Commercial aerospace giant Boeing released its quarterly numbers on Wednesday, revealing ongoing losses despite positive free cash flow. This raises the question of how cash flow can be strong while earnings remain lackluster.
In the second quarter, Boeing reported a $149 million loss based on generally accepted accounting principles (GAAP), reflecting the challenging period faced by the company due to the impacts of Covid-19 and the grounding of the 737 MAX aircraft following two fatal accidents.
Over the past seventeen quarters, Boeing has only reported GAAP net income in three of them. According to Bloomberg, losses in the past four quarters have totaled over $4 billion. However, during the same period, free cash flow amounted to nearly $8 billion. This stark contrast begs the question - what is causing this disparity?
The answer lies in accrual-based accounting. While GAAP accounting aims to align revenue and expenses with the period in which they occur, this methodology doesn't always align with cash flow. A perfect example is a car warranty. Most cars will experience some sort of issue at some point, and Tesla recognizes the potential expense for warranty repairs every time it sells a vehicle. However, no cash outflow happens at the time of the expense occurrence. The cash payment only takes place when something covered under warranty breaks - an event that never affects the income statement. In this scenario, the expense for warranty coverage is already accounted for when the car sale is recorded.
For Boeing, the difference between earnings and free cash flow in the past four quarters amounts to nearly $13 billion. This discrepancy is not primarily driven by warranty expenses. Rather, the main contributor is $3.2 billion in progress payments from customers. Essentially, this represents cash received by Boeing as it builds planes, even before revenue recognition from selling those planes. This influx of cash occurs before sales revenue is officially recognized.
Another significant factor impacting cash flow is inventory. As Boeing continues to work through its undelivered 737 MAX jets, the process of building inventory requires cash. However, selling planes from inventory generates cash inflow.
In conclusion, despite ongoing losses, Boeing has managed to maintain positive cash flow. While GAAP accounting might not fully capture the financial realities, a deeper understanding of accrual-based accounting highlights the significant contributions of progress payments and inventory management to the company's overall cash flow.
Boeing's Strong Cash Flow Signals Post-COVID Recovery
Boeing, a leading aerospace company, reported a robust inventory balance of $78 billion at the end of the second quarter. This marks a significant increase from the pre-MAX grounding and pre-pandemic inventory balance of $65 billion in 2019. The company is optimistic about generating more cash by gradually returning inventories to normal levels.
One notable aspect of Boeing's financials is its tendency to have higher accounts payable than accounts receivable. This dynamic has proven beneficial in generating cash flow, especially with the company's sales rebounding after the COVID-19 pandemic. Boeing receives payments from customers faster than it pays its suppliers, further contributing to its positive cash flow.
The interplay between inventory, working capital items, and customer funding for airplane production constitutes the main factors behind the net income-cash flow paradox that Boeing experiences. Judging whether cash flow or net income should be given more attention remains a matter of debate among investors. However, currently, Wall Street is placing strong emphasis on cash flow analysis due to past periods of volatility.
The positive cash flow generated by Boeing recently received recognition through an upgrade from BofA Securities. Renowned analyst Ron Epstein upgraded Boeing's shares from Hold to Buy, increasing the price target from $225 to $300 per share.
Epstein explained his decision by stating, "We are currently in the midst of the post-COVID commercial recovery with passenger demand emerging back to pre-pandemic levels. As such, we are raising our price target on improved free cash flow expectations."
Following this upgrade, 67% of analysts covering Boeing rate the stock as a Buy, according to FactSet. Comparatively, the average Buy-rating ratio for S&P 500 stocks stands at around 55%. Meanwhile, the average analyst price target for Boeing is approximately $247 per share.
In theory, cash flow and net income should converge in the long run. However, the current significant disparity between these metrics is a reflection of the unique challenges and anomalies experienced by the commercial aerospace industry in recent years.
As a result of this positive news, Boeing's stock has risen by 2.1%. In comparison, the S&P 500 and Dow Jones Industrial Average have experienced gains of 0.6% and 0.2%, respectively.