When Boeing (NYSE: BA) began delivering its 787 Dreamliner in late 2011, it set the program accounting quantity -- an estimate of foreseeable sales over the next decade -- at 1,100 units. Two years later, it raised this estimate to 1,300 units, providing a modest boost to its profitability.
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Boeing may be close to raising the Dreamliner program accounting quantity again. Let's take a look at what that means, when it could happen, and why it matters for investors.
Program accounting 101
When a new aircraft type is introduced, the first few models produced tend to be extremely costly. Indeed, Boeing spent an average of about $400 million to build the first 40 or so Dreamliners, according to the Seattle Times. That's several times the average selling price.
Boeing incurred huge losses on the first 40 or so Dreamliners it built. Image source: Boeing.
However, costs decline significantly over time. It's fairly typical for costs to fall by about 15% every time the number of units produced doubles. In other words, the 200th plane off the line costs 15% less to build than the 100th plane, while the 400th plane built is 15% cheaper than the 200th.
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Program accounting allows Boeing to smooth out the profitability of new aircraft programs. It looks up to 10 years ahead and estimates the program's total profitability over that time period. The estimated profit is essentially spread evenly over each plane produced. Thus, Boeing can report steady earnings rather than rack up huge losses on early production models followed by profits later on.
Program accounting has been stretched to its limit for the 787. Cash costs related to Dreamliner production over the past decade have exceeded revenue by more than $30 billion. However, Boeing hasn't reported losses on the Dreamliner program, because it expects to offset the cash losses it has incurred thus far with large profits over the next six years or so. Not surprisingly, this has stirred up quite a bit of controversy.
Will Boeing raise the 787 program accounting quantity again?
For the past three years, Boeing's program accounting quantity for the 787 has been 1,300 units. This covers about six more years of production. That's much less than the 10-year forecast horizon Boeing used when it originally set the accounting block at 1,100 units.
Theoretically, this means that Boeing could extend the 787 accounting block. (As noted above, it did this once in late 2013, increasing the accounting quantity to 1,300 units.) To extend the accounting block, Boeing must be able to estimate the revenue and costs associated with those additional airplanes.
This doesn't mean Boeing needs to have sold all of those planes. For example, Boeing had fewer than 1,000 Dreamliner orders when it extended the block from 1,100 to 1,300. However, Boeing has faced significant pricing pressure and a slowdown in orders for the 787 recently. That makes it harder to estimate the profitability of planes it will be delivering in the mid-2020s.
A flurry of 787 orders to end 2016?
Between the beginning of 2014 and the end of last month, Boeing booked just 131 net orders for the 787 family: 41 in 2014, 71 in 2015, and 19 through the first nine months of 2016. That gave it a total of 1,161 Dreamliner orders as of the end of last quarter.
However, Boeing could add significantly to that total in the last few months of 2016. Last week, it announced that Qatar Airways had ordered 30 787-9s. This week, Boeing added another order for 12 787-9s from China Southern Airlines.
Additionally, China's Donghai Airlines committed to buy five 787-9s earlier this year, but that order is still waiting to be finalized. Saudia also recently announced plans to buy 13 787s, although it isn't clear whether those are already included in Boeing's order book.
Boeing has captured dozens of Dreamliner orders in the past month. Image source: Boeing.
The big prize is a potential order from Emirates. By year-end, the Middle Eastern airline giant is expected to decide between the 787 and Airbus' A350 for an order of roughly 70 jets. Finally, Pakistan International Airlines appears to be on the verge of ordering eight Dreamliners.
If the Emirates deal comes to fruition and these other orders are finalized, Boeing would end the year with nearly 1,300 total orders for the 787. Additionally, racking up more than 100 orders in a few months would give Boeing a lot more clarity about the Dreamliner's future profitability. As a result, it could cause Boeing to extend the 787 Dreamliner accounting block again.
Extending the program accounting block would have zero impact on Boeing's cash flow, which is arguably the most important metric for any business. Nevertheless, most investors pay close attention to accounting earnings as well as cash flow -- and a block extension would have a big impact on Boeing's earnings.
For now, Boeing is reporting very slim profits on each Dreamliner it delivers, because the projected cash profits of future deliveries in the 1,300 unit accounting block are barely enough to offset the losses sustained thus far. By contrast, since aircraft production costs decline continuously, any units added to the accounting block would be highly profitable sales.
Those profits would be spread across all the remaining deliveries in the 787 accounting block. As a result, extending the accounting block would immediately increase the amount of profit Boeing reports for each 787 delivery.
787 accounting block extensions are thus a crucial aspect of Boeing's plans to boost profitability at its commercial airplanes division. The sooner Boeing can meet the requirements needed to extend the 787 accounting block, the sooner it will be able to report the strong profit growth it has promised to shareholders.
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Adam Levine-Weinberg owns shares of Boeing. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.