Replies to post #2523 on The Rising Influence of Rising Affluence

[DewDiligence]

BA—The big question though is military. At some point the absurd US spending on this needs to be cut.

That’s why BA’s executives (like those of other defense companies) are talking up the prospects for international military sales. From the Barron’s article:

Only 17% of military sales came from international customers, but W. James McNerney Jr., the company's CEO, sees that rising to 25% in the next few years.

There are two possible interpretations: a) international military sales will grow sharply; or b) international sales will grow modestly (or not at all), but the international % of military sales will go up because US military sales will decline. I’m pretty sure McNerney meant a), but b) might be closer to what actually happens.

[oldberkeley]

The big question though is military. At some point the absurd US spending on this needs to be cut.

I've vaguely noticed just a slight relationship between military spending and unnecessary, multi-trillion dollar Wars of Choice, but I could be imagining things.

Perhaps the Department of Defense could hire some private consultants and do a study on this.

[DewDiligence]

Barron’s Likes Hexcel

[HXL is an indirect aerospace play, flying in the coattails of Boeing and EADS as those companies build more and more planes to satisfy The Global Demographic Tailwind (#msg-62155190). Although rather expensive in terms of its 2011 P/E of 20x, HXL’s enterprise value of about $2B gives it considerable buyout vig, IMO. Does anyone here follow this name?]

http://online.barrons.com/article/SB50001424053111904210704576357543980572176.html

›Enjoying a Strong Tail Wind

SATURDAY, JUNE 4, 2011
By NEIL A. MARTIN

Before Neil Armstrong even stepped on the moon on July 20, 1969, executives and engineers at composite-materials maker Hexcel had breathed a big sigh of relief. The San Francisco company made the footpads for the Apollo lunar-landing module, so its arrival had provided the most anxiety. No one was "absolutely sure what kind of surface the craft would be settling down on—hard, soft, sandy or soluble," confides an insider. There was "obviously great relief when everything proved stable."

"We like to say that Hexcel was the first to the moon," jokes CEO David E. Berges.

Founded in 1946 by a couple of Berkeley-educated engineers working out of their basements, Hexcel (ticker: HXL) has evolved from its modest start on through the early space age to become the country's leading provider of carbon fibers, reinforcements and honeycombed composite materials. (Honeycomb refers to a unique structure similar to a beehive.) It's probably best known for the light, innovative skis it made under its own brand in the 1970s. Although it gave up selling Hexcel-branded skis, the company's composites today show up in a wide array of products ranging from commercial aircraft and helicopters to wind-turbine fans and from satellites and spacecraft components to bicycles and snow boards.

After revenue growth averaging about 4.2% in the five years through 2010, Hexcel's ascension rate has begun to rise. Despite their recent, well-publicized stumbles, big clients like Boeing and EADS, which account for more than half of Hexcel's roughly $1.2 billion in sales, are expected to lift spending as their new jumbo planes gradually take hold. At the same time, surging demand from established and emerging-markets countries for new planes should bolster sales of the light, flexible, ultra-strong materials that Hexcel is known for. The company also has healthy growth prospects supplying advanced materials that go into "green" energy suppliers like wind turbines.

"Current build rates and new programs could result in solid double-digit [revenue] growth for years to come in commercial aerospace markets large and small," says Berges.

Berges, 61, and Hexcel have already provided investors with some good news. Near the end of April, when we met with him at what's now the company's Stamford, Conn., headquarters, Berges had just announced a 67% jump in first-quarter profit and higher sales across its aerospace, defense, industrial and wind-energy markets. He'd also lifted Hexcel's full-year earnings target. The stock reflects much of this improvement, rising to 20 last week from 14.89 a year ago.

But bulls believe Hexcel has further to go. Deutsche Bank aerospace analyst Amit Mehrotra in Boston rates Hexcel a Buy with a 12-month, $27 price target, which would be 25.7 times his 2011 earnings-per-share estimate of $1.05, rising to $1.33 in 2012. The company projects 95 cents to $1.05 a share for this year on sales of $1.275 billion to $1.35 billion, up from 78 cents a share on sales of $1.17 billion in 2010. Hexcel, says Mehrotra, is "poised for significant growth" as a result of the aviation industry's continuing shift to composites to replace metals and rising production rates around the world. About 55% of its sales come from abroad, with Europe [i.e. EADS] kicking in 41%; the U.S. accounts for the 45% remainder.

Hexcel is in a sweet spot not just because airplane orders are going up. Its materials are also gaining favor. They're light and durable, saving on energy and replacement costs. Mehrotra predicts that 44% of large aircraft produced in 2017, in dollar terms, will be "high Hexcel content," versus 14% in 2011. "The new programs like the Boeing 787, the Airbus A380 and Airbus A350 have between 25% and 50% composite content by weight, compared with zero-to-15% for older models," he says. That "should support 15%-20% annual sales growth [and 25% to 30% earnings growth] in Hexcel's commercial aerospace businesses through at least 2014."

Also pushing growth: Hexcel is a leading supplier of blades for wind-turbine engines.

There is caution about the stock on Wall Street, given its recent rise. Michael Sison, with KeyBanc Capital Markets in Cleveland, cites the lack of "meaningful" near-term catalysts like big new orders to drive margins—and the stock—higher. "While we believe there is potential for multiple expansion," he writes in a recent report, "near-term uncertainty for demand in global wind markets, as well as the status of defense spending and noise surrounding the 787 delivery and production schedules, prevents us from becoming positive at this time."

Shareholder Nick Galluccio, who runs Teton Advisors and the Gamco Westwood Small Cap Equity Fund, is a longer-term bull: "Hexcel will benefit over the next five years from the aging of the world's commercial aircraft fleet and the need to replace those planes with more modern, fuel-efficient aircraft. The Hexcel story has legs," he says.

Even more promising: The world's air fleet is aging fastest outside the U.S. "If you look at Boeing's or Airbus' backlogs, you'll see that maybe less than 25% represents U.S. carriers," says Berges. "It is a small portion compared with times in the past. In fact, since the 2001 difficulties, the vast majority of the orders have been the Mideast and Europe, Brazil, China. Our growth has not been U.S.-driven." Given the state of the U.S. space program, that's a good thing.‹

[DewDiligence]

Fueling the Next Aircraft Boom

[See #msg-62155190 for related story.]

http://online.wsj.com/article/SB10001424052702304474804576369682130633072.html

›JUNE 7, 2011
By LIAM DENNING

Old airplanes aren't necessarily unsafe; after all, how else do they get to be old? But they do guzzle oil. The world's airlines are expected to make a profit of $4 billion this year, down 78% from last year, according to the International Air Transport Association's latest estimate, released Monday. High fuel prices are the major culprit, set to account for 30% of operating costs this year, the highest since 33% in 2008. The figure 10 years ago was 13%.

Airline stocks sold off on the news, as you might expect. But like makers of small cars when gasoline is at $4 a gallon, aircraft manufacturers and suppliers should benefit.

An important difference between today and 2008 is that, despite oil's strength, airlines should still be profitable this year. In the U.S., cost cutting has made room to absorb higher fuel prices. Labor accounted for 35.4% of the U.S. airline industry's operating costs in 2001, but just 25.3% in 2009, according to the U.S.'s Air Transport Association. Slashing routes has also kept planes full and ticket prices high.

Squeezing labor, raising ticket prices, and cutting routes have finite utility, though. Workers and passengers revolt eventually: Price-sensitive demand for economy-class seats has fallen 3.5% over the past five months, says IATA. Cutting routes, meanwhile, means remaining ones have to absorb more overhead.

Replacing planes with more fuel-efficient models is, therefore, one of the few levers left to airline management for preserving profits. An Airbus A320, for example, saves more than a quarter on fuel costs compared with the older McDonnell Douglas MD-80. Boeing's delayed 787 Dreamliner and Airbus's A320 Neo are just two examples of new models designed to cut oil consumption.

At the same time, airlines, particularly in the U.S., have been scrimping on investment in new planes in recent years to preserve cash: Capital expenditure by the world's 50 largest airlines was just 8% of revenue last year, the lowest in at least a decade, according to Nomura. The stage is set for a wave of replacements of older planes in developed markets, to complement the continuing growth of aircraft fleets in developing markets.

Single-aisle aircraft, workhorses for regional routes and trans-Atlantic flights, represent a big opportunity. J.P. Morgan Cazenove identifies models like the MD-80 and sister model MD-90, Boeing 757s and older-generation Boeing 737s as being particularly disadvantaged in terms of fuel efficiency. Altogether, there are almost 4,500 of these aircraft in service globally.

As airlines replace their fleets, the obvious beneficiaries are Boeing and EADS, which owns Airbus. Investors should also consider suppliers to the two big manufacturers, such as Goodrich Corp.

More discretion is required when it comes to aircraft-engine manufacturers such as France's Safran. While they benefit from new engine orders, they also lose high-margin post-sale service revenue when older aircraft are scrapped. Even so, airlines' persistent pain at the pump should boost aircraft suppliers' profits for years to come.‹

[DewDiligence]

Boeing Aims to Capture $1T of Orders With 737 MAX

[That’s “T” for trillion. BA expects demand for the new 737 with a more fuel-efficient engine (737 MAX) to reach about 12,000 planes during the next 20 years! BA’s own PR is at http://finance.yahoo.com/news/Boeing-Launches-737-New-prnews-1720776968.html?x=0&.v=1 . See #msg-64389033 and #msg-63958871 for related info.]

http://www.bloomberg.com/news/2011-08-30/boeing-approves-upgrading-737-after-496-order-commitments-1-.html

›By Susanna Ray - Aug 30, 2011 5:02 PM ET

Boeing Co. (BA) aims to capture half of a $2 trillion market in the next 20 years with the 737 MAX, a new version of the world’s most widely flown jetliner that will be powered by more fuel-efficient engines.

“This is an airplane that’s going to allow us not to just maintain the market share we have, but one that will allow us to grow the market share,” Boeing Commercial Airplanes President Jim Albaugh said at a news conference in Renton, Washington, near the factory where the 737s are built.

Boeing’s board approved development yesterday of the upgraded 737 after winning 496 order commitments from five airlines, the Chicago-based planemaker said today in a statement. Deliveries are slated for 2017, two years later than the A320neo from Airbus SAS.

The order commitments are “a very positive indicator of demand for what has been viewed as a ‘me too’ offering by Boeing,” Robert Spingarn, a New York-based analyst with Credit Suisse, said in a note to clients. They “may signify Boeing’s ability to take some share from Airbus.”

The MAX will use modified Leap-1B engines from CFM International [CFM is a JV of GE and France’s Safran] and offer 7 percent lower operating costs than rivals. Boeing’s 20-year forecast calls for 23,000 narrow-body jets to be sold by planemakers around the world, at a value of almost $2 trillion. [BA hopes to get orders for approximately half of this market.]

The 737 upgrade made up half of the 200-jet order Boeing won from American Airlines in late July, pending the board’s go- ahead. The Fort Worth, Texas-based carrier split its purchase of 460 aircraft between the U.S. company and Airbus, which began offering more fuel efficient engines on its A320 narrow-body in December.

Fuel Efficiency

The Airbus order broke an exclusive arrangement between American and Boeing dating to 1987, compelling the planemaker to shift from its stated preference developing an all-new jet rather than the quicker, cheaper option of upgrading the 737.

“In today’s operating environment, it is critical for us to maximize the fuel- and cost-efficiency of our fleet,” said Vasu Raja, American’s managing director for corporate planning. “Boeing’s latest evolution of 737 product is an important step forward for airlines and our customers.”

Fuel consumption on the upgraded 737 will be 16 percent less than the existing A320 and 4 percent less than the A320neo, said Marc Birtel, a Boeing spokesman. It will also be slightly more efficient than Bombardier Inc.’s upcoming CSeries narrow- body jets, said Nicole Piasecki, Boeing’s head of business development.

Engine Fan Size

Engineers are studying whether to use a 66-inch or 68-inch fan size for the new engines, up from 61 inches now, Albaugh said. They have been told to make minimal changes to the rest of the plane -- essentially only stiffening some sections to handle the heavier engines -- and avoid the temptation to creep toward the new-plane development that the company rejected, he said.

The new engines will be offered for the current 737-700, - 800 and -900 models, which will be renamed the -7, -8 and -9.

A fleet of 100 737 MAX-8s would save an airline about $85 million in fuel a year compared with the 737-800, Boeing said. The company should be able to command a premium for the new version, Albaugh said, declining to comment further on pricing. The average 737 has a catalog price of $78 million.

Boeing climbed $1.43, or 2.2 percent, to $66.03 at 4:15 p.m. in New York Stock Exchange composite trading. The gain was the largest among the 30 companies in the Dow Jones Industrial Average.

Demand for the 737 upgrade should be similar to that for the new A320neo, Piasecki said in an interview Aug. 26. Airbus racked up more than 1,000 orders and commitments for the plane within seven months and plans to start deliveries in 2015.

‘Prudent And Disciplined’

Albaugh is “challenging the team” to get the 737 MAX to the market as soon as possible, while being mindful of the delays that have plagued the two current new-development programs, Piasecki said. The 787 Dreamliner is running more than three years late and the 747-8 is two years behind schedule.

“Given our recent track record, we are being very prudent and disciplined to make sure that whatever we talk to our customers about, we actually have a plan to deliver on,” Piasecki said after the press conference. “I think you’ll see improvements on the 2017” delivery targets.

Airlines are reluctant to switch between planemakers, so most of Boeing’s existing 737 customers “will be taking a serious look” at the new version for fleet replacement and growth, Robert Stallard, an analyst with RBC Capital in New York, wrote in a report today.

While Boeing will work with carriers if they want to convert existing orders into contracts for the MAX, the company expects most to stick with the current 737, Albaugh said. Boeing’s existing models will cost less to operate than the new A320neo when including other expenses such as maintenance, the company said.

Manufacturing Site

The planemaker expects to continue selling and building the current 737 until “well into the end of this decade,” Albaugh said. Delta Air Lines Inc. last week ordered 100 737-900ERs, boosting a backlog that was already more than 2,100 planes.

Albaugh has been trying to trim the seven-year backlog so that customers don’t have to wait so long for new planes.

He’s boosting production of the 737 by 33 percent over the next three years, to 42 planes a month, and has said the company will need to build 60 a month by the end of the decade to meet demand. Production slots are sold out through 2016.

The company has teams looking at where to build the 737 MAX, with Renton “at the top of our list,” though other brand- new sites are being considered, Albaugh said. He expects to make a decision in six to eight months.

Executives have said they could build up to 60 planes a month at Renton, which is the only narrow-body jet plant Boeing has now, if they utilize the facility where the P-8A military derivative is assembled.‹

[DewDiligence]

Boeing Delivers First 787 As Program’s Costs Top $32B

http://seattletimes.nwsource.com/html/businesstechnology/2016310102_boeing25.html

›By Dominic Gates
September 25, 2011

Boeing is set to deliver the first 787 Dreamliner to All Nippon Airways (ANA) of Japan on Sunday in Everett, but it's far from the end of the journey for a jet that has reshaped the company.

To reach this milestone, the company has spent a staggering amount: A conservative estimate by The Seattle Times puts Boeing's total investment on the program so far at more than $32 billion.

That massive sum, half spent on development costs and half on manufacturing the jets already built, means profitability for the plane won't come before well into the 2020s — if ever.

Boeing pitched the 787 from the outset as a "game-changer" that would wow passengers with its comfort and bring profitability to airlines with its fuel economy. It chose to build the plane out of carbon-fiber-reinforced plastic composite and tasked partners around the globe with manufacturing large 787 sections. Those decisions dramatically changed the way airliners are built, but also brought more than three years of delays.

Far from reducing Boeing's investment, the unprecedented outsourcing swelled it enormously.

"The plane may be the best plane ever produced, but in losing money it may also be the record holder," said Adam Pilarski, a senior vice president with the aviation-consulting firm Avitas.

A senior Boeing engineer, who spoke anonymously because he isn't authorized to talk to the media, said the company managed to "dig ourselves a tremendous hole." Yet he's optimistic that as production stabilizes, Boeing can squeeze out costs and "we can do a good job of pulling that back."

Seven years and five months after the jet program launched in 2004, thousands of engineers and production workers will celebrate the first delivery at the Everett factory Monday.

A second Boeing engineer, one who has flown on 787 flight tests, thinks it will ultimately prove a winner with both airlines and passengers.

Looking out of the jet's big windows in flight, passengers will notice the upward curve of its composite wings, he said. Even those who have only watched the jet from the ground are impressed by this distinctive note of aerodynamic grace.

"The airplane flies beautifully," he said. "Pilots love the way it handles."

Tickets are already selling well for ANA's early scheduled flights after the initial charter flight in late October.

"This is a damn fine airplane," the senior engineer said.

Ready for service?

For those working on the Dreamliner, relief at the pending delivery is mixed with concern over how the early planes will perform.

The jet ANA will fly away Tuesday, Dreamliner No. 8, is one of the planes that had to be structurally reinforced and modified after its initial botched assembly. When ANA pilots flew it last weekend, it was still experiencing minor problems, according to two people with knowledge of the flight.

A clunking sound in the nose gear, traced to a small gap in the hinge that swings the gear, had to be plugged with a shim. A fan in one of the compressors that feeds air into the cabin failed and had to be replaced, a repeated problem since the program's earliest flights.

In addition, the flight-control system is producing nuisance messages, false alarms that must be investigated each time. A software fix is in the works, but in the meantime such messages could delay flights and affect ANA's flight schedule.

Boeing spokeswoman Lori Gunter said the 787 team is "on track" to make the delivery.

But an experienced mechanic working on No. 8 believes that jet simply isn't ready for service. The engineer who flew test flights fears it won't immediately meet the standard of reliability required by ANA.

The senior engineer, however, dismissed such "bugs" as normal in any new program. "They won't be nearly as bad as they were for the original 747."

Aviation consultant Pilarski said the first delivery begins an extended proving period during which Boeing will have to respond quickly to early customers if anything goes wrong.

"Theoretically, the plane should do well," he said. "We have to see how things work in real life.

"Boeing is very good at adapting and making changes."

Company changes

In the meantime, the Dreamliner has changed Boeing.

First, in conceiving its global-supply system for the plane, Boeing delegated design and manufacturing responsibilities as never before. The wings were made in Japan, the horizontal tail in Italy and the fuselage assembled in huge pieces by partners in Charleston, S.C., and Wichita, Kan.

Then, to fix the unreliability and tardiness of that supply chain, Boeing was forced to buy out the partners in Charleston.

In 2009, Boeing expanded that site into a full manufacturing complex with its own final assembly line, creating a permanent counterweight to its Puget Sound-area plants.

Boeing executives say they've learned hard lessons with the Dreamliner and won't outsource so much work on the next new jet. Yet doing work in-house no longer means it has to be here.

Still, Boeing's ambitious plans for the Charleston site — which may be Boeing Chief Executive Officer Jim McNerney's and the Dreamliner's most enduring legacy at Boeing — remain a strategic gamble. Pilarski, of Avitas, thinks the South Carolina complex will take a considerable time to get up to speed, and in the meantime will increase costs on the 787.

"There's a reason people get paid good money in Seattle. They've been doing it a long time," Pilarski said. "It's not as easy as it sounds. ... I believe Charleston will initially be more expensive."

A 2004 Boeing internal analysis obtained by The Seattle Times showed that executives projected then that they would spend $5.8 billion to develop the Dreamliner.

But with each delay, that tab has soared. At the company's annual investor conference in May, McNerney conceded that the missteps on the Dreamliner have cost Boeing "billions upon billions" in additional development dollars.

A money pit

Based on Boeing's published financial results, The Times estimates development costs have swollen to at least $15 billion.

Boeing doesn't report its development costs for specific jet programs and declined to comment on that part of The Times estimate. [BA’s finances are the most opaque of any company I follow.]

Apart from that $15 billion, the company spent an additional $16 billion to build the 40 or so jets that were rolled out or partially completed by June 30, according to its latest regulatory report. (That figure doesn't include the first three planes, which Boeing has written off as unsellable.)

At least $1 billion more was spent to buy out the partners in Charleston.

The only way to dig out of that money pit is to quickly reduce the cost of building the jets.

The initial planes in any program are vastly more expensive than those built once production is humming. The "learning curve" on the assembly line, the rate at which those costs come down, determines profitability.

Including advance payments to suppliers and some tooling costs, the average direct cash cost to Boeing of manufacturing the airplanes built so far — excluding those first three off the line — is $400 million each. Consulting firm Avitas estimates those planes sold for about $100 million or less.

In a June analysis, David Strauss, of UBS, wrote that even if Boeing manages to get costs down as fast as it did on its previous all-new plane, the 777, the manufacturing cost for years will vastly exceed the revenue coming in. "We see 787 burning $4 billion in cash on average annually through 2015," Strauss wrote.

He figures Boeing's outlays for building the jets will swell from $16 billion now to $35 billion by 2019 before cash flow on the program becomes positive.

It could take 1,900 planes before Boeing recovers those costs, Strauss estimated. Only after that would it begin recouping the $15 billion in development expenses.

Using a much more optimistic alternative assumption on how fast Boeing could get its costs down, Strauss reckons Boeing could break even after 1,100 deliveries. An analysis by Doug Harned, of Bernstein Research, came up with a similar number.

"You probably don't have another airplane program where you produce 1,000 units and you didn't have a penny of profit," said analyst Pilarski. "Over a decade, you don't even make a penny."

Can the program ever make it into profit?

Eventually, sometime in the 2020s, well after the first 1,000 deliveries, Boeing would hope to be making 20 percent margins per airplane — an estimated profit of about $23 million per 787 jet, based on the average value of the various Dreamliner models. It would take an additional 650 deliveries or so at that optimal return to recover the $15 billion in one-time development expenses.

Yet the senior engineer puts his faith in the dramatic leaps in productivity and cost-cutting that Boeing has made on the 737 and 777 programs.

"Lean (manufacturing) will save the program eventually," he predicted. "Break-even won't be as far out as current ugly projections suggest."

Airlines need reliability

The Dreamliner's advance sales were stellar. And even with more than 140 cancellations in recent years, Boeing still has 821 on order. But if the company is ever to make a profit on the 787, it must be a big hit with the first airline customers and produce many more follow-on orders.

Stan Sorscher, a staff researcher with Boeing's white-collar union, the Society of Professional Engineering Employees in Aerospace (SPEEA), said it will be hard to match the early record of the last all-new plane that Boeing delivered 16 years ago, the 777: more than 99 percent reliability.

"It's not going to be as reliable from day one as the 777," said the Boeing engineer who's flown test flights.

That's because Boeing built "a more complicated airplane, with newer ideas, new features, new systems, new technologies."

ANA is about to perform a reality test on all that innovation. For the Dreamliner, first delivery is truly just the beginning.‹