Will Boeing's Cost Cuts Kill Its Suppliers' Profits?

It's big business doing business with Boeing -- but it can be risky business, too.

Aug 18, 2014 at 5:45PM

Boeing (NYSE:BA) rivals beware: This stock market giant is aiming to become one of the most profitable companies in the entire aerospace and defense industry.

File
Much like this E-3 Sentry AWACS aircraft, Boeing wants to turn its cost structure upside down. Photo: Wikimedia Commons.

That's the upshot of Boeing's announcement last week, in which it promised to cut $6 billion in costs from its defense business. With $5 billion in net profits earned companywide over the past year, Boeing could soon be earning better than 11% net profit margins -- and earning twice as much money as it did last year.

That's excellent news for Boeing stock investors, but for investors in other defense companies, primarily those in the aerospace and defense products and services industry that feed plane parts to Boeing -- not so much.

Chadwick

Chris Chadwick is smiling at the thought of $6 billion in savings -- but he may be the only one. Photo: Boeing.

Describing his plan to excise $6 billion from the cost structure of Boeing's defense, space, and security business, division chief Chris Chadwick said that "probably 66% of that will come out of the supply chain, maybe more."

This means that Boeing's suppliers could be on the hook for as much as $4 billion worth of the cost cuts -- money coming directly out of their pockets.

Out of whose pockets, specifically?
Chadwick named three products as particular focuses of Boeing's cost-cutting efforts:

  • The P-8 Poseidon sub-hunting maritime patrol plane, based on Boeing's 737 airframe.
  • The KC-46 aerial refueling tanker, based on the Boeing 767.
  • Boeing 707-derived products, which might include E-3 Sentry AWACS airborne command centers.

Key suppliers to these airframes -- and the companies in the crosshairs for Boeing's cost-cutting -- might therefore include firms such as:

  • Spirit AeroSystems (NYSE:SPR), which builds fuselage sections and nacelles for the 737, and the wings and fuselage sections for the Boeing 767
  • Honeywell (NYSE:HON), which provides much of the cockpit avionics on the 737, the interior lighting systems, cabin pressure control systems, and auxiliary power systems on the KC-46 
  • General Electric (NYSE:GE), which, through a joint venture with Safran, builds the F108 turbofan engines that power the P-8 Poseidon sub-hunter, a variant of the 737, and which is re-engining some E-3 Sentry aircraft
  • United Technologies (NYSE:UTX), whose PW4062 turbofans will power the new KC-46 Pegasus aerial refueling tanker, and whose TF33-PW-100A turbofans power other E-3 Sentries

Who is most at risk
There are many more suppliers -- dozens, scores -- involved in selling plane parts to Boeing, not just these four. But these companies help to illustrate what investors in Boeing's parts suppliers can expect going forward.

Spirit AeroSystems, for example, is currently operating at a loss, with a net profit margin of negative 3%. As such, it's ill positioned to absorb the kind of cost reductions that Boeing will be demanding of its defense business suppliers. GE and United Technologies both net profit margins of roughly 9% apiece and can absorb Boeing's cost cuts more readily. Honeywell, with close to an industry-leading 10% profit margin, will probably be least affected by Boeing's actions.

Indeed, suppliers such as Honeywell, boasting fat margins that allow more room to cut prices and still earn a profit, may be best positioned to take advantage of incentives that Boeing is offering its suppliers by making it up on volume. In exchange for making improvements in "efficiency" and "cost reduction," Chadwick said Boeing suppliers who play ball could enjoy a "tremendous opportunity" to win more business from Boeing.

Whether the additional revenues from winning bigger Boeing contracts will suffice to offset profits lost to cost concessions remains to be seen. The upshot for investors, though, is this: The more profitable a Boeing supplier was before the cuts, the better its chances of coming out of this ordeal unscathed.

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It's going to get harder for suppliers to siphon off Boeing's profits going forward. Photo: Boeing.

Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Berkshire Hathaway and Spirit AeroSystems Holdings and owns shares of Berkshire Hathaway and General Electric. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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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