As the markets rise and fall, manufacturing companies like Boeing (NYSE: BA ) typically go through a boom-and-bust cycle. Customers have trouble financing purchases over $100 million when times are tough, so jetliners are the first thing to go.
This year seems to be an anomaly in some respects, though, since the broader Dow Jones Industrial Average (INDEX: ^DJI ) is actually outperforming Boeing's stock by 4%. Shareholders are left wondering when Boeing will take off, especially given the industry's projected $4.5 trillion market opportunity over the next 20 years. Boeing's 2.4% dividend looks healthy, and backlog is strong, but there are still a few reasons for investors to fret about the future for the leading American plane manufacturer.
Building a bubble
The sharp rise in production since the 2008 recession has led many industry analysts to question whether aviation could represent the latest and greatest bubble in the markets. Despite a rocky global economy and high jet fuel prices, customers have sent demand skyrocketing. Much of the demand stems from China, where more than two-thirds of the world's newest airports are currently under construction. The other factor contributing to soaring demand, however, is cheap financing due to incredibly low interest rates.
As a result, the plane makers have focused on streamlining their supply chains, and recently announced efforts to increase production by 40%. One method of delivering production efficiencies would be through consolidation, but with thousands of suppliers, manufacturers like Boeing and Airbus need to be highly selective. As pointed out by the CEO of GE (NYSE: GE ) Capital Aviation Services recently, "The market is sort of in balance now, but there's less margin for error in the industry."
For many years, Boeing and Airbus have controlled a substantial portion of the market for large commercial aircraft, but Brazilian, Chinese, Canadian, and Russian companies are poised to attack. At last year's air show, Airbus CEO Tom Enders gave credence to the trend, but implied the two behemoths would continue to dominate in the larger jet segment. He noted, "The duopoly is over in the 100 to 150 aircraft segment because this is where the new entrants ... want to be -- so that doesn't mean the duopoly is over in the entire range of products."
Since then, however, the competition has grown even fiercer, with competitors even dictating trends in the smaller market segments. For example, Canadian-based manufacturer Bombardier aims to enter the 100-plus aircraft segment with its fuel-efficient CSeries next year, a threat scarcely acknowledged by Boeing and Airbus upon announcement. However, steady, escalating fuel prices prompted Airbus to introduce the A320neo in an attempt to increase efficiency, which forced Boeing to reconsider and upgrade its 737 model. It's clear that preserving their top spots won't be easy for Boeing and Airbus in the years to come.
The contraction of the defense market is nothing new, with Western countries slashing budgets in the face of tepid economic growth and the U.S.' role in Afghanistan and Iraq declining over time. Even greater defense cuts to the tune of $500 billion could result from the sequestration measures being taken in the U.S., which would take effect on Jan. 2, 2013. Boeing's strong presence in commercial aircraft could offset these declines if it is able to react strategically over the next few years.
On Monday, Boeing stated that it would withdraw from competing for a $3 billion Air Force contract to pursue other priorities, a sign that the company truly is taking the commercial market more seriously these days.
Blue skies ahead?
China's cooling market could pose problems for the big manufacturers in the near future, but few experts can predict whether one of the world's fastest-growing markets is in for a hard or soft landing. And perhaps the aviation demand will continue even if real estate and other Chinese markets falter.
Just yesterday, signs emerged that aviation drove second-quarter profits higher for the diverse manufacturer Honeywell (NYSE: HON ) , which could indicate solid results in this sector overall as earnings are released. Another company betting big on aviation growth is General Electric, set to report on Friday. For GE, the recent financial crisis struck a blow, but management took advantage of the market's dip to make strategic bets in transportation and energy. If you're a GE investor, you need to understand how these bets could fuel GE's stock. To help, we're offering comprehensive coverage for investors in a premium report on General Electric. Our industrials analyst breaks down GE's multiple businesses and provides reasons to buy or sell GE based on underlying fundamentals. Plus, you'll receive continuing updates as major events unfold during the year. To get started, click here now.