The secrets of Boeing's success.

The secrets of Boeing's success.

The secrets of Boeing's success.

Moneybox
Commentary about business and finance.
Aug. 4 2005 4:41 PM

Boeing Almighty

Why the aircraft manufacturer is taking off.

Friendly skies again for Boeing
Click image to expand.
Friendly skies again for Boeing

In recent years, Boeing, an iconic American firm, seemed as if it couldn't achieve liftoff. A series of unfortunate events in 2002 and 2003—the firing of CEO Phil Condit, the involvement of Chief Financial Officer Michael Sears in a Pentagon corruption case, and allegations of industrial espionage —led Douglas Gantenbein in December 2003 to dub Boeing"the current poster child of bad management." Last March, CEO Harry Stonecipher, who was brought in to clean up the mess, was forced to resign after being caught having an extra-marital affair with a Boeing executive. Meanwhile, Boeing's core commercial aircraft business has suffered horribly. Many of its biggest customers—U.S. network carriers—went bankrupt after Sept. 11. And in the years since, excess capacity (too many airlines and planes, too few passengers), intense competition from aircraft manufacturers like Airbus and Brazil's up-and-coming Embraer, and high fuel costs have hindered recovery. Plane deliveries plummeted from 620 in 1999 to 281 in 2003.

But Boeing's stock has more than doubled since the middle of 2003 and is approaching its 2000 peak. Here's a one-year chart of Boeing against the S&P 500. Why has Boeing achieved liftoff? Sure, the company has hired a smart new CEO, James McNerney, the Jack Welch protégé who did an excellent job at 3M. But personnel moves alone don't explain the dramatic recovery. Perhaps because there's so much focus on the continuing travails of U.S.-based airlines, many have overlooked the source of Boeing's recent strength—globalization and low-cost carriers.

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Boeing's second-quarter earnings, released on July 27, showed that the defense unit, which accounts for about half of revenues, did well. But the commercial-aircraft division, which delivered 85 planes in the quarter, notched a blockbuster quarter the likes of which haven't been seen since the 1990s. Revenues rose 20 percent from the year before, and profits spiked 24 percent. More gratifying, Boeing netted firm orders for 376 planes. By contrast, in the first quarter of 2005, it delivered 70 planes and tallied only 63 new orders. Thanks to the strong demand, Boeing said it expects deliveries to rise from 320 in 2005 to 395 in 2006 and raised its earnings projection for this year and next.

Boeing has filled orders from well-known airlines; in the first quarter, orders came in from Air France, and in June, Alaska Airlines ordered 35 737-800 planes worth $2.3 billion. Virgin Blue, Richard Branson's Australia-based low-cost carrier, has ordered 50 planes in the past five years. But like many U.S. multinationals, Boeing finds it difficult to rely solely on these kinds of longstanding customers in the saturated, slow-growing market. So, it has found loads of eager customers in unexpected places. In the first quarter, orders came in from airlines most stock analysts have never heard of, let alone flown: Indian low-cost carrier SpiceJet, Brazilian discounter GOL Airlines, and England's First Choice Airways. Some established airlines in developed economies, like Air Canada, may be canceling orders, but discounters in established markets are bulking up. In April, WestJet, a Canadian low-cost airline, received its first 737-800, and it will take delivery of eight planes this year and at least three next year.

The flagship carriers in countries generally regarded as economic basket cases are becoming important customers. In the second quarter, Boeing announced deals or transactions with Ethiopian Airlines, Vietnam Airlines, and Lion Air, the first discount airline in Indonesia, which struck a preliminary deal for up to 60 planes.

The momentum is clearly continuing in the third quarter. After the Paris Air Show in July, Boeing trumpeted deals with Spanish airline Air Europa (for 18 737-800s) with Central European discount airline SkyEurope Airlines, Air Algerie, and Air Angola, which is buying six planes. Then, of course, there's China. In July Boeing agreed to supply freight planes to China Cargo Airlines, and Shenzhen Airlines is taking delivery of five 737-900 planes this year. This week it confirmed an order worth more than $1 billion from Chile's LAN airlines.

This may be just the beginning. Thanks to expanding trade and an ever-expanding global tourism market, the volume of goods and people moving from point to point around the globe is rising. And as millions of people climb out of poverty each year, domestic travel and cargo markets are likely to rise in places like China and India as well. Boeing's 2005 Commercial Market Outlook notes that over the next two decades, the Asia-Pacific region will account for about 36 percent of total deliveries. Rising demand concentrated in the East isn't necessarily good news for U.S.-based manufacturers. But it is for Boeing. Unlike, say, cars, jets are sufficiently complicated to design and assemble that it will be difficult for Chinese manufacturers to emerge as competitors anytime soon. Planes are also one of the few sectors in which customers recoil from buying cheap-o versions.

And unlike McDonald's, Starbucks, or Coca-Cola, whose growth in emerging markets depends largely on the artificial stimulation of demand, a good deal of the growth in airlines is driven by simple demographics. In heavily populated countries where incomes are rising and regulation is falling, there's a clear demand for air transportation services. Anita Jain reported in the Financial Times last week that India has "10 discount airlines planning to enter the market over the next 18 months." Discount airlines are beginning to appear in Mexico, too. Of course, some of these airlines are likely to fail. And Airbus will take its fair share of orders. But if Boeing continues on its current course, it could single-handedly put a dent in the trade deficit.