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Boeing's Reputation Taking a Hit Because of Troubled Tanker Program

By Lou Whiteman - Mar 23, 2018 at 8:15AM

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The KC-46 was supposed to be a chance for Boeing to prove its chops as a defense contractor. The results to date have been just the opposite.

Air Force Secretary Heather Wilson recently lashed out at Boeing (BA 2.23%), asserting that the aerospace giant is overly focused on its commercial cash cow to the detriment of defense projects, including the long-awaited KC-46 refueling tanker.

"One of our frustrations with Boeing is they're much more focused on their commercial activity than on getting this right for the Air Force, and getting these aircraft to the Air Force," Wilson said during an appearance before the House Armed Services Committee on March 20. She said that Air Force officials held face-to-face meetings with Boeing in recent weeks about the KC-46, and that "we have asked them to put their A-team on this to get the problems fixed."

Rendering of a KC-46 refueling a fighter mid-flight.

Rendering of the KC-46 in action completing a mid-flight refueling. Image source: Boeing.

The public scolding comes as Air Force officials are telling reporters they fear the first KC-46 deliveries, which were originally slated for August 2017, will not arrive until 2019. The jets are needed to replace a fleet of 1950s-era Stratotankers that the Air Force says are vital if the service is to deploy as needed. Boeing officials have insisted deliveries will begin before the end of this year.

The delays have already cost Boeing money. A bigger worry at this point is how big of a black eye the KC-46 will prove to be for the company, and how these troubles will impact its success in future military competitions.

Star-crossed from the start

The quest to replace the Air Force tanker dates back more than a decade and has had drama at every turn. In the early 2000s, the Pentagon proposed leasing tankers adapted from Boeing's 767 commercial design, but a congressional investigation revealed corruption leading up to that decision. The lease plan was cancelled, and the incident led to an executive overhaul at Boeing.

In 2008 Boeing's 767 design lost out to a modified Airbus A330, but that decision was overturned on protest. The eventual contract caps the Air Force's development spending on the project at $4.9 billion and requires Boeing to pay for any overruns. The Air Force currently believes the program will come in at about $6.3 billion, though the company believes the program will be completed for $5.9 billion.

Boeing has already taken more than $2 billion in pre-tax charges due to fines and cost overruns for the KC-46 program.

At present, the Air Force still sees several deficiencies that Boeing needs to work out before deliveries can begin. Notably, issues with the tanker's remote-vision system have caused the process of extending the boom used to refuel jets mid-flight to be inconsistent, leading to the probe scratching the jet's outer surface. That's both dangerous for in-flight operations and could potentially rub the stealth coating off fighters, making them more vulnerable in combat.

Boeing believes software refinements, and not a design overhaul, can solve most of the issues.

Jack of all trades, master of one

Boeing can swallow the cost overruns, but the reputational damage done to its defense unit could be harder to overcome. Wilson's criticism that the company favors its commercial side echoes a common complaint among Pentagon insiders. And given commercial's success over the last decade and its growing importance to Boeing's overall results, the unit is arguably where management's attention should be most focused.

Commercial accounted for more than 60% of Boeing's 2017 revenue, with its defense, space, and security unit generating just 22% of total sales and its global services unit responsible for the rest. Demand for Boeing jets including the 737 and 787 -- Boeing at year-end had a backlog of more than 5,800 jet orders -- has made selling commercial jets a very lucrative business for the company.

Among defense contractors, Boeing has always had to fight a perception that it struggles to develop new platforms. Some of its most high-profile military platforms, mainstays like the AH-64 Apache helicopter, the F-18 Super Hornet fighter, and the F-15 Strike Eagle, were developed outside of Boeing and came to the company via acquisition. And Boeing has lost out in some high-profile recent competitions, including the joint strike fighter, which went to Lockheed Martin, and the long-range strike bomber, which went to Northrop Grumman.

The KC-46, even if all goes according to plan from here on, is a missed opportunity for Boeing to prove its critics wrong and show it can bring a new defense program to market without extensive complications. Instead, comments like what Wilson told Congress would likely only reinforce perceptions of the defense unit, making future contract wins that much harder.

Three cheers for commercial!

Fortunately for Boeing investors, that massive commercial business has been a driver of Boeing's share price. The company's stock is up 87.5% over the last year and 294% over the last five years, even after a recent pullback related to tariff-retaliation fears. And the order book suggests the business will be in good shape for years to come.

The bottom line is, Wilson is correct, and Defense is indeed increasingly a junior partner inside Boeing. Investors can take some comfort in the diversification the defense business provides. But understand that, for the foreseeable future, Boeing's fate is tied to commercial aircraft.

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