Boeing (NYSE:BA) was heavily favored to win South Korea's contract for 60 fighter jets over Lockheed Martin (NYSE:LMT) and other competitors. The fact that Boeing's offer was rejected and it is currently missing out on the $7.7 billion contract is bad enough. The real slap in the face, though, is that Boeing's bid was the only offer under South Korea's initial budget and was still dismissed.
Lockheed: new front-runner?
"South Korea needs measures for retaliation against North Korean provocation," Defense Ministry spokesman Kim Min-seok said in Seoul earlier this week after the decision, according to Bloomberg. "South Korea needs to secure military capability in line with recent aviation technology developments."
Holding true to Seoul's initial word months ago, the budget wasn't the primary factor in making a decision. More crucial was acquiring a fighter aircraft with strong stealth capabilities, which Lockheed's F-35A offers. As South Korea reopens the contract for bidding, this likely moves Lockheed to the front of the pack to snatch the $7.7 billion contract. This could begin a disturbing trend for Boeing's defense segment.
As the U.S. government continues to cut its defense budget, Boeing could be less likely to develop a replacement for its F-15 Silent Eagle; that means revenue from its defense side could continue declining.
"Revenues from their legacy aircraft programs are going to ramp down to painful levels" over the next three years, said Richard Aboulafia, an analyst with the Virginia-based Teal Group, according to Reuters. "The day of reckoning has just been accelerated a notch."
After the news was announced Monday some investors worried that Boeing's defense revenues would continue to crash and burn, ruining the stock's potential. Oblivious to the worries, Boeing's stock price continued its flight higher, setting all-time highs. I think that the decline in Boeing's defense revenues is overblown, and here's why.
Boeing has a well-known backlog of orders worth a staggering $410 billion; that's more than 4.5 times the company's entire 2013 sales estimate. Long-term investors aren't worried about this military contract loss because increased demand for Boeing's commercial aircraft will outweigh weakness in its defense segment.
One reason for the optimism regarding Boeing's commercial aircraft is its recent 20-year forecast upgrade. The aerospace giant predicts that global commercial aircraft demand will reach 35,280 new airplanes -- that's worth a staggering $4.8 trillion over the next two decades. Boeing looks positioned to take more than its fair share as its aircraft are often more fuel efficient than those built by its competitors.
Another positive aspect for investors is Boeing's growing cash pile that could be used for additional share buybacks and dividend increases.
This cash pile should continue to grow as production of its 787 Dreamliner ramps up and margins improve. Consider that Boeing was producing just two 787s per month at the end of 2011, but is expected to quintuple that to 10 per month by the end of 2013.
Don't cry for Boeing
Boeing's stock might be flying higher because the folks on Wall Street are actually thinking with the long term in mind. I know it sounds crazy, and it's certainly a rare occurrence with today's mindset of instant gratification. Losing contracts every now and then is just part of the business, and investors were right to ignore the slap in the face from South Korea. As emerging markets grow and saturated markets replace aircraft, the increased demand in Boeing's commercial segment should outweigh any potential decline in its defense side. In addition, Boeing has plenty of visible revenue in its backlog for rough times, and it continues to improve production rates. Management has also consistently rewarded shareholders with its cash pile, and that will continue. Boeing's stock price is testing all-time highs, but there's plenty of room and reason for it to fly higher.
Fool contributor Daniel Miller has no position in any stocks mentioned. The Motley Fool owns shares of Lockheed Martin. 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.