Boeing’s turbulent defence unit stalls turnaround

Washington — Boeing’s defence business is proving harder to turn around than executives initially predicted, with supplier errors and high manufacturing costs contributing to $1.7bn in losses in 2023 on programmes such as the next Air Force One and Nasa’s Starliner capsule.

Despite absorbing $4.4bn in losses in 2022 — which executives said would lower the risk of future cost overruns — the unit has seen little improvement in 2023.

Excluding 2022, losses on Boeing's defence programmes in 2023 exceed those from all years since 2014, according to a Reuters review of Boeing’s regulatory filings. Boeing is unique among its defence contractor peers, as companies such as Lockheed Martin, General Dynamics and RTX are seeing higher revenues due to demand from the war in Ukraine.

Unlike those companies, however, Boeing is locked into handful of contracts that force the plane maker to take a loss when technology development goes over budget.

The defence unit’s losses this year include $933m in charges in the third quarter, mostly comprising a $482m loss building two Air Force One planes and a $315m charge on an unidentified satellite programme that had not previously lost money.

Boeing’s executives said they are putting in place new training and deploying resources to suppliers to ensure the unit moves from negative margins to high-single digit margins by 2025-2026, when its most troubled programmes are slated to be past flight testing and on more stable footing.

“We're driving lean manufacturing, programme management rigour and cost productivity consistently across the division,” CFO Brian West said during a Wednesday earnings call. Boeing declined to comment beyond executives’ comments on the call.

Byron Callan, a defence analyst with Capital Alpha Partners, said Boeing’s 2025-2026 timeline to get to positive margins is feasible but questioned why it took the company years to institute programmes to improve execution.

“Someone really dropped the ball on all of this,” he said.

Boeing shares have lost 6% in 2023, compared with the broad-market S&P 500’s 9% gain.

Fixed price contracts

Analysts also say there is little Boeing can do to offset the financial burden of its long list of fixed-price development contracts with customers such as the US defence department and Nasa, which lock the plane maker into paying all costs above an agreed-upon threshold.

These deals, which make up 15% of Boeing's defence programme revenue, were reached before Boeing's commercial aeroplanes business was decimated by the Max crisis and before the pandemic and high inflation caused costs to spike for materials and labour. Other headaches include a recent manufacturing snafu where a supplier improperly coated KC-46 fuel tanks.

The losses suggest Boeing lacks a true understanding of costs as each new charge “is an upward revision to cost expectations, vs only three months prior,” said Seth Seifman of JPMorgan, in a Wednesday note to investors. “Even after excluding charges, Boeing Defense Space and Security still did not generate a real profit.”

Boeing has been adamant it will not enter into new fixed-price contracts for the development stage of weapons because the unpredictability associated with designing and testing a new product often brings unforeseen costs.

However, the company's current fixed-price development efforts, which include the US Air Force’s KC-46 refuelling tanker and T-7 training jet, new Air Force One planes, the Navy's MQ-25 tanker drone, and Nasa’s Starliner have all continued to run over budget in 2023.

The latest charge for Air Force One brought total losses to $2.4 billion on a $3.9 billion contract to develop two planes. The program’s current schedule calls for the first jet to be delivered by September 2027.

West also noted $136m in additional losses taken during the quarter, including a $71m charge for the MQ-25 programme.

While KC-46 appears to be stabilising and T-7 will eventually make a profit, there's “not much you can do” for costly, low-volume programmes like Air Force One or MQ-25, said Richard Aboulafia of AeroDynamic Advisory.

A better bet, and one Boeing’s defence segment is aggressively pursuing, is inking future contracts for next-generation fighter jets and cutting-edge drones.

“It’s a target-rich environment,” Aboulafia said. 

Reuters