, in line with Boeing statement:

“The positive cash flow will gradually pay back the earlier production costs to finally break even on manufacturing the planes roughly 10 years from now, Boeing said.”

Influence of the discount in prices

I have used a 38% discount over prices. I feel quite confident that Boeing discounts are around that figure, nevertheless, let’s see what would happen to the reference case (84% curve) if discounts were just ~20%, about half of those used, which would make cash inflows much higher at the moment when deliveries start.

787 cash profile for a learning curve of 84%, discount rate as parameter and discount over price of 20%.

We can see that in that case, the break even would be within the first 30 years, at about 2024 already for a DCF discount rate of 10%. Nevertheless, I doubt that pricing power of Boeing will allow it to stop giving ~38% discounts.

Influence of the down payments

In the simplified case that the down payment at the time of ordering the aircraft wasn’t in the order of 3% but 20%, this would bring forward cash inflows especially related to the first 800 aircraft ordered and thus improve the business case. However, once the programme is in steady state it wouldn’t change much.

You may see that maximum cumulative negative cash flow for the 5% curve only reaches about ~19bn$ vs. ~32bn$ in the reference case. Also for the 5% curve the break even is brought forward 2 years (from 2028 to 2026).

787 cash profile for a learning curve of 84%, discount rate as parameter and down payment of 20%.

“Boeing’s view” on the matter?

As we have discussed above, Boeing is targeting a learning curve of 75%, ambitious if compared to that of the 777, but not far from that used by Reinhard in his paper.

"Boeing's view": 787 cash profile for a learning curve of 75%, discount rate as parameter.

In this case, you may see that with a discount rate of 10% break even is reached in 2023. Again, as mentioned above, this is in line with Boeing’s comments in the conference call. Even for a discount rate of 12% break even would come within the next decade at around 2026.

This stresses the importance of the learning curve effect and cutting costs during the series production phase. Being in the state that the programme is now, with about -22bn$ cumulative cash flows through 2011, the only way to save it is through experience gained at the production sites.

The question then is: Will Boeing be able to achieve that 75% curve?

Side note: Let me now come back to the price discounts. I find that the results shown in the last graphic, with the curve Boeing intends to achieve (75%) and a discount rate for cash flows of 10%, as another confirmation of the discount used for prices of aircraft.

The model I built takes the 38% figure discounted from list prices, and I find it remarkable that with that figure the model predicts lower unit costs than aircraft discounted prices by 2015 (as mentioned by the CFO, James Bell) and predicts a programme break even at around 2023, about 10 years from now, as mentioned in the conference call. I take the last conference call as an implicit confirmation from Boeing of the discounts it applies to its 787s.

What has been the effect of this 3-year delay?

This is not easy to estimate, but I’ll give it a try.

Most of the assumptions remain constant. I believe that the delay has primarily deferred cash inflows from deliveries, extended R&D related to engineers working in the development for 3 years more sorting out problems and increased WIP of aircraft waiting in the production line. I will also remove cash spent in buying out partners, though this might be arguable as possibly the price of the buyout is cash neutral taking into account partners’ margins disappearing.

Below you may see the two graphics, one for the reference case (84% curve) without delay and the other for Boeing’s target (75%):

Effect of 3-year delay to 787 cash flows for learning curve of 84%.

Effect of 3-year delay to 787 cash flows for learning curve of 75%.

You may see that even in the conservative scenario (84%) break even is reached in 2014 or 2015 depending on the discount rate. With the more aggressive learning curve, 75%, the prospect is even rosier: from 2013 for both discount rates the programme would have reached break even less than 10 years since its launch in 2004 and 10 years before what now seems to be Boeing’s target break even year, 2023.

This result clearly points out how much a delayed programme may hurt the business case of an aircraft development: from being a sound project to converting it into a nightmare that may never break even, jeopardizing future developments in terms of lack of financial and human resources available.

What is the “accounting block” size used for then?

As its name points out, this is a mere accounting issue. It permits Boeing to spread already incurred costs that have been capitalized (in the balance sheet, not in previous years’ income statements) among aircraft to be delivered in the future. Since Boeing has a backlog of almost 800 aircraft and believes it will sell over 2,500 aircraft, it has prudently opted to spread costs over 1,100 aircraft, allowing itself to start reporting profits on each aircraft delivered almost from day one (from about 2015 in fact), having a shinier income statement and the bonuses that come with it.

Finally, as Richard Aboulafia would put it:

“Yours, ‘Til The 787 Breaks Even”

31 Comments

Filed under Aerospace & Defence