For the past few months, I've questioned if Boeing (NYSE: BA ) would be able to deliver the tanker on time and on budget. While the question of on time still remains up in the air, it's starting to look like Boeing is headed for a $300 million cost overrun on the KC-46 tankers. For Boeing shareholders, this could mean problems.
When aggressiveness bites you back
The possibility of a cost increase on Boeing's tanker contract was first disclosed at this year's Paris Air Show. Ash Carter, head of Pentagon acquisitions, was referring to the projected $300 million cost overrun when he said, "It's not our problem because it's a fixed contract, and it was written with protections for the taxpayer."
With continuing talks of defense budget cuts, and projects like Lockheed Martin's (NYSE: LMT ) F-35 program seeing skyrocketing costs, maintaining fixed prices on contracts has become a high priority for Pentagon officials. In the case of Boeing, officials have made it clear that going over budget is the company's, not the government's, problem.
Although Boeing is maintaining that it's not yet over budget and "expects to make money on this program," Boeing tanker spokesman Bill Barksdale admitted that the Boeing's bid on the tanker contract was "aggressive."
Carter responded to Boeing's statement by saying that Boeing has decided to absorb a loss on the EMD contract, but expects to make up for it on the production side. What does all this likely mean? Yup, Boeing is over budget on the tanker -- no surprise there -- and will be forced to absorb the cost because of the nature of the contract. However, Boeing is hoping international sales of the tanker will offset that loss.
While it doesn't surprise me that Boeing will go over budget on the tanker contract, it's a little surprising that there's already talk of being over budget, and this brings to mind bigger questions:
- At this stage in the game, is it likely to think that Boeing will be able to stick with being just $300 million over budget, or is it plausible to think that the KC-46 tanker is headed for further turbulence down the runway?
- Boeing already has a reputation for underbidding contracts. If it goes way over budget on such a high-profile contract, how will this affect the chances of it being awarded future contracts?
Will it fly?
Although Boeing may still be able to pull off a win with its tanker contract, because of Boeing's past performance, I'm remaining skeptical. Add in Boeing's recent downturn in stock price, and it appears I'm not the only one. This is of course great news for Boeing's competitors Northrop Grumman (NYSE: NOC ) , General Dynamics (NYSE: GD ) , Textron (NYSE: TXT ) , and L-3 Communications (NYSE: LLL ) , but undoubtedly bad news for Boeing shareholders. Look to see these companies 1) manage their own project costs like hawks (not doves), and 2) snare any business they can away from the reeling Boeing. With defense spending likely to decrease, you can expect competition for contracts, and between contractors, to take off.
Looking to invest in a better defense company that has the potential to bring in multi-bagger returns? The Motley Fool's free report, "Too Small to Fail: Two Small Caps the Government Won't Let Go Broke" details two small-cap stocks that have solid deals with the government, and have the potential to bring you great returns. Click here to access your free report today!