Can Boeing Increase Margins on Its Commercial Airplanes?

A look at the underlying issues behind Boeing's quest to increase margins, and at the pressure it's putting on companies such as Triumph Group and Spirit AeroSystems.

Jul 11, 2014 at 2:32PM

One of the key considerations for Boeing (NYSE:BA) investors in 2014 is whether the aerospace giant can increase operating margins on its commercial airplanes. Already this year, suppliers such as Spirit AeroSystems (NYSE:SPR) and Triumph Group (NYSE:TGI) have faced issues on different Boeing programs, and the increasing complexity of newer planes appears to be causing Boeing some production problems, too. All of this could contribute to cost overruns. It's time to look closer at some of these issues.

Boeing, Spirit AeroSystems, and Triumph Group
The company's full-year 2014 operating profit margin guidance of around 10% for its Boeing commercial airplanes, or BCA, segment looks a little conservative in light of the first-quarter result of 11.8%. As such, Boeing appears to have substantive opportunity to beat internal guidance, but it won't be plain sailing for a few reasons.

Fools already know that Boeing is still on track to ramp up production of the 787 Dreamliner to a rate of 10 a month in 2014. However, Boeing has had production issues with the 787, including the discovery of hairline cracks on the wings of some planes in production.

Moreover, two suppliers have also had issues on Boeing programs. Earlier, in the year, Triumph Group saw its costs increase due to internal quality issues that required replacement of some parts on the 747-8 -- a relatively new aircraft that Boeing has had difficulty selling. The aircraft maker only received 17 gross orders for its 747 planes in 2013, and it only has one order in the year to date. Boeing made two production rate cuts on the 747-8 last year.

In addition, earlier in the year, Spirit AeroSystems reported a loss in its fourth quarter due to charges associated with losses it expects to take on its participation on Boeing's 787 Dreamliner program. Spirit reported $546 million in pre-tax charges in the quarter with $385 million relating to the 787 Dreamliner. Analysts see the pricing pressure on Spirit, as being part of Boeing's ongoing attempts at driving down cost -- a point that I will return to later. 

The impact on these issues can be readily seen in the two companies' share price charts.

TGI Chart

TGI data by YCharts.

Both companies were forced to reduce full-year guidance as a consequence, and the production difficulties speak to the challenges of manufacturing technologically advanced planes, let alone the pressure of ramping up output.

Why Boeing's commercial sales matter
The BCA segment is clearly under pressure to increase margins, as Boeing's defense, space, and security, or BDS, segment is faced with weakness in military spending. In Boeing's first quarter, BDS earnings fell 6% to $778 million, compared to the 23% rise at BCA to $1,502 million. In addition, BCA margins increased by 40 basis points to 11.8%, while there was a 10 basis point decline at BDS to 10.2%.

As discussed above, Boeing's guidance of 10% BCA margins for the full year looks a little conservative. Still, Fools need to consider that the 787 production ramp-up could trim back overall margins, while production issues suggest adopting a margin of safety toward any assumptions.

On a more positive note, at its recent investor day, Boeing management said it sees more opportunities for cost reductions with its "Partnering For Success" initiative. Essentially, the program involves Boeing seeking out cost reductions in return for suppliers receiving the benefit of being locked into production volumes at Boeing. The idea is that suppliers will be able to plan for long term production with Boeing, but this will be offset by lower pricing to Boeing. In addition, if suppliers, like Spirit, can plan for the long-term, then they maybe able to generate extra cost savings on the program. Indeed, Spirit is believed to be better positioned to generate cost savings on the 787 Dreamliner.  While, the program makes perfect sense to Boeing, it does imply more cyclical risk for the suppliers, because they are more heavily tied into Boeing's long-term order cycle.

The takeaway
Boeing looks capable of beating its margin targets with BCA, but production risks remain. Suppliers such as Spirit AeroSystems and Triumph Group have already lowered guidance this year, partly due to meeting Boeing's requirements on its newer 747-8 and 787 Dreamliner programs. This suggests that while Boeing looks well positioned, investors might want to exercise some caution around the fortunes of its suppliers.

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Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends Spirit AeroSystems Holdings. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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