Boeing And The Dreamliner Are Positioned To Weather The Storm

Jan. 9.13 | About: The Boeing (BA)

This week cannot come to a close quickly enough for Boeing (NYSE:BA). The last three days have brought about three independent instances of malfunction for the advanced but troubled 787 Dreamliner. Shares of the aerospace and defense company plummeted 4.6% combined on Monday and Tuesday in correlation to the heavily publicized mishaps, but rallied back on Wednesday to gain 3.52%. In addition to the relentless criticism of the 787, fears of the potential impact of looming defense spending cuts have been an obstacle for the company and for the stock. It may seem as though investing in Boeing means taking on an unnecessarily large risk, but the flaws of the Dreamliner are not turning into cancelled orders, nor are they turning into diminishing demand as Boeing continues to perfect the project. Furthermore, with diversification in the commercial airplane business, a wide variety of defense products, as well as internal efforts to shield itself from defense cuts -- Boeing is well positioned to weather the storm of spending cuts going forward.

Boeing regrettably made headlines throughout the beginning of the week because of the issues associated with the seemingly plagued 787 Dreamliner project. While delving too deeply into the technical difficulties may be irrelevant, it is worth noting the general nature of each problem. According to Yahoo, an electrical fire broke out on Monday due to the explosion of a battery that powers the electrical systems of the jet when the engines are not running. This was then followed by a fuel leak on Tuesday, and by issues with the brakes on Wednesday. Needless to say, these malfunctions harmed investors' confidence in the project that has suffered starting with its initial three-year delay. While the worries have some substance to them, the differentiation of the problems most likely means that they are not reoccurring, and are not apparent on a large quantity of the planes. Rather, the incidents are representative of the immaturity of the 787 project, and will continue to dissipate with time as they have with other newly released airplanes.

The technical difficulties that the 787 Dreamliner has experienced have certainly been illuminated by the media, but what the media often fails to acknowledge is the similar issues that other high-profile commercial jet launches have endured. Parallels can be drawn to none other than the Boeing 777. Introduced in 1995 with United Airlines, the 777 had far from a painless entrance into flight. Its early days were hindered by gearbox bearing wear issues, which actually resulted in British Airways removing the 777 fleet from Transatlantic flights in 1997. Fortunately, the issues were resolved, and the planes reentered service later that year. The Airbus A380 was not released without problem, either. Just the second aircraft delivered experienced fault with its alternate brake system in Sydney. The fact of the matter is that new projects, especially those as technologically advanced and progressive as the 787, are bound to have their share of problems. Although it may seem as if the Dreamliner's performance will equate to less demand, that was not the case with the 777, and it will not be for this jet.

The importance of the Dreamliner to Boeing's business and future is significant, but the emphasis on it, especially this week, can cause investors to forget just how large the scope of Boeing's operations truly is. The company's commercial airline sector makes up 49% of Boeing's revenue, as calculated by S&P. The 787 makes up a portion of this figure now, and will continue to grow going forward, but for the time being, it is far from the sole factor driving business forward. This means that even if the 787 were to endure setbacks, Boeing would be far from a sinking ship. Investors, particularly this week, have voiced concerns that the issues may lead to complications with the FAA or difficulty eliminating malfunctions. The serious implications on Boeing's stock price and business, following suit with the aforementioned mentality, would translate to the 787 experiencing order cancellations and a lower quantity of new orders. This is not a current reality, and unless something drastic were to happen, it will not become one. On Wednesday, Qatar Airways CEO Akbar Al Baker said in a statement of support that "there will be small teething problems from time to time but this if foreseen with any new aircraft program." Remarks from Boeing executives about the safety of the situation business-wise are expected and relatively insubstantial, but when reassurances are coming from airline executives, especially CEOs, it is apparent that the support is there -- vacating the assertion that 787 mishaps will lead to monetary harm to Boeing (beyond repairs, etc.).

Boeing's commercial airline division experienced an awe-inspiring year in 2012. According to a Yahoo article, Boeing had 1,203 net commercial orders, which served as the second-largest in company history, and had 4,373 unfilled commercial orders, the most ever in company history. To supplement these feats, the 737 broke records for most orders and deliveries in a year. The staggering success of the 737 and the entire commercial aviation branch in 2012 is a testament to Boeing's dominance in this field, and amounts to confidence and optimism that Boeing should carry out a similar performance in 2013 and beyond. This will be made true largely because the 787 program will work out its imperfections and run on a smoother basis. A trend among airlines has been to revamp fleets with fuel efficient planes. Boeing has exceeded its competition in addressing this pattern with the 787 in particular. It uses 20% less fuel than planes of similar stature, allowing airlines to save money and thus reward the company's focus on fuel efficiency. Boeing's strength of product allows it to thrive in the commercial airplane market, and as air traffic continues to increase by about 6% annually, there is no reason to believe that this division, which comprises half of Boeing's business, will slow any time soon.

The other half of Boeing's business comes from its Defense, Space, and Security division. According to the company's 10-K filed in 2012, this division makes up almost $32 billion in revenue as a whole. More specifically, $14 billion is generated by military aircraft, $8.7 billion is attained through network and space systems, and $8.4 billion is created through global services and support. Under normal circumstances, this sector of Boeing would be healthy and without issue, but the looming $45 billion in spending cuts disrupt this claim going forward. First and foremost, the impact that defense cuts would have on Boeing do not endanger the entire $32 billion in revenue generated by the defense division. A solid portion of that figure comes from international markets. In 2009, exports accounted for 16% of defense sales, and leadership saw progression to 20% within five years -- a percentage of the business that is not in danger from a reduced Pentagon budget. Furthermore, the $8.4 billion in global services and support should be relatively unharmed.

As military spending cuts create a cloud over the entire defense sector, Boeing has taken steps internally to minimize potential damage, and offers products that place it best to endure the reduced opportunity for domestic contracts. Dennis Muilenberg, CEO of Boeing Defense, Space, and Security, stated that they are preparing for the worst-case budgetary scenario, and have been "designing [their] cost structure to accommodate a $1 trillion cut." Muilenberg has repeatedly asserted that the division is as best prepared as possible and will survive defense spending cuts even in the face of drastic spending reduction.

To compliment cost-control is the type of military aircraft that Boeing offers. With fighter jets such as the F/A-18E/F Super Hornet and the F-15E Strike Eagle, Boeing offers proven aircraft that are much more cost-efficient than next generation fighters such as Lockheed Martin's (NYSE:LMT) F-35. This bodes well for Boeing domestically, as well as internationally, as BB&T Capital Markets analyst Carter Leake points out in an article on The Street. Leake states that "we are not naïve to the fact that all of the global defense suppliers can't all be right when they say increased international sales will be their savior, but if we look at the big, upcoming international fighter opportunities, Boeing's platforms are clearly the next best choice." Quality, cost, and diversity of the products offered will carry Boeing Defense, Space, and Security through the $45 billion in defense cuts this year if made effective in two months by the Fiscal Cliff deal. These cuts may not foster the growth in this sector that many would like to see, but Boeing is best positioned amongst its peers, and has taken the steps necessary to weather the storm.

To round out Boeing's commercial and defense prospects is its exceptional balance sheet. The company, according to its 10-K, holds $12.37 billion in debt, which is down from $12.42 billion in 2010. The reasonable debt figure is juxtaposed by $11.27 billion in cash, which is up dramatically from just $2.3 billion in 2002, and $3.28 billion in 2008. The balance sheet is headed in the right direction with stable to decreasing debt, and a rapid increase in cash held. The stock's valuation is reasonable as well, with a P/E of 13.5. Furthermore, Boeing's effectiveness is captured by its astonishing 63% return on equity, which puts the industry average of 21.45% to shame [for reference, United Technologies (NYSE:UTX) has a return on equity of 21.99%]. Boeing's fundamentals, particularly its balance sheet, are quite lucrative, and will come to benefit the company down the road.

Seemingly infinite problems with the 787 Dreamliner and worries of the impact of a reduced Pentagon budget have, until Wednesday, left investors fleeing. The 787 is having malfunctions just as any newly released, highly innovative aircraft would -- struggles that are no different from those experienced in the past. Boeing's commercial division, which will be led more and more by the Dreamliner, continues to dominate and produce stable, attractive growth. Defense cuts are a threat, but Boeing has taken the necessary steps to protect itself, and through diversification of product and by offering what is demanded under current circumstances, it will be fine even amidst a worst-case scenario. There are reasons to be dissuaded from investing in Boeing stock, and those reasons turned into execution on Monday and Tuesday, but the selling was short-lived as the superficiality of the 787 issues became realized. After the 3.5% rally on Wednesday, it is best to wait for a dip and initiate a long position around the levels that it was trading at on Tuesday at $74 a share. As the Defense, Space, and Security division stays afloat, 13% growth foreseen by S&P in its commercial aviation sector will be enough to fuel Boeing's success, and to drive its share price higher.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in BA over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.