Boeing: Business Is Great But Profit Margins Need Work

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Aerospace industry giant Boeing (NYSE:BA) builds aircrafts for both the commercial air travel sector and the governments of many nations, and those two operations have vastly different implications for the company’s profitability. Currently, its defense business is facing a tough environment thanks to constrained government spending, while its commercial aircraft business remains strong. Yet, there is a common theme; the company wants to improve profit margins at both its commercial and defense arms.

In a Wednesday interview at an investor conference in New York, Boeing Chief Executive Officer Jim McNerney explained that company plans to improve margins by increasing jet production rates for its commercial aircraft while securing better terms from its suppliers. According to the chief executive, some of those suppliers are even more profitable than Boeing itself, the player in the jetliner construction process that takes much more risk. “The relationship between risk and reward I think is out of kilter in some places,” said McNerney, according to the Wall Street Journal. Improved internal efficiency combined with the company’s “Partnering for Success” program, aimed at securing better terms from suppliers, will lead to better margins, he added.

Still, Boeing’s commercial airliner business is stronger than McNerney has seen it in his career. But with faster jet production and better prices from suppliers, the unit’s margins have room to widen he told investors, according to Reuters. Currently, approximately one-third of the jet manufacturer’s suppliers are involved in the “Partnering for Success” program, through which both parties work together to reduce costs and share the resulting benefits. The remaining two-thirds of suppliers are either in discussion or not engaged in the program, McNerney told Reuters reporters, but he expects the program to grow. “We have volume to offer and they have efficiency they can offer,” he said.

The company’s commercial airplane unit generated $53 billion in 2013, with earnings from operations increasing 23 percent to $5.8 billion. Comparatively, Boeing’s defense, space, and security division reported $33.2 billion in revenue for 2013, a 2 percent jump from the previous year.

McNerney also told investors the company aims to improve profit margins for its defense unit, although a cohesive plan had not yet been formalized. But the company’s defense business — where profit margins are “flatish,” according to McNerney — is in need of attention. Defense margins widened to 10.8 percent in the fourth-quarter from 8.4 percent in the third-quarter.

While Boeing’s defense unit performed surprisingly well in the fourth-quarter, widening margins as the company’s commercial airplane profit margins narrowed, as it is under pressure from decreasing defense spending by the U.S. government. In the summer of 2013, McNerney noted the company was not “out of the woods,” meaning that earnings would still be impacted by the automatic budget cuts known as sequestration. In fact, he said: “we are entering the woods.”

Budget uncertainty still plagues Boeing. “We remain very concerned about longer-term U.S. budget uncertainty” and the possible cuts to the country’s defense budget would have a “devastating impact” on the U.S. industrial base, said the chief executive during Boeing’s January 29 post-earnings conference call.

On March 1, automatic spending cuts to United States federal government spending, known as sequestration, began, reducing the U.S. military’s budget by $37 billion and forcing the Department of Defense to make difficult decisions as to how that money was spent. As part of the budget deal that ended the government shutdown in the third week of October, Congress passed a continuing appropriations resolution that kept funding for federal programs at existing levels, meaning Pentagon spending will remain at an annualized level of $496 billion in the 2014 fiscal year, which began on October 1. That level is about $31 billion below the amount requested by President Barack Obama, but it is $21 billion above the caps set in place by the Budget Control Act of 2011 — the legislation that brought about sequestration.

Had Congress not inked a new spending deal in mid-January that pushed automatic spending cuts two years into the future, the Pentagon would have had to implement another across-the-board cut. But still, the threat of “sequestration has not gone away,” as McNerney said at the conference, according to Reuters.

While Boeing described its fourth-quarter performance as a “strong” result that “underscored an outstanding full year of core operating performance that drove record revenue and earnings and increased returns to shareholders,” Boeing investors were not satisfied with the guidance given for this year. “For 2014, we remain focused on maintaining our commercial airplanes market leadership, strengthening and repositioning our defense, space, and security business and continuing to meet the needs of our customers by improving productivity, executing to development plans and delivering our unmatched portfolio of innovative aerospace products and services,” McNerney said in the earnings press release.

However, in terms of a full-year guidance, Boeing exercised caution. The company said core earnings would only increase approximately 2 percent while operating cash flow would fall by more than 20 percent. Comparatively, investors were bidding shares higher on the belief that cash flow was building to a substantial peak as Boeing builds jets at a faster rate in the coming years. It is important to note that Boeing typically begins the year with a low forecast, which is then raised as the year progresses.

Boeing investors advanced shares of the company’s stock more than 80 percent in 2013, but currently the stock is trading about 18 percent below its 52-week high of $144.57.

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