:: January 2013 Letter ::


January 2013

Dear Fellow Anti-Change Agents,

I donít like change. But every so often, Iím forced to re-examine my long-held beliefs. This is one of those moments.

During my 25 years as an aerospace industry analyst, Boeing looked more competitive than Airbus. My job is to forecast and provide recommendations to industrial and financial clients, and Boeing almost always delivered better results. When random Euro-sycophants accused me of being ďanti-Airbus,Ē (as if it were a cultural/national bias) I merely offered to discuss numbers (i.e., financial returns and benefits to industrial partners). Theyíd get that confused deer-in-headlights look (which confirmed that many people in this business donít quite understand market economics), and sadly mope away.

I expected this routine to continue for the next 25 years. Yet times have changed. A client recently showed me some jarring numbers. As of January 25th, EADSís stock has returned 137% or 7.1% annualized since it was listed in July 2000. In the same period, Boeing has returned 117%, or 6.4% annualized.

This trend, of course, is quite recent. Boeing stock has been impacted by the 787ís problems. It has significantly underperformed broader US stock averages with a total return of about 1% (including dividends). EADS, on the other hand, has been soaring and is up 36% since the start of 2012, with about 20% of that in the past month. Before that steep rise, Boeingís stock would have still have performed better than EADSís. Underperformance or outperformance obviously depends on the starting and end dates.

Yet EADS has risen while battling its own serious headwinds over the past year, and while generally underperforming Boeing in revenue and profit. Boeing jetliner output rose 47% by value in 2012 over 2011, while Airbus rose just 12%. Boeingís profit margins are considerably better than EADSís. With the 777 and 787, Boeing has a better twin aisle product line, while Airbus is stuck with that A380 albatross. EADS/Airbus still has serious governance and ownership issues. EADS has seen more savage home market defense budget cuts than Boeing has. It also has seriously underperformed Boeing in defense export markets, as evidenced by the F-15ís continued long run and Eurofighterís string of campaign failures. The battle over share prices and investor returns shouldnít be a battle at all. Boeing should be way ahead.

How to explain this disconnect? Iíve got a theory. The jetliner business is a duopoly, and the jetliner market is growing faster than any other manufacturing industry. Investors want to be part of it. And Boeing is starting to scare them. After all, Boeingís stock price hasnít been clobbered by the 787 problems; rather, it has simply stayed stagnant. Airbus/EADS, by contrast, has been benefiting from a strong jetliner market without any program disasters. In other words, it isnít that thereís something particularly right with Airbusís strategy. Rather, thereís something wrong with Boeingís strategy, and their execution.

Letís review. Last summer, Boeingís top management axed the engineer CEO who had been turning around BCA and making it better again. They replaced him with a non-engineer CEO. Then, management got into a confrontation with the engineerís union (which may also partly be the unionís fault, but itís not a battle management can afford right now). Then Chicago put off the very promising 777X until the next decade, which, from a customer perspective, might as well be an indefinite postponement. These moves were on top of a 787 development model that de-emphasized in-house engineering and relied on industry partners for much of the development work.

Since the 787 appeared to be out of the woods, and the 777X was put off until the next decade, Chicago likely didnít think it needed much from engineers. Then that damn 787 battery thing happened. Oops. Back in Seattle, engineers, represented by a disgruntled union and forced to report to multiple layers of non-engineer management, are working overtime on the problem, but after several weeks, nobody appears to be close to a solution. As this is written, the likely outcome is a six to nine month grounding (due to the need for re-certification).

This terrifying state of affairs for the Dreamliner, of course, was merely background for Boeingís fourth quarter earnings call this month. The 787 fiasco wasnít discussed, except that (a) the investigation was continuing and couldnít be discussed and (b) 787 production was continuing full speed ahead, despite uncertainties about what needed to be done for the battery system, or any other aspects of the planeís design. If these planes being built need major retrofit work in the future, well, thatís for the engineers to worry about.

Meanwhile, there was no contrition or soul-searching on the call about how the 787 could have gone this wrong, or what could be done within the company to make it right (once again, 787 program analysis was left to the journalists). Instead, the call emphasized some impressive sales and profit numbers. It was like a farmer showing off a great crop, but not mentioning that the tractor just broke, he fired the mechanic, and outsourced tractor maintenance to Bolivia. And that customers for next yearís crop had been promised penalty payments if the farm didnít deliver.

Chicagoís view of engineering, as seen in management changes, union negotiations, product launch decisions, and design outsourcing moves, is that itís a secondary consideration, far behind financial and market considerations such as Return On Net Assets (RONA). But clearly this strategy of downplaying engineering is starting to have a deleterious effect on the companyís financial performance, at least in terms of equities returns relative to the competition. Sure, investors may be scared by the high compensation costs associated with the 787ís woes. But itís also possible that investors may be getting spooked by a company that seems to lack a proactive approach for dealing with a serious crisis. Even when the 787 gets back to service, it may face further difficulties. Thereís also the likelihood that Boeing may be returning to the bad old days of 1998-2003, when it spent next to nothing on new product development.

In other words, Boeingís problem isnít just that the engineers have been nudged aside by the bean counters. Itís that the bean counters need to rethink the way they manage the company. Until that changes, investors may continue shifting their focus towards Airbusís virtues, particularly if Airbus continues to emphasize spending on new products.

To start the new year, January aircraft reports include the annual World Aircraft Overview. Weíve also updated the Gripen, MiG-29, S-92, E-6, AW101, and Superjet. All the best in 2013.

Yours, ĎTil The Universe Gets Rearranged Again,
Richard Aboulafia

© Richard Aboulafia 1997-2006, All rights reserved.
  ~  Last updated on January 08, 2006