Boeing Co. (BA, Financial) has faced plenty of serious setbacks in recent years, from the disastrous and deadly rollout of the 737 Max to the abortive attempts to launch the glitchy Starliner spacecraft.
While the venerable aerospace company has endured much in its efforts to reestablish both its reputation and a firm financial footing, certain business segments have continued to be plagued with issues. Perhaps the most troublesome among these of late is Boeing Defense, Space and Security (BDS), the company’s struggling defense business.
This segment has underperformed compared to the rest of the company for years. Remarkably, the segment showed virtually no growth at all from 2018 through 2021. In 2018, the segment brought in $26.4 billion in revenue; in 2021, it brought in $26.5 billion. Things have failed to improve in 2022; year to date, the segment has brought in just $22.8 billion in revenue.
Things look even worse for BDS upon review of the segment’s margins, which fell from 6.3% in 2018 to 5.9% in 2021. A number of charges booked this year have sent margins deeply into the red, coming in at -13.4% through the first three quarters of 2022, representing a 12-month trailing net loss of nearly $3 billion.
While one might be tempted to blame the exacerbated troubles of 2022 on idiosyncratic events and one-off charges, this is simply an inadequate explanation for a business segment that is clearly experiencing severe, long-term pathologies. Aerospace analyst Dhierin Bechai made this point forcefully in a Nov. 18 research note:
“The reduction in revenue reflects charges that Boeing took in the third quarter bringing twelve-month trailing losses to $3 billion. What's more worrisome is that Boeing actually took those charges. Normally those charges are one-off items, but with Boeing they have become standard business practice. The Defense segment normally should be a segment with margins in the 10% to 12% range. However, driven by charges, Boeing has not been able to deliver satisfying margins for at least the past five years and that likely is also a reason for Boeing to restructure the defense segment. Doing so could shave off overhead costs, although Boeing has not discussed any potential savings as part of the restructuring.”
BDS has failed both to grow meaningfully as a business segment, and to deliver margins remotely close to the industry average. Indeed, even before the recent reversals over the past year, Boeing’s defense business margins were barely half of those enjoyed by its principal rivals.
A much overdue reorganization
After years spent either publicly discounting or outright ignoring the problems proliferating within its defense business, Boeing appears at last to have woken up to the issue in earnest. On Nov. 17, the company announced a sweeping reorganization of BDS that “aims to accelerate operational discipline, program quality, safety and performance.”
The restructuring was kickstarted with the immediate halving of the number of divisions within the defense business unit from eight to four, consisting of: Vertical Lift; Mobility, Surveillance and Bombing; Air Dominance; and Space, Intelligence and Weapon Systems. This consolidation comes after years of failure to adapt to changing market conditions and industry demands. In a statement accompanying the restructuring announcement on Nov. 17, BDS CEO Ted Colbert expressed high hopes for Boeing’s reorganized defense business:
“I am confident this reorganization will drive greater and more simplified integration and collaboration across Boeing Defense, Space and Security. These changes will help accelerate operational discipline and program quality and performance, while stabilizing our development and production programs. These are necessary steps to put BDS on the path to stronger, profitable growth.”
The reorganization should help Boeing reduce unnecessary overhead, cut costs and streamline operations within the BDS business, which ought to help it stabilize itself financially, as well as lay the groundwork for future margin expansion. However, many lingering issues remain that will have to be addressed if BDS is truly going to rise from the ashes bigger and stronger than ever.
Getting cost overruns under control will have to be a key priority, which BDS leadership has acknowledged. This is especially important with regard to the numerous fixed-cost development programs in BDS’s portfolio, many of which have suffered from severe delays in recent years, such as its next-generation military tanker aircraft, which I have discussed previously, and the new Air Force One development.
Boeing Defense, Space and Security has weighed on its parent company for years, but there is finally a glimmer of hope that a turnaround is nigh. While the immediate and deliberate actions to streamline the BDS organization are a good sign for the future, in my opinion, it is still only a first step - a good first step, but a first step nonetheless.
Boeing has faced many struggles as an organization. Its turnaround efforts to date have shown some promise thus far, but I see a difficult road still ahead. In my assessment, investors interested in this name should be laser-focused on these turnaround efforts, both within BDS and across the Boeing organization. Their success or failure will likely set the course for the venerable aerospace company for years to come.