The Boeing Company (BA) has been stuck in neutral for most of the past five years, as investors have worried about a variety of potential pitfalls awaiting the company. The most high-profile issue has been a series of delays to the highly-anticipated 787 Dreamliner program. The 787 was initially supposed to begin deliveries in 2008, but a series of postponements pushed the first delivery back to late 2011. Production problems have continued, though on a smaller scale, with Boeing recently informing United Airlines (UAL) that it will not be able to deliver United's second 787 on time.
A second major overhang for Boeing's stock has been the threat of sequestration, a term describing automatic cuts of roughly $500 billion over ten years in the U.S. defense budget that could potentially take effect beginning in 2013. These provisions were put in place as part of the debt ceiling compromise last year, in an attempt to force lawmakers to find agreement on cuts in other areas. While most observers agree that the sequestration will not go into effect (i.e. the government will avoid automatic cuts to military spending), Boeing's military business is still likely to be pressured by lower defense spending going forward.
However, I believe that ongoing weakness in Boeing's defense business will be more than offset by growth in the commercial airplanes division. From 2003 to 2006, Boeing derived more revenue from the defense business than from the commercial airplanes division. As recently as 2010, the defense business and commercial airplanes division produced equal revenue shares, but the commercial airplanes business has delivered significant growth since then. For the current year, Boeing Commercial Airplanes expects revenue of $47.5-$49.5 billion, making up nearly 60% of total company revenue estimated at $80.5-$82.0 billion. The growth of the commercial airplanes segment as a proportion of Boeing's total revenue is thus helping to insulate the company from its previous high reliance on military spending.
In the commercial airplanes division, Boeing will benefit over the next year and a half from planned production increases and stabilization in the 787 program. Thus far, 787 production has been hampered by design changes, which have required assembled aircraft to be refurbished before final delivery. In recent months, Boeing has made significant progress in ensuring that 787s coming off of its assembly lines are ready for delivery. This will lower production costs and lead to a more predictable delivery schedule.
Moreover, Boeing is in the middle of expanding production to meet demand. The biggest bump in production is for the 787, which will go from roughly 3 per month year to date to 10 per month by the end of 2013. In addition, 737 production will be increased from 35 per month to 42 per month by early 2014, and 777 production is increasing from 7 per month previously to 8.3 per month in 2013. The cumulative result is that Boeing will produce roughly 180 additional aircraft in 2014 vis-a-vis its 2012 projection of 585-600. This could add more than $15 billion in incremental revenue, representing a CAGR of roughly 15%.
Boeing's production increases are supported by an order backlog of over $300 billion in the commercial airplanes segment. Boeing already has over 800 firm orders for the 787, meaning that even at the planned 10/month assembly rate scheduled for the end of next year, it will take until after the end of this decade to fulfill all current orders. That gives the company plenty of time to line up additional orders. As the 787 order book grows, I expect Boeing to increase the accounting quantity for the 787 program beyond 1100. By spreading development costs over more aircraft, this would substantially boost margins for the 787.
Furthermore, Boeing had a strong showing at the Farnborough Air Show this summer, unveiling orders for 373 new aircraft, mostly Boeing 737 MAX aircraft. The company has secured several other major orders in recent months, such as a 50-plane order from longtime customer Alaska Airlines (ALK) announced last month. While Boeing lags behind rival Airbus (EADSY.PK) in orders for next-generation narrowbodies, the company is likely to close the gap by the time these models enter production. The 737 family has a weight advantage compared to the A320 family, which should give the 737 MAX a cost advantage compared to the A320 NEO and may boost sales. If 737 MAX orders are strong enough, Boeing has the flexibility to increase production even further than the planned 42/month rate with minimal additional CapEx.
In summary, weakness in Boeing's Defense, Space, & Security division in the next few years is likely to be outweighed by significant gains in the Commercial Airplanes division. Production increases, supported by a strong order backlog, will lead to better than 30% revenue growth in the commercial segment (currently 60% of revenue). With Boeing currently trading at less than 15X projected 2012 EPS of $4.96, the company is a compelling investment opportunity, particularly for investors with a long-term focus.
Disclosure: I am long UAL.