Wednesday, November 18, 2009

Boeing's Latest Dreamliner Glitch: The Risk of New Aircraft Development

Friday's Wall Street Journal carried an article detailing the last derailment of Boeing's 787 Dreamliner.

From the end of the article, we learn,

"Boeing executives are under intense pressure to get the Dreamliner aloft. The plane is now more than two years behind schedule, and Boeing last quarter took a $2.5 billion charge related to development costs associated with the program. These delays have cost the company hundreds of millions of dollars in concessions and penalties to its customers, though the company still has orders for 840 Dreamliners."

Looking at the company's equity price for the past five years, compared to the S&P500 Index, it's easy to see that, by only matching the index, Boeing's equity has not delivered returns which compensate for its risk.

Since we know from the Journal piece that the Dreamliner is two years overdue, this price chart illustrates how investors began to punish Boeing's equity around the time that this delay became apparent, i.e., mid-2007. Since that time, the company's equity price has fallen in absolute terms, as well as relative to the index.

While this most recent article discussing the plane's problem with metal bolts inside the composite wing structure causing delamination was the impetus for this post, my broader question, spurred by the article, is how Boeing could have better-prepared for such a huge technological leap in designing and producing the Dreamliner.

The second price chart tracks Boeing's equity price, compared to the S&P500, since 1962. This spans the eras of the vaunted 707 and, later in the 1960s, the 747.

Boeing bet the company both times, successfully. First, it moved from propeller-driven aircraft to jet propulsion, then from narrow-body to the gigantic wide-bodied 747.

It seems that the company's equity price soared, both in absolute and relative (to the index) terms, as the 707 proved itself by the late '60s. Then investors withdrew until the 747's impact became significant after the stagflation of the early 1970s. For two decades, in which Boeing designed and produced new planes without substantial technological breakthroughs or risks, its equity price soared ahead of the S&P.

Even with the recent battering of the stock's price, Boeing's equity performance isn't yet too far below its two-decade trend.

Never the less, one gets the impression that Boeing just isn't a good investment during periods of introduction of significant new technology. Its total return performance is clearly inconsistent at these times, and there doesn't seem to be any realistic way for the company to mitigate this.

Between the nature of the firm's customers and their frequent struggles with profitability, those customers' tendency to play the firm off against Airbus, and the connection of its well-being with long duration economic cycles, even in good times, Boeing doesn't exhibit the sort of explosive outperformance one would seek in a growth equity.

It goes to show why, though we may respect and favor the products a company, like Boeing, produces, it's not always possible to find compelling reasons to expect consistently superior total return performance from the firm's equity.

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