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Boeing Straightens Up And Flies Right


There's something in the air at Boeing Co. (BA) The company's stock has jumped nearly 50% in the past year. It is posting record earnings and aircraft sales. Operating profit margins in its commercial airline unit are expected to climb into double digits and remain there for several years -- a first. Booms and busts at the notoriously cyclical company are smoothing out, and CEO W. James McNerney vows to remain disciplined in ramping up production to meet strong demand for commercial aircraft in the years to come. Meanwhile, the company's defense business remains strong.

The changes have been so striking that some analysts have begun tossing around a proposition that would have seemed unthinkable a few years ago: that Boeing is shedding its cyclical skin and turning into a true growth company. The stock chart supports that argument. Boeing smashed through its normal trading range of 30 to 60 last May and hasn't looked back, closing on Apr. 25 at 85. Morgan Stanley (MS) analyst Heidi Wood suggests that Boeing shares could reach 140 in three years.

Wood and others say the case for valuing the Chicago aerospace giant as a growth stock, with a higher price-earnings ratio than in the past, has never been stronger. Boeing's earnings have been much more reliable in recent years. Thanks to cost cuts, the commercial airline unit, which accounts for about 48% of total revenues, has posted operating profits throughout the U.S. airline slump that began in 2001. Boeing generated $5.5 billion in free cash flow last year, up from $2.3 billion in 2004. And on Apr. 26 it posted better-than-expected first-quarter profit growth of 29% on a 48% surge in commercial airline revenues. There's no sign of trouble on the horizon, say the bulls.

Of course, the airline industry is one of the most volatile around. Any number of things could jeopardize Boeing's steady growth -- chief among them higher oil prices, rising geopolitical tensions, and a declining global economy. What's more, Boeing still needs to demonstrate that it can ramp up production of the new 787 Dreamliner without big cost overruns and schedule setbacks. The plane enters service in 2008 and is in high demand.

OFF THE ROLLER COASTER

But the likely scenario for Boeing, say analysts, is an extended commercial plane boom that ends merely in a softened downturn. That in itself suggests a dramatic change from the past two roller-coaster cycles.

What's driving the transformation? It starts with surprisingly steady aircraft demand in recent years. The airline industry is cleaving into discernible groups. Major U.S. carriers such as American (AMR), United (UAUA), and Delta (DALRQ), along with big European airlines such as British Airways (BAB), traditionally spark recoveries rather than follow them. But they haven't yet emerged from their slumps, haven't been buyers, and likely won't be for a while. At the same time, though, business is booming for big carriers in Asia and the Middle East, which are ordering planes in large numbers. Also buying: low-cost carriers such as Southwest (LUV), JetBlue Airways (JBLU), and Ryanair (RYAAY), as well as thriving startups in Asia.

As momentum slows for low-cost and Asian carriers, the big Western carriers will likely come back onstream. That promises to keep Boeing's orders relatively smooth. If American Airlines, for example, begins to place orders next year, Boeing might not deliver until 2010. By then, it could absorb a slowdown in Asian demand relatively easily.

Another key to Boeing's success: a better sales mix. The company is winning the majority of widebody airplane orders, which generate much higher profit margins than do smaller, narrowbody jets. In 2005 it booked 438 widebody orders, vs. just 166 for chief rival Airbus. Those sales are boosting Boeing's profit margins to new heights. Commercial airplane operating margins have averaged just 4.5% over the past 25 years and have never exceeded 10.3% for a full year during that period. Boeing is forecasting commercial airplane margins of over 10% next year and possibly 12% after 2008.

Another success driver: Boeing's newfound discipline on the factory floor. It has come a long way from the troubles it faced in 1997, when production problems shut down two assembly lines and cost the company $2.5 billion. Now the company says it will ramp up steadily. "If they do this right, they are golden for a long time," says Richard Aboulafia, an analyst at consultant Teal Group Corp.

The new strategy shows Boeing's desire to focus on profitability more than market share. In the past the company would double or triple its production rate when orders picked up to grab share. But high labor and operating expenses killed profit margins. Now, Boeing is raising production rates without rehiring more of the 30,000 people it has laid off since 2001. Airplane deliveries, not orders, account for the majority of revenue and profit. A cool head at this stage could extend the good times longer than in previous cycles. "Production is going up, but they aren't blowing the lid off," says Edmund Greenslet, editor of Airline Monitor. "It's going up by an amount that leads one to think they can sustain those rates longer." Steady as she goes.

By Stanley Holmes


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