The Boeing Company (NYSE:BA) gave a mixed set of earnings recently. Its results perfectly highlighted how its internal operations are adjusting to changes in end demand. Simply put, for a variety of reasons, the defense market looks set to go through a sustained period of historically weak demand, while the commercial aerospace sector is seeing a stronger than usual cyclical recovery. Naturally, Boeing isn't alone in having to adjust, as companies like Honeywell International (NYSE:HON) share the same industry dynamics. With that said, how is Boeing's business changing? In addition, how should Fools measure the company's progress?
Commercial aerospace good, defense bad
It's no secret that defense spending is being pressured by public spending constraints, and particularly with large-scale military hardware. Indeed, Honeywell International -- a company whose largest profit center is aerospace -- saw its overall aerospace sales decline by 2% in its most recent quarter. However, if you exclude the 8% drop in defense and space revenue, the aerospace segment would have seen a 3% rise. It's a similar story with an aviation services company like AAR Corp, which saw its defense based revenue being challenged recently.
Furthermore, a quick look at how Boeing's segmental revenue has evolved over the last five years demonstrates the underlying dynamics very well. Defense based spending is flat, but commercial aerospace has enjoyed a cyclical recovery.
Moreover, the commercial aerospace industry backdrop is positive with the latest International Air Transport Association, or IATA, forecast for airline profitability demonstrating an ongoing cyclical recovery. In particular, North American airlines are increasing profitability strongly -- good news for Boeing.
What to look out for with Boeing
Major changes in end markets always necessitate adjustments, and Fools need to ask the follow questions every time Boeing gives earnings:
- Is its commercial order book growing, and indicating an ongoing recovery, in the face of fears over emerging market weakness?
- Is Boeing able to ramp up production of its 787 Dreamliner and its single aisle 737 planes?
- Can Boeing increase its operating margins, or is it coming under cost pressures due to the ramp in commercial airplane production, and the increasingly complex nature of modern planes?
Putting these points in the context of its recent first quarter results suggests a mixed performance from Boeing.
First, its commercial backlog now stands at $374 billion compared to a commercial backlog of $322 billion for the first quarter of 2013. This quarter's figure represents around seven years of production (just divide the backlog by the last revenue figure in the first chart above). On the other hand, it's flat compared to the $373 billion figure in December 2013. It's not a major issue -- airplane orders are always lumpy -- but something to look out for in future.
Second, Boeing has had some highly publicized production bottlenecks caused by some issues with the mid-fuselage section of the 787, and having to check for hairline cracks on 787 wings that are in production. These issues threatened its plan to ramp-up production on the 787 program to 10 deliveries a month. Furthermore, to the end of March, Boeing had only delivered 115 (averaging around 38 a month) of its 737 planes, when the plan was to ramp-up production to 42.
Fast-forward to the latest results, and the good news is that Boeing hit its production target of 10 a month for the 787 in March, and on the recent conference call, its management confirmed its target for 110 delivered in 2014. As for the 737 program, Boeing's management said: "In April, we also delivered the first next generation 737 produced at the increased rate of 42 per month. And we're on-track to further increase 737 production to 47 per month in 2017."
There was more good news on the margin front, with Boeing's commercial airplane operating margin increasing to 11.8% from 11.4% last year. While, its defense, space, and security operating margin declined 10 basis points to 10.2%. In fact, commercial airplane operational earnings increased by $283 million, helping to offset a $54 million decline in the defense, space, and security segment. Overall, core operating margins increased to 10.2% from 9.9% last year -- a good result.
The bottom line
Honeywell International is forecasting a 1% increase in its overall aerospace segment, but that is largely to do with its large military exposure. Meanwhile, Boeing did well in expanding its commercial operating margin in the first quarter. On the other hand, its commercial operating margin is forecast to be around 10% in 2014, implying a figure not far from the 10.9% recorded in 2013.
Overall, it was a decent report from Boeing, its plans to ramp up production of its 787 and 737 programs remain in place, and there hasn't been any significant effect on margins yet. For the moment, Fools should focus on its commercial order book and the macro-environment in general, because despite some hiccups, Boeing is dealing with its commercial production ramp-up quite well.