Brighter Skies for a New Boeing
If Boeing Co. can harness all of the potential in its commercial and military aircraft, space and missile businesses, it will emerge in the next five years as one of the world’s most powerful, profitable and impressive companies.
That’s far from the conventional description of Boeing today. Analysts and commentators have been highly critical of management after years of troubles in commercial aircraft, where mighty Boeing has been humbled by Airbus Industrie, the European consortium. The recent loss of an order for one fighter plane and government criticism of another, plus launch failures in Boeing’s Delta rocket program, have further damaged its reputation and stock price.
But views on Boeing are beginning to change, thanks to improved earnings at the Seattle-based company. Second-quarter net income reported last week totals $520 million, excluding a one-time gain from a tax settlement. That was a 55% rise
from operating earnings a year earlier, on a 13% increase in revenue, a clear indication that the company has brought its jetliner production back from the chaos of a few years ago. Boeing stock has recovered from a three-year low of $29.50 a share in October to $46 on Friday.
And Boeing management is aiming higher. On Thursday, Chairman Philip Condit and Chief Financial Officer Deborah Hopkins announced a new set of targets for cutting overhead, inventories and time to market, with the goal of more than doubling profit margins to better than 10% in the next three to five years.
To be sure, Boeing is not a quick or a guaranteed turnaround story. The world market for airplanes is in a severe downturn as recession-bound countries in Asia and Latin America cancel orders and airlines everywhere watch their pennies.
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Whereas Boeing had orders for 563 new planes last year, the number is likely to be closer to 400 this year, down almost 30%. Reflecting weaker orders particularly in Asia, Boeing expects its revenue to drop by $10 billion next year to $48 billion. The slack times are likely to continue until 2003, analysts say.
Even if Boeing can regain its footing, Airbus has ended the Seattle-based company’s total dominance of the commercial plane business. Airbus captured almost as many orders as Boeing last year. With the two in furious competition since 1995, Airbus has forced Boeing to cut prices heavily on many planes. The result is that neither plane maker sees good profits in planes now being delivered. Airbus, in fact, lost money last year, and Boeing made only a slim profit on commercial aircraft.
Yet so much else has changed for Boeing that focusing only on civil aircraft misses the point that this is a new company. Because of the 1997 acquisitions of Rockwell International and McDonnell Douglas, Boeing now is the largest producer of space systems and the second-largest military contractor in the U.S.
The military and space businesses have changed the nature of Boeing’s finances, accounting for more than 97% of the company’s pretax profit of $1.5 billion last year on only 36% of its total revenue of $56 billion. Those divisions, which do almost all their business with the U.S. government, may well be a financial mainstay for Boeing in the next few years as the commercial aircraft group works through difficult times.
But beyond revenue and earnings, the Rockwell and McDonnell additions have brought Boeing a new generation of management and new prospects. The real story at Boeing today, say analysts, no longer lies with Condit or his second in command, President Harry Stonecipher, the former chief executive of McDonnell Douglas. Rather, the company’s plans and hopes rest with the managers of its three main divisions:
* Jim Albaugh, 49, who holds degrees in math and physics as well as an MBA, heads the Space & Communications Group. This division, based in Seal Beach, is charged with providing revenue growth for Boeing.
* Michael Sears, 52, who holds electrical engineering and management degrees, heads the Military Aircraft & Missile Systems Group, based in St. Louis. This division provided most of Boeing’s profit last year, earning $1.3 billion on $12.9 billion in revenue.
* Alan Mulally, 54, the aeronautical engineer who headed the design team for the successful Boeing 777, is in charge of the Commercial Airplanes Group, the traditional heart of Boeing. This Seattle-based division, where Mulally took command last fall, eked out a $63-million profit on $36 billion in revenue in 1998, after having a loss of $1.8 billion for 1997. Mulally’s challenge is to cut Boeing’s production costs and restore its reputation with customers.
The segments provide Boeing with a hedge classic in the aerospace business: the improbability that all three businesses will hit a downdraft simultaneously. Already it appears that Boeing’s space and military businesses are poised to grow while commercial aircraft sales face several lean years.
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The Space & Communications Group, which invested $570 million of government and company funds in research and development last year--the most for any Boeing division--has many expanding programs.
The division looks for growth in satellite launches with a new version of McDonnell Douglas’ old Delta rocket, Delta IV, powered by a new engine from Rockwell’s Rocketdyne division, of which Albaugh was president before the Boeing merger.
Albaugh, however, has had his share of problems. Boeing is the prime contractor for the International Space Station, a project whose cost overruns are close to $1 billion, making it unlikely Boeing will profit much from the effort.
Two Delta III rockets failed in the last year, destroying one commercial satellite and leaving another in an unusable orbit. The failures blotted the Delta rocket’s reputation as a reliable workhorse and prompted a high-level inquiry within Boeing. The first failure was blamed on a computer control problem, and the second failure is believed to have been caused by a second-stage engine.
“In the engineering world, you rely a lot on models,” says Gale Schluter, general manager of expendable launch systems for Boeing. “We thought we understood it better than perhaps we did.”
Still, Albaugh is confident that Boeing can capture a big share of the rapidly growing commercial space business with two other key programs. The next-generation Delta IV, powered by an engine that has 95% fewer parts, will prove a breakthrough in “reliability and cost.” And Boeing has high hopes for Sea Launch, which will send off Ukrainian rockets from a floating launch pad in the Pacific Ocean. The joint-venture company, in which Boeing has a 40% stake, already has a backlog of 19 orders, with its first commercial payload scheduled for later this summer.
Albaugh’s division also encompasses Boeing’s prime contractor role in the national missile defense program, a descendant of the Reagan-era “Star Wars” missile defense, now to be aimed at protecting the U.S. from missile threats by rogue nations such as North Korea.
National Missile Defense is a $1.6-billion research program that could grow beyond $15 billion over the next decade if Congress decides next year to deploy the system, says Robert Paster, Boeing’s vice president for missile defense.
In the long range, Boeing hopes to provide airline passengers with broadband Internet access on flights by combining global positioning satellite technology from Rockwell with airborne warning and control know-how from Boeing, says Kenneth Medlin, vice president of information systems.
Such growing programs, Boeing expects, will double the space and communications group’s annual sales from today’s $7 billion within the next decade. Asked what benefit the consolidation of Rockwell with Boeing has brought to the business, Albaugh replies instantly: “Capital. Rockwell was a great company, but it wouldn’t have had the capital to make the investments necessary to design and build the new products for this aerospace market we’re in.”
Boeing’s military business also has both troubles and possibilities. It recently failed to win a key sale of F-15 fighter planes to Greece and was forced to write off millions of dollars in parts and tooling. The F-15 program, which originated in the late 1960s, appears to be in its final days, although it’s possible new government appropriations for the jet could keep it alive as the company seeks new orders from Israel and Saudi Arabia.
And Boeing’s new fighter, the F/A-18 Super Hornet for the Navy, has come under criticism from the General Accounting Office, the investigative arm of Congress, which recommends that the Navy postpone ordering the plane until critical performance problems have been resolved.
Louis Rodrigues, author of the GAO report, criticizes the Super Hornet, a new version of an existing carrier-based fighter, for having added little capability at great expense. He doubts that the new Hornet will find buyers overseas.
“There isn’t much that is long-legged in [Boeing’s fighter] program,” agrees Richard Aboulafia of the Teal Group, a defense consulting firm.
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But Sears disagrees with Aboulafia and also discounts the GAO criticism--as do some other longtime defense industry experts. Costs will come down as planes are produced and both the U.S. Navy and forces of other nations want the plane, Sears argues. “The Super Hornet provides terrific improvements that the Navy needs for the next 20 to 30 years of operations,” he says.
Sears is also confident of the company’s chances in the competition for the Joint Strike Fighter, which is being developed for use by the U.S. Air Force, Navy and Marines as well as by military forces around the world. “I really like our airplane. Even through the merger, we’ve worked together well to meet the requirements,” Sears says, referring to his old McDonnell company and Rockwell and Boeing.
Another source of growth is the services business, which Sears expects will soar to as much as $8 billion a year in the next five to 10 years from $3 billion last year, as Boeing takes on the job of maintaining and refurbishing more of the military’s air fleet. And Sears expects to see growth in exports of products such as the C-17 air freighter, the Apache helicopter and a kit that turns dumb bombs into guided missiles--all of which received positive coverage in the recent Kosovo conflict.
Meanwhile, in commercial airplanes, Mulally has reduced costs and raised efficiency.
“In 1998 we delivered 53% of the planes on time. In 1999, 100% of the planes will be delivered on time,” Mulally says. After working through serious production problems, the company is pumping out its next-generation 737s at an unprecedented rate of 24 a month.
Boeing’s plane production will earn 3.5% to 4.5% on the sales dollar this year, up from near zero last year, and rise 1 more percentage point next year. Planes now take 10 to 12 months to build, compared with last year’s rate of 15 to 18 months. “They are getting the production problems behind them; the next step is getting the efficiencies they are targeting,” says aerospace analyst Bill Whitlow of Safeco Asset Management in Seattle.
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Mulally’s ultimate aim is to achieve 7% profit margins in commercial aircraft, eliminating wasteful reworking and repair on the vast assembly lines of Boeing’s plants in Renton and Everett, Wash., and by consolidating parts production among 18,000 outside parts makers, down from 31,000 today. He also plans to reduce overtime and cut jobs, which could cause friction this summer as Boeing faces tough negotiations with its labor unions. Insiders say Boeing could save hundreds of millions of dollars by outsourcing parts.
Boeing is already achieving higher efficiency by standardizing plane configurations and eliminating costly options. That’s in line with a trend as airlines themselves form global alliances to standardize service and maintenance. “We’re moving to a world of, in effect, three airlines and two leasing companies,” says consultant John Harbison of Booz Allen Hamilton.
A world of airline alliances puts a premium on airplane manufacturers offering a family of planes to fit every category of passenger capacity and flying range. Boeing’s clearest lead is in the 200-to-300-passenger range, where its 757 and 767 planes dominate, says Dietmar Kirchner, head of purchasing for German airline Lufthansa.
Its newest plane, the long-range 777, which can go more than 8,000 miles without refueling and carry 300 to 400 passengers, reflects the view expressed repeatedly by Boeing’s Condit that the growth of air travel in the next decade will be in “point-to-point” flights--taking passengers nonstop from Chicago to Bangkok, for instance. Boeing scored a coup recently when Singapore Airlines opted to buy 777s and traded in Airbus 340 jets to Boeing in the bargain.
But analysts say the Boeing 717, a 100-seat plane that will begin delivery from the firm’s Long Beach plant starting in September, is a write-off waiting to happen. Lufthansa’s Kirchner calls it “a lonely crow” that is too heavy and its cockpit too different from other Boeing planes to be an attractive option.
And Boeing’s largest and most profitable plane, the 747, may be vulnerable. Airbus’ French, German and British partners are seriously considering a 550-passenger A-3XX, a new jumbo jet that would take more than $12 billion to develop. Boeing talks of boosting the range of the 747 by modifying its wings, but eventually the company has to make a hard decision about investing billions for a new jumbo to remain competitive.
But with profits recovering, and a strong balance sheet (more than $12 billion in shareholders equity and $6 billion of debt), Boeing can come back strong “if they can better manage their defense and commercial businesses,” says analyst Nicholas Heymann of Prudential Securities.
In Boeing’s favor are problems at its largest competitors. Airbus continues to stumble in becoming an independent company rather than a tax-exempt, partly state-supported entity, and the Clinton administration is promising to put new pressure on Europe to cut back on those subsidies. Similarly, Boeing’s competitors in defense markets also have their share of problems. Lockheed-Martin Corp., the largest defense contractor as the result of a 1996 merger, is under a Pentagon review to see how well the merged operations are working.
Boeing, in contrast, hopes to be a model for how three “heritage” companies can be knitted together to the benefit of the whole. The Phantom Works, an old McDonnell name, actually represents a new “central R&D; organization that has the ability to pull concepts from throughout the corporation,” says Sears.
A factory being built in Alabama for the Delta IV is benefiting from lean-manufacturing know-how in Boeing’s Seattle operations and tooling skills from McDonnell Douglas’ St. Louis operations. Rockwell’s space shuttle engineers are helping Boeing develop a new generation of reusable rockets.
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Boeing’s future could provide a landmark for U.S. business. It is now a company of 230,000 employees from three different corporations. Clearly the potential for division and bureaucratic obstruction is there. But so is the potential for great accomplishment if Boeing’s three parts work together. In that respect, the very fact that Albaugh from Rockwell and Sears from McDonnell Douglas are running two of Boeing’s three main groups is a healthy indicator.
It wasn’t intended to be that way when the mergers occurred. Instead, Mulally, a 30-year Boeing veteran, was appointed at first to head all the military and space operations. In 1997, Condit would visit installations of the former Rockwell and McDonnell companies proclaiming, “It’s Boeing time.” He no longer does that.
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Climbing Back
Boeing’s quarterly net income or loss, in millions:
2nd quarter 1999: $701 million*
*Includes a $181-million one-time gain.
Source: Bloomberg News
Flying Again
Boeing stock price, quarterly closes and latest:
Friday: $46.00
Source: Bloomberg News
