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Commercial jet producer and defense contractor Boeing (NYSE: BA ) is due to report its third-quarter earnings on Wednesday. The company's large order backlog should provide some clear revenue visibility, but Boeing's results will also give investors some insight into how the company is coping with some critical developments. As a defense contractor, Boeing is facing big cuts to the military budget. As a jetmaker, Boeing is attempting to ramp up production of its 787 Dreamliner to meet demand, hoping to increase production from 3.5 per month to 10 per month over the next year.
Today, you can find out more about these challenges with a sneak peak of The Motley Fool's premium research report on Boeing. In the full report, you'll find out whether Boeing is a buy with our research and analysis on the risks and opportunities facing Boeing, as well as a third key area that's critical to Boeing's long-term success.
Defense spending. Boeing's defense, space, and security division holds a number of high-value defense contracts, including the F-22 Raptor fighter jet and the recently won KC-46 refueling tanker. The U.S. Department of Defense contributed 76% of the division's revenue in 2011, the remainder coming from NASA, commercial satellite markets, and international militaries. With the U.S. winding down two wars and facing extreme budgetary pressure, this reliance on Department of Defense contracts leaves Boeing vulnerable.
The most immediate threat is the "fiscal cliff," the large package of tax increases and spending cuts that would deal an immediate blow to defense spending and require $55 billion in cuts annually from 2013 to 2022. Because these are cuts from projected increases, the defense budget will still grow, but only by 1.5% annually rather than the 8% or so seen over the past decade. The defense industry's primary customer cutting spending to less than the rate of inflation sets up many defense contractors to underperform the market significantly.
While Congress and the president may well act to avoid the immediate impact of the fiscal cliff, Washington's focus on deficit reduction makes it likely that defense spending will be a smaller share of GDP in the near future. Investors should watch how contractors like Boeing adapt to this shrinking industry, and how capably they are able to diversify their revenue streams away from defense.
Production capacity ramp-up. As Boeing's massive backlog illustrates, just because the company has the customers doesn't mean it's always able to deliver. Building a modern jet plane is a complex business, and Boeing has a history of severe problems with being able to meet demand. The last time the company faced skyrocketing orders as the economy climbed out of a recession was in the '90s, and, then as now, Boeing struggled to keep up. Costs escalated, manufacturing facilities were stretched to the breaking point, deliveries were delayed, and in 1997 the catastrophe culminated with production lines stopping for a month so Boeing could catch up. The year after the shutdown, the S&P grew 10% while Boeing's stock shrank by 40% -- a difference of 50 percentage points.
To cope with the sheer complexity of assembling modern aircraft, both Boeing and Airbus have adopted a strategy of requesting that global suppliers shoulder a larger share of the burden. Boeing has encouraged consolidation among smaller aeronautics firms, and has outsourced design and technical work on an unprecedented scale. The 787 Dreamliner, for example, was not built at Boeing's facility from the ground up, but instead from pre-manufactured "subassemblies" that were shipped to Boeing for final assembly from all over the world, with Japanese producers creating nearly a third of the plane.
However, in diversifying and globalizing its design and manufacturing process, Boeing has exposed itself to a host of disruptions worldwide, including the risk that subassemblies will not integrate properly. As a demonstration, the first delivery of the 787 Dreamliner was delayed by over three years. If Boeing remains serially unable to supply its most advanced products, customers will look elsewhere and investors will suffer.