Boeing's 787 bet finally paying off

Boeing's problem child is shaping up. After showing up late and behaving rather badly on some early outings, the 787 Dreamliner now is dutifully rolling off assembly lines and performing admirably.

Increasing confidence in the 787 has been good for Boeing shares, which are rising again after dipping partly on worries that lower oil prices would dampen airlines' enthusiasm for the ultra-efficient jet. At an investor conference earlier this month, CEO Jim McNerney assuaged those concerns by attributing recent decisions by United Airlines and American Airlines to back off some 787 orders to “totally normal fleet planning adjustments.”

Of course, investors have other reasons to feel good about Boeing  —a huge order backlog, surging sales of its workhorse 737 and other commercial jets and, of course, stock buybacks. “There's a lot of confidence around the resiliency and the long-term outlook for this company,” analyst Peter Arment of Sterne Agee said.

Still, I doubt Boeing stock would be up 4 percent since May 6 without renewed optimism that the 787 is on track after a rocky start. The Dreamliner has commanded an outsized share of attention since Boeing began developing it a dozen years ago. Boeing staked its future on the new jet, which promises to reduce airlines' operating costs and enable them to serve new routes profitably.

To do so, Boeing took on a huge innovation challenge. New carbon fiber would make the body stronger and lighter. Increased use of electronics over hydraulics would take more weight off. And advanced aerodynamics would help the plane move through the air more efficiently. At the same time, Boeing planned to reduce financial risk by outsourcing more responsibility for R&D and production.

Growing pains

Not surprisingly, all this unexplored territory held some nasty surprises. Many suppliers couldn't handle their new responsibilities, causing production snafusthat delayed the first 787 commercial flight by more than three years. Batteries overtaxed by higher power requirements caught fire on two early commercial flights in 2013.

Nevertheless, 787 orders kept rolling in. As of April 30, Boeing's backlog of 787 orders stood at 835 planes, about six years worth of production.

After resolving supply chain issues and fixing the battery problem, Boeing has focused on turning orders into airplanes. It has delivered 271 Dreamliners to 33 different customers, a spokesman said. Monthly deliveries accelerated to 10 planes this year and are expected to reach 12 in 2016.

In more signs of progress, Boeing has started delivering a new version of the Dreamliner, the 787-9, and announced it no longer needs a supplementary production line to keep deliveries on pace.

Costs are falling as volumes and manufacturing efficiency increase. At the investor conference, Boeing commercial jet chief Ray Conner said unit production costs have dropped 30 percent. Boeing expects the 787 to reach break-even on a cash-flow basis this year.

The eventual profitability of the entire 787 program never may be known. Boeing doesn't break out profits for individual planes, although it would have to 'fess up publicly if the program were in the red. (Profitability of commercial aircraft is determined on the basis of “program accounting” that spreads costs over several years.)

Playing the long game

So the 787 apparently will make money. But after factoring in steep discounts typically awarded to “launch customers” of new aircraft, and billions of dollars in unexpected early production costs, margins on the first decade or so of 787 production are likely to be slim.

Analyst Neal Dihora at Morningstar figures “it's going to be low single-digit profitability” until the early 2020s. But new planes rarely make big profits early on, Dihora explained. The first objective, he said, is “getting customers locked in to your program.” Margins grow later as prices rise with new iterations of a jet, while production efficiencies drive down costs.

That's the trajectory Boeing has seen on planes such as the top-selling 737, which has become hugely profitable after nearly 50 years on the market.

The 787 appears to be following a similar course. Airlines are reaping the promised benefits in lower operating costs and new route options. Concerns about United and American notwithstanding, the strong order book suggest customers are “locking in” to the program.

Profits on the 787 aren't the full measure of its value. Boeing also can use Dreamliner technologies in other planes, giving them a competitive edge.

Another uncertainty is Boeing's appetite for more so-called “clean sheet” projects like the 787. Some recent comments by McNerney have been interpreted as ruling out such projects, also known as “moon shots.” While Conner clarified that McNerney's earlier remarks didn't mean Boeing would never design another completely new plane, he did suggest the company isn't eager to repeat certain aspects of the 787 experience.

“I think where Jim was coming from on that was not necessarily that you would never do another new airplane," Conner said. "It's the fact that you don't take these massive technology jumps in one single fell swoop to create — you take a jump that you know you can deliver that you don't have to have multiple innovation processes going on at one particular point in time.”