South Korea Setback Shows Pressure On Boeing Warplane Orders

South Korea’s decision to reopen bidding for a fighter-jet contract rather than accept Boeing Co’s (BA.N) F-15 Silent Eagle signals a wider problem for the aerospace giant: revenue from its most profitable but aging military aircraft is winding down.

At the same time, U.S. government budget cuts have dimmed the prospects of Boeing developing replacements for the higher-margin legacy aircraft, such as the F-15, acquired when it merged with McDonnell Douglas in 1997.

That suggests overall profit margins from Boeing’s defense business will come under pressure in coming years. It is a situation worsened by the rock-bottom bids the company has made to build a new U.S. Air Force refueling plane and the U.S. ground-based missile defense system.

“Revenues from their legacy aircraft programs are going to ramp down to painful levels” over the next three years, said Richard Aboulafia, analyst with the Virginia-based Teal Group.

“The day of reckoning has just been accelerated a notch.”

Boeing’s defense business already generates the lowest profit margins of the big weapons makers, and is likely to head even lower, analysts say.

Manufacturers are relying on foreign orders to help them weather the U.S. spending downturn. But Seoul’s decision to launch a fresh fighter competition, announced early Tuesday, highlights the vagaries of foreign military competitions. Once-solid orders can vanish overnight, often through no fault of the bidding company.

In the South Korean competition, Boeing had followed all the bidding rules and cemented its close, six-decade-old ties with the South Korean government and industry. Behind closed doors, some government officials were describing Boeing – the only company that came in under Seoul’s 8.3 trillion won ($7.7 billion) ceiling – as the likely winner.

But military threats from North Korea ultimately prompted Seoul to insist it needed a so-called “fifth-generation” warplane with special coatings and other features that make them nearly invisible to enemy radar.

That means a likely victory for Boeing’s arch-rival on the fighter front, Lockheed Martin Corp (LMT.N), which builds the only export-grade stealthy fighter, the F-35 Joint Strike Fighter. Boeing officials say they are still exploring all their options, including a possible protest to South Korean authorities over the decision to rebid the contract.

NEW LONG-RANGE BOMBER

In some sense, the South Korean decision is an earlier loss coming home to roost. Boeing lost the competition to build the Joint Strike Fighter to Lockheed in 2001, and the Pentagon has dragged its heels about starting many other new aircraft programs in recent years.

Boeing, Lockheed and Northrop Grumman Corp (NOC.N) have contracts under an advanced design program for a new long-range bomber, but it will many years before a winning design is chosen and that program translates into real orders.

In Brazil, where Boeing’s F/A-18 Super Hornet fighter had looked favored to win a large fighter competition, disclosures of spying by the U.S. National Security Agency have triggered retaliatory measures, including a ban on fighter sale purchases from Boeing, Brazilian officials told Reuters.

“I don’t think Boeing did anything wrong in either case,” said Aboulafia. “These were dynamics that were out of Boeing’s control.”

Aboulafia said Seoul’s decision did not spell disaster for Boeing given its strong order book, which still features a huge Saudi Arabian F-15 fighter order, orders from India for C-17 transport planes, and a 179-plane U.S. refueling plan deal.

Given the dearth of big new programs in recent years, Boeing now faced declining revenues from very profitable legacy aircraft programs like the F-15 and F/A-18.

Profit margins in Boeing’s defense sector have been edging higher over the past few quarters but remain just under 10 percent, compared with between 12 to 13 percent at such companies as Raytheon Co (RTN.N), Lockheed and General Dynamics Corp (GD.N).

Loren Thompson, chief operating officer of the Virginia-based Lexington Institute, said the margin pressures were exacerbated by Boeing’s aggressive bids for the Air Force tanker program and the biggest U.S. missile defense program. In both cases, Boeing’s low bids saddled it with low-margin contracts.

“Boeing wants to be the principal provider of large military aircraft, like the tanker, a new bomber and various radar planes. But it hasn’t won the bomber contract yet, and the Air Force hasn’t moved ahead with a new radar plane,” he said.

The U.S. military will likely spend more than $10 billion to buy an estimated 60 to 80 new electronic-warfare planes in the coming decades, but those orders are far from showing up on any order books, Thompson said.

Boeing is also a big provider of rotor craft for the U.S. military, and has signed two multi-year agreements for both its CH-47 Chinook program, and the V-22 tilt-rotor that it builds together with Textron Inc’s (TXT.N) Bell Helicopter unit.

But budget cuts have slowed or stalled some potential new helicopter programs, including the Air Force’s drive to build a combat rescue aircraft, and the Army’s plan to buy new armed reconnaissance helicopters.

“You’ve got a fantastic five years ahead, but after that the numbers fall off the cliff,” Aboulafia said.

All of those factors left Boeing highly dependent on foreign arms sales, which were historically less reliable than big U.S. orders, Thompson said.

“International sales are a wonderful add-on for a stable domestic production line, but as a stand-alone strategy they tend to be unstable and hard to sustain,” he said.

Jim McAleese, a Virginia-based defense consultant, said the South Korean decision marked a setback for Boeing’s F-15 line, but a Saudi order would keep that line running through 2018.

He said the company remained the No. 1 U.S. exporter, and the top generator of foreign military sales among arms makers.

Boeing also has strong supporters in Congress, where appropriators from both the Senate and House of Representatives have already earmarked initial funding in the fiscal 2014 budget that would pave the way for 22 additional F/A-18 Super Hornet purchases in fiscal 2015.

“They have more than adequate number of orders to meet their 2014 guidance,” McAleese said. “It’s too early to write them off. This is just a short-term setback.”

Source : Reuters