The Business

The Boeing Company is the worlds leading aerospace outfit and the largest manufacturer of commercial jetliners and military aircraft combined, with over 174,000 employees and revenues fast approaching $85 billion annually. The Chicago, Illinois-based company also designs and manufactures rotorcraft, electronic and defense systems, missiles, satellites, launch vehicles, and advanced information and communication systems. And it provides various support services to NASA, the military, and the commercial airline industry. There are three principal business segments, including Commercial Airplanes (about 60% of the top-line mix), Boeing Defense, Space & Security (40%), and Boeing Capital, the companys small financial solutions wing (less than 1%).

Strengths

Robust Commercial Order Book: Part of this is due to brisk demand for new airplanes, such as the Boeing 787 Dreamliner and its variants, coming out of the last recession. Aircraft are now being upgraded more frequently than ever before, it seems, which is helping the company and Airbus (a subsidiary of EADS), its primary European rival, to rack up new business wins. (Boeings backlog stood at 4,800 jets and a record $345 billion at the end of the September interim.) And we expect this trend to persist well into the future, given the intense competition, low interest rate environment, and heightened emphasis on light, fuel-efficient designs. This, in turn, should encourage Boeing to further increase its planned production rates, a move that would be good news for both earnings and cash flow.

The KC-46 Tanker Program: The success of this platform, based on the 767 jet liner, is supporting results throughout Boeings otherwise-sluggish Defense, Space & Security segment, along with cost cuts and gains in fast-growing emerging markets. Notably, in 2011, the KC-46 won a key competition and was selected by the U.S. Air Force to replace aging KC-135 Stratotankers.

Financially Sound & Shareholder Friendly: Boeing, which maintains a healthy balance sheet (Financial Strength: A++), is committed to returning most of its cash from operations to shareholders in the form of either quarterly dividends or stock buybacks. Managements preference, we believe, is for repurchases (they are set to exceed $2 billion this year alone), since they would likely afford the company a bit more financial flexibility. We still anticipate a dividend hike in 2014 (to an annual rate of $2.00 a share or more), however, and expect the shares to trade at a decent yield in the 1.5%-2% range going forward.

Weaknesses

High R&D Spending: While Boeing is trying to keep investment spending in check, R&D expenditures remain quite high ($3.3 billion, or 4% of sales, in 2012), which is squeezing margins and penalizing the bottom line. Moreover, while the pressures may ease somewhat over the next few quarters, we envision even higher spending levels later in the decade, as the company endeavors to leverage its popular 737 and 777 platforms.

Pension Costs: Boeings pension load stood at a hefty $75 billion-plus at the end of last year, far more than the fair value of its plans assets. This is forcing the company to continuously dip into its earnings to meet its obligations to retired workers. The profit drain is bound to persist, too, notwithstanding the likelihood of better investment returns and efforts to negotiate less-taxing pension plans with its labor unions.

Execution: Execution has been spotty at times, especially with regard to the important 787 program, which has gotten off to a rough start. Things seem to be getting better, however, and Boeing remains committed to resolving any operating glitches in a timely manner.

Opportunities

Industry Fundamentals: After crashing during the financial crisis and recession, the airline industry has been in a powerful recovery mode over the past few years, buoyed by pent-up demand, stable fuel prices, and an improved macroeconomic backdrop. In fact, carriers, by and large, are looking to secure new planes as quickly as possible these days, rather than, as has been the historical norm, defer a bulk of their deliveries. This suggests that the company will continue to have the wind at its back for some time to come.

The 787 Dreamliner: This platform, as weve indicated, has been plagued by its share of delays and execution problems, and was even grounded briefly in the United States and several other countries earlier this year because of fire hazards related to its lithium-ion batteries. Yet, orders for the revolutionary long-range, fuel-efficient jet airliner -- its the first commercial jet to use mostly composite materials -- continue to pile up. And we expect the 787 to become far more profitable in the years to

come (ramp-up costs are now quite high) and emerge as a leading driver of free cash flow. By the second half of the decade, 787 production rates should reach 14 per month, up from a rate of closer to 10 per month today.

Threats

Stepped-Up Competition: Orders are ramping for Bombardiers new CSeries jets (Bombardier Aerospace is a Canadian manufacturer) and for the C919 family of airliners produced by the Commercial Aircraft Corporation of China (Comac). This, along with an ongoing market-share battle with Airbus, could take a toll on Boeings own order book over time, and compel the company to further boost R&D spending and upgrade its product lines with greater regularity.

Defense Spending: Though operating conditions are rather favorable for the core commercial business, this is not the case for Boeings smaller defense unit. In fact, reductions in U.S. defense spending continue to hamper results across the Defense, Space & Security division. And we dont see this situation reversing anytime soon, especially considering the push in Washington for more budgetary cuts.

That said, we think that the company will be able to offset the top-line headwinds, at least partially, by making inroads abroad and streamlining its overhead. Boeing has already made strides beefing up its international business (overseas sales tend to be pretty high-margined), which currently accounts for about 23% of the defense segments total revenues and 40% of its work backlog. Whats more, the company maintains its goal of eventually shedding $2.5 billion from the cost structure.

Conclusion

In sum, while these shares appear to be on the expensive side, theres a lot to like about the Boeing story, from the companys good finances and rising free cash flow to its booming commercial business and reasonably stable defense unit. Indeed, Boeings strengths and opportunities look to easily outweigh its weaknesses and threats at present. Consequently, we believe that this Dow component still has a place in diversified equity portfolios.