One of the most common bear arguments against Boeing (BA 1.51%) involves looming government defense budget cuts and their impact on the aerospace giant's top and bottom lines. It's a valid point, to be sure; Boeing's defense segment will likely suffer to some degree as budget deficits force the government to slash defense spending as much as $1 trillion in the next nine years. That's no small chunk of change. Investors don't seem worried as Boeing's stock price continues to rise, but should they be?
While Boeing's commercial aircraft typically dominate the media headlines, its defense, space and security segment brings in roughly 38% of the company's revenue. That's down from delivering 50% of revenue in 2010, and the figure will continue to drop as military spending does the same. Analysts at Morningstar expect the segment to represent 32% of Boeing's revenue in 2015; that's a pretty drastic decline in just five years.
While the decline in its defense segment isn't ideal, Boeing does have a couple of factors that will help the company fly through the turbulence. Because of its successful commercial aircraft business, Boeing has a much more diverse and stable companywide revenue stream.
Graph by Author. Information from Boeing's Q2 Earnings Report.
Anticipated government cuts on defense spending will hurt Boeing far less than Lockheed Martin (NYSE: LMT) and other competitors that rely on defense contracts for nearly all of their revenue. Lockheed has been able to use its brand and competitive advantages to actually increase its operating margin by 140 basis points to 11.4% in the second quarter; even while posting a 4% decline in sales. However, as time drags on, the armed forces may opt to purchase fourth-generation fighter aircraft in place of Lockheed's F-35 -- increasing the downward pressure on its operating margins.
While Boeing will feel the same margin pressure on its defense, space and security business, it will be able to ramp up production in the commercial side to maintain companywide operating margins. Consider that over the next year, Boeing plans to increase production of its 737 and 777 aircraft from 38 and seven planes a month to 42 and eight, respectively.
Even more important is the 787 Dreamliner, which has struggled to deliver profits due to budget overruns and production delays. At the end of 2011, Boeing was producing just two 787s per month; that's expected to quintuple to 10 per month by the end of 2013. Those production improvements will go a long way to help offset the margin pressure in its defense, space and security business, something most competitors aren't able to imitate.
Another huge factor aiding Boeing through defense spending reductions is its massive backlog of orders. Its diverse business segments enable the company to grow its backlog faster and larger than competitors who rely solely on defense contracts. Consider that Lockheed's entire backlog of orders is expected to reach $80 billion this year; that compares favorably to the Boeing defense, space and security backlog, which now has a value of $51.5 billion. However, when you add in Boeing's backlog of commercial orders, its value balloons to $410 billion -- a huge advantage, representing roughly four and a half years' worth of revenue.
The ultimate impact of sequestration and defense cuts remains largely unknown, and that uncertainty is nothing new in the aviation industry. That said, Boeing's business diversification, backlog of orders, and projected growth in its commercial aircraft demand should be enough for the company to offset lost revenue from defense cuts and allow its stock to continue flying higher.
