Looking Beyond Boeing's 787 Dreamliner

| About: The Boeing (BA)

Despite Boeing's (NYSE:BA) well-documented troubles with its revolutionary 787 Dreamliner, the aircraft will likely dominate the small wide-body jetliner segment for many years to come. Investors correctly remain focused on the plane's first delivery later this year, and subsequent production ramp up to satisfy a massive backlog of unfulfilled orders. And while successful execution on its 787 program would be welcome news, especially as it eases inventory build and bolsters cash flow, looming threats posed to its workhorse 737 in the narrowbody arena— the largest market as measured by units and dollar-value during the next couple decades-- should not be ignored.

What once was a duopoly in the large commercial aircraft market may not even be a rational oligopoly in future years. Engineering know-how and high capital costs represent some barriers to entry to the aircraft-manufacturing business, but these are far from permanent. Thanks in part to government assistance, EADS, (the owner of Airbus) proved that it was able to overcome this impediment, and jet making has now moved to the forefront across the globe. For starters, Bombardier's (OTCQX:BDRBF) C-Series uses a high percentage of light-weight, composite materials and offers a compelling choice for airlines seeking a smaller plane in the narrowbody segment. Brazil's Embraer (NYSE:ERJ) may eventually make a move into this market to keep pace with its Canadian peer. Orders for Russia's Irkut MS-21-- a 150-212 seat aircraft-- are already approaching 200, and Japan's Mitsubishi (OTCPK:MHVYF) Regional Jet may lay the groundwork for that country to produce a larger commercial aircraft in the years ahead. China is also aggressively entering the narrowbody segment, with Comac (Commercial Aircraft Corp. of China) expecting to deliver the first C919 later this decade. Boeing’s and Airbus’ recent production rate increases on their 737 and A320 platforms, respectively, can arguably be viewed as a move to thwart future cancellations and get ahead of these numerous threats.

The existing competitive dynamics of the narrowbody aircraft market are well known. Airlines and leasing firms engage in deep negotiations with both Boeing and Airbus in order to land the best possible deal, especially since the current choice of narrowbody planes (737, A320) is essentially commodified – read little differentiation. As a result, the bargaining power of airline customers is relatively high, which keeps a cap on economic returns at the commercial OEMs. Further, Boeing and Airbus are all too willing to offer heavy discounts to secure large orders and retain long-term customer relationships. Boeing’s massive backlog of unfulfilled orders should cushion the company against the next downturn, but it would not be surprising to see commercial margins head south in a hurry, as competitive pressures intensify toward the latter part of this decade.

Boeing does have some things in its favor, however. The aerospace giant’s track record for building dependable aircraft and servicing them over their useful life are key strengths over unproven new entrants. And while Boeing may find entrenched regional jet makers more difficult to fend off-- should they continue to build larger planes, the need for operating efficiencies in the form of maintenance and pilot training costs should hinder a large majority of existing airline customers from migrating away from Boeing's 737, and eventually its next-generation narrowbody-- the plans of which Boeing may announce later this year. And as investors know all too well with the 787, estimated entry-into-service dates by competitors may also find a way of getting pushed back.

Among other risks (787 production ramp up; 777 response to the A350-1000; 747-8 roll out; changing defense priorities, etc.), correctly assessing the implications of encroaching foreign competition on the narrowbody market will ultimately determine whether Boeing’s current market price is justified. After all, the 737 represents well over half of the jet maker's 3,400-plus plane backlog, as measured by units. But even if Boeing manages to retain market share in the narrowbody market in the decades ahead, investors looking for clear skies following the 787's long-awaited launch and production ramp-up may come to find the most lucrative portion of Boeing’s commercial aircraft portfolio-- its popular 737-- under full attack.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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