Boeing's Impressive Orders at Dubai Airshow Boost Strong Growth Outlook

Narrow-moat  Boeing (BA) announced the official launch of the 777X program on Nov. 17 at the Dubai Airshow, with 259 orders and commitments worth more than $95 billion at list prices. It also announced orders for the 787 program as well as the 737 program, including MAX and Next Generation, with the 737 program reaching more than 1,000 total orders since launch. These orders put Boeing's early take at more than $100 billion, and add to the $344 billion commercial backlog from the third quarter of 2013. Boeing's strong growth rates supported by continued strong orders compelled us to raise our fair value estimate to $120 per share from $113.

The 777X program customers include Lufthansa with 34 airplanes, Etihad Airways with 25, Qatar Airways with 50, and Emirates with 150. Middle East-based airlines continue to provide support for wide-body programs at both Boeing and Airbus.

Boeing Returns to Its Risk-Taking Roots
Risk taking has been a hallmark at Boeing, and the revolutionary 787 has returned the company to that historical culture. Boeing is the largest aircraft manufacturer now because of its willingness in the late 1960s to introduce a product like the 747, a plane that didn't even have a market at the time. Airbus was able to enter the airplane marketplace in part thanks to the risk-averse mentality of recent company leaders who focused on baby steps to product evolution. While the 787's cost overruns, supply chain issues, and grounding by the Federal Aviation Administration have caused anxiety among investors, we think the product will be a long-term winner. Moreover, the 737 re-engine allows the company to strengthen its balance sheet and regain market share as it ponders the development of other aircraft variants. The company largely operates in a commercial aircraft duopoly with Airbus--a market that Boeing estimates at $4.5 trillion (34,000 aircraft with 14,300 replacements) during the next 20 years--even as rivals in Canada and China seek to take a slice of this pie.

Air travel has consistently grown 1.5% faster than GDP over a long time frame. High fuel prices make purchasing fuel-efficient aircraft a profit-enhancing move, and cheap financing allows customers to do so. Boeing has leveraged research and development funding from defense into the commercial arena, and the reverse. We believe the company generally enjoys the backing of the U.S. government in financial and negotiating matters, including both commercial and defense sales.

The defense business generates nearly 40% of the firm's earnings. Boeing correctly anticipated austere budgets and proactively cut staff and facilities to protect profits. Total defense cuts could reach $1 trillion over the next nine years to 2021. Its strong product offerings are likely to be overwhelmed by budget issues, and we forecast defense will decline to 32% of total sales in 2015 versus 50% in 2010.

Barriers to Entry Secure Boeing's Economic Moat
Boeing's economic moat is built on the relatively high barriers to entry imposed by the technical knowledge required to design, assemble, and certify a commercial aircraft. The company has leveraged its know-how between its defense and commercial businesses over the years, and we expect this to continue. Even in the face of a declining defense budget in the U.S., we anticipate that Boeing will focus its efforts on saving programs that will provide the greatest benefits to the overall firm.

As an assembler, Boeing designs the aircraft, operates and coordinates a global supply chain, tests the product for certification, and provides after-sales support all over the world. These tasks involve a high degree of technical and operational knowledge that new players cannot easily duplicate. Further, during the past 50 years, competition from  Lockheed (LMT),  General Dynamics (GD), de Havilland, McDonnell Douglas, and several Russian manufacturers has disappeared, and Boeing now operates in a duopoly with Airbus in the all-important single- and twin-aisle segments. Lastly, Boeing enjoys sticky customer relationships because airlines are often hesitant to try unproven new products that increase fleet complexity. Boeing has leveraged these competitive advantages to deliver annual returns on invested capital, averaging a solid 22% during the past five years, evidence of the firm's narrow economic moat.

The Boeing-Airbus duopoly continues to dominate the market for commercial aircraft. The total backlog between the two competitors stands at more than 10,000 aircraft as of Sept. 30 and represents nearly five years of production at peak announced rates. All manufacturers continue to push technology over time, including for comfort and fuel efficiency, including Pratt's geared turbo fan and  GE's (GE) Leap engines. Switching costs, such as pilot and crew training along with maintenance supplies and personnel, further prevent established airlines from trying new products.

However, startups and fast-growing carriers in emerging countries do not face the same obstacles. This could allow new manufacturers, especially those backed by deep-pocketed governments, to take market share. For example, China-based COMAC launched a regional aircraft in 2002 (and may enter into service in 2014) and the larger C919 in 2008. Both offerings have missed initial entry into service dates and continue to be plagued by setbacks related to the strong barriers to entry into the commercial aircraft market.

Within the defense business, the operating environment will become more difficult as revenue opportunities diminish. However, Boeing has been proactive with labor and facility adjustments and has protected profitability. Overall, we believe Boeing's ability to generate returns above its cost of capital remains strong and we now rate the firm's moat trend as stable.