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Boeing Co. (BA
), the nation's top exporter in total revenue, has passed many heart-thumping, bet-the-company tests in its white-knuckled history. But rebounding after the Sept. 11 terrorist hijackings may prove to be the biggest challenge of all. The attacks have brought the airline industry to its knees, triggering billions in losses and nearly 70,000 layoffs industrywide so far.
A hard economic landing was not in the script. Boeing's Commercial Airplane division had
engineered a remarkable turnaround in the three years since its production system stumbled
badly in late 1997, forcing the stoppage of two aircraft assembly lines. With renewed focus on cost-cutting and lean-manufacturing initiatives, operating margins began to rise, and Boeing's stock climbed to $70.93 a share.
Now, though, the bleak outlook has forced Boeing executives to slash up to 30,000 jobs and cut commercial jet deliveries by nearly 40% over the next two years (see BW Online, 9/19/01, "Why Downsizing Is Boeing's Only Choice"). Shares of the Chicago-based aerospace giant, which receives nearly 60% of its $51 billion in annual revenues from the commercial airplane business, have tumbled to six-year lows, closing Friday, Sept. 21., at about $30 a share, before bouncing back up on Monday, Sept. 24, to $33.
A turnaround at Boeing's airplane division is now in jeopardy
REALITY CHECK. Certainly, Boeing executives had already been anticipating a downturn, planning to pare the Seattle-based airplane division's staff of 96,000 and shrink factories while still trying to keep margins at 10%. But no one anticipated that terrorists would use passenger jets as weapons. "Never in our wildest dreams did we believe that we'd be in this kind of situation," says Boeing Commercial Airplane President and CEO Alan Mulally. "This is absolutely gut-wrenching.... We need to deal with reality, and we need to do it quickly. And we need to do the right thing for the long term so we can keep opportunity going for everybody."
Wall Street analysts are finding it difficult to predict when all the bad news for Boeing will end. "It's really hard to say we've hit bottom," says Sam Pearlstein, analyst for First Union Securities. "There are a lot of things that aren't clear yet." That suggests short-term investors may want to wait until a clear picture of the airline industry's recovery emerges, since Boeing's financial health is linked to that of the airlines.
For long-term investors, Boeing's beaten-down price could be a good deal. First, the company's push to diversify into defense and space businesses is absorbing some of the financial downdraft from its commercial airplane business. And the expected boost in defense spending could further soften the blow, if Boeing wins additional military contracts. "I think the big difference between now and then is that they do have a bigger defense and space business," says Byron Callan, analyst for Merrill Lynch. The military and space segments now account for 40% of the company's revenues, up from less than 15% before the 1997 mergers with McDonnell-Douglas and Rockwell Aerospace.
LOTS OF CASH. Second, the company's low price-to-earnings ratio of 8 suggests that its stock price has fallen disproportionately to its profits, which in 2000 were $2.1 billion. Boeing is still generating gobs of cash. Its operating cash flow -- net earnings minus preferred dividends plus depreciation -- was $4.9 billion last year. That's arguably one of the best measures of a business' profits. For the first half of this year, Boeing churned out $906 million in free cash even after making a $900 million tax payment. Earlier guidance indicated that the company would produce upward of $4 billion in free cash for this year, but that may now change because of the airline crisis.
Also in Boeing's favor: It's not embarking on a major airplane development program, which
normally drains the company's operating profits. Throughout its history as a commercial
airplane builder, Boeing began developing new planes just as its sales for existing aircraft started falling. The 747, 757/767, and 777 development programs all consumed billions of dollars, pushing operating profits into low single-digit numbers. Boeing's proposed high-speed plane, dubbed the Sonic Cruiser, won't begin to demand significant research and development funds for several years.
That's if Boeing decides to launch the program, which is no sure bet. During the next two to three years, the company may be able to preserve some of its cash flow and perhaps even keep its operating margins up during the worst of the downturn.
SHRINKING ASSETS? That's certainly Boeing's strategy. Mulally took the first step when he announced massive layoffs. That was done in an effort to preserve hard-won profit-margin improvements. "They've done quite a lot," says Chris Mecray, a Deutsche Banc Alex. Brown analyst. "They've leaned down, improved their accounting visibility, and cut costs."
Investors should watch for signals that Boeing will shrink its fixed assets. The company has plans to reduce office and factory space -- even closing its final-assembly plant in Renton, Wash., and moving the operation to the larger, more modern plant in Everett, Wash., where all final production would be consolidated. Potential savings could be enormous, say Boeing executives involved in the planning.
At the same time, Boeing's future depends on the airline industry's health. The company's production is based on growth in passenger traffic of about 5% annually, but the terrorist attacks may fundamentally restructure, even shrink the demand for new aircraft. Now, U.S. airlines have cut 20% of their pre-Sept. 11 capacity, and foreign fleets are following. Passenger jets are flying about 30% full and must fly at 70% to break even.
"BODY BLOW." Several carriers, including Continental Airlines and U.S. Airways, are staring at bankruptcy. And it could be some time before planes are flying full again. During the Persian Gulf War, merely the threat of terrorist action sent passengers fleeing from airlines. It took 15 months for them to fill up planes again. Now, terrorists have not only shattered consumer confidence but they've exposed serious security flaws at our nation's airports.
"This is a kind of body blow to everybody," says Merrill Lynch's Callan. "Last time, the concern was international travel. This time, everybody has been hit by it, creating a profound cash-flow problem." The lack of liquidity squeezing airline balance sheets is now rocketing toward Boeing, which gets most of its money when it delivers a new airplane to its owner. The $15 billion U.S. government bailout of the airline industry should inject some cash into the system, but that doesn't guarantee the return of passengers.
The hope, of course, is that travel eventually will rebound, as it did after the Gulf War. But what happens to Boeing if that 20% reduction in fleets is permanent? What happens if annual passenger growth falls to only 3%? For Boeing, that means fewer airplanes as well as decreases in revenue, staff, and possibly profits.
And that might not be all. Mulally, in a speech to Seattle business leaders on Sept. 20, says Boeing could shed even more jobs if America's airlines continue to bleed. "It could get worse," Mulally says. "We're assuming that the airlines will stay financially viable. I think we have a bigger issue if we can't keep our airlines and our transportation system going."
TOO MANY PLANES. The suicide attacks aren't solely to blame. Prior to the assaults on the World Trade Center and the Pentagon, Boeing and rival Airbus Industrie were scheduled to supply 900 aircraft in 2002 -- about 200 more than the industry really needed. That's because the economy already was beginning to weaken, and airline capacity was dropping, reducing the demand for new aircraft, says John Walsh, president of consultancy Walsh Aviation. Lucrative business traffic was falling, and airlines started reporting record losses for the year.
Now, airlines are lining up to push back delivery of their airplanes, even telling Boeing they can't take some planes that were scheduled for this year. "Airlines apparently want to stop deliveries right now," Walsh says. "I see it being a very difficult period."
Even profitable carriers such as Southwest Airlines, the nation's seventh-largest, are
considering halting delivery of new Boeing aircraft. More worrisome, Boeing has to secure about 180 airplane orders in the next 18 months to ensure that it will deliver 300 airplanes in 2003. In today's pessimistic environment, winning 180 new airplane orders looks tough. If aircraft deliveries fall below 300, Boeing could start losing money.
It's probably going to get worse for Boeing's largest division before it gets better.
The terrorist attacks spurred questions and created scenarios that Boeing's leaders can't resolve at this time. About the only thing certain is that the world's largest supplier of commercial jets will end up a much smaller aircraft company. Investors have to decide if that means Boeing will emerge from the downturn quite lean, fit, and profitable.
Holmes covers the aerospace industry for BusinessWeek in Seattle Edited by Beth Belton
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Copyright 2001 , by The McGraw-Hill Companies Inc. All rights reserved.
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