Monday, November 21, 2011

Boeing: We Are Ready for Whatever Happens

By Ted Reed - The Street Nov 21, 2011 11:50 am

Boeing (BA) is prepared for the worst.

The worst would be the extremely unlikely event that "sequestration" actually occurs, cutting $500 million in defense spending over 10 years, on top of the longer-term downward trend in defense spending as the wars in Afghanistan and Iraq wind down.

"As we look forward to where the U.S. budget is headed, at a minimum expected a $500 billion reduction over 10 years, and a maximum of a trillion over 10 years," said Dennis Muilenburg, CEO of Boeing Defense, Space & Security, at a recent Bank of America/Merrill Lynch investor seminar. The latter would include the impact of sequestration.

"We are assuming that worst-case scenario, designing our cost structure to accommodate a $1 trillion cut," Muilenburg said. "We are preparing ourselves and have been preparing ourselves for that worst-case budget scenario."

A congressional "super committee" on Monday may announce it has failed to reach an agreement on deficit spending that would trigger automatic across-the-board spending cuts to a wide variety of domestic programs and the Pentagon budget, starting in January 2013.

If the worst-case scenario does not occur, Muilenburg said, that creates opportunities. But Boeing, he added, knows what other successful companies know, that "in a defense down cycle budget cycle, it's very important to not hunker down," but rather to invest.

Boeing's other strategies, which it has frequently discussed during the past year, include an effort to expand international defense and security sales in order to offset the decline in U.S. sales. Boeing spokesman Dan Beck said 83% of BDS revenue, which totaled $32 billion in 2010, is from government contracts, with the vast majority from the defense department. About 17% of BDS revenue is from international sales: The unit's goal is that international sales will generate 25% to 30% of revenue by 2013.

Additionally, Boeing has sought to expand into other related businesses including security, intelligence and energy management at military bases. And of course, Boeing is shielded from declines in defense spending by its vibrant commercial aviation sector, which accounts for about half of revenue.

BB&T Capital Markets analyst Carter Leake said that while defense contractors face obvious challenges from the current defense environment, Boeing appears to be better positioned than many of its peers.

"We are not naive 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," Leake said.

In particular, Boeing's F18 Super Hornet appears to offer particular advantages in price and readiness over the F-35. So far, Boeing has made about 500 deliveries of the F18, a fighter plane developed for the Navy that entered service in 1999.

By contrast, the Lockheed Martin (LMT) F35 has faced delays, rising costs and mounting debate over its future, although it does have strong backing from Secretary of Defense Leon Panetta.

"Unfortunately for Lockheed, the F-35 program is by far our country's most expensive defense program," Leake said. "As such, the program is just too big a target for defense doves to ignore.

"We continue to believe that Boeing has effectively positioned themselves as part of the defense austerity solution with their 'capable but affordable' mantra," he added. "Every F-35 delay or cost increase only strengthens the case for Boeing's F-15 and F-18 platforms which are proven, significantly cheaper, and ready for delivery."

Teale Group analyst Richard Aboulafia, however, said that while questions may surround the F35, "the idea that the F35 gets killed is pure fantasy. There is too much at stake."

Three versions of the F35 are planned. One, targeted to the Marine Corps, would enable short takeoffs and vertical landings aboard amphibious ship. "Budget-cutters have begun to look on Marine Corps aviation acquisition as a real splurge," Aboulafia said. "The plan got really ambitious and expensive.

"But the defense industrial base is organized in a way that hedges against serious defense cuts," he said. "Even if the F35, that is Lockheed, really is vulnerable, I don't think (the impact) would be disproportionate. Everybody is so diversified in their portfolio that I think the impact would be fairly evenly spread."

In trading early Monday, Boeing shares were down $1.04 at $66.42, while Lockheed Martin was trading down $1.35 at $73.75.

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