We recently established a position in the Boeing Company.
Boeing is in the process of introducing one of the most important innovations in the commercial aircraft industry since the invention of the jet engine. Specifically, they are now using composite materials instead of metal to build the fuselage and wing systems of commercial jet aircraft. These materials are lighter and reduce the fuel cost of operating airplanes. The use of composites has been extensive in the newer generations of military aircraft like the B-2 Stealth Bomber. Now the aerospace industry is in the process of migrating this technology to the commercial aviation market.
Not surprisingly, the migration has been difficult. The manufacture of these new components has required new skills and assembly techniques to construct the final product. As with any major new technological innovation, there are kinks that must be worked out. But the plane has had the largest and fastest order ramp-up of any commercial airplane in history. Its use of composites lightens the plane, making it significantly more fuel efficient than the current technology. Given high oil prices, customers have been anxious to place their orders, so Boeing’s backlog is at record levels. Interestingly, because of their financial problems, U.S. airlines have not been overly aggressive placing orders for the new aircraft. But with fuel costs high, we expect that all carriers will need to place orders in the not-too-distant future.
Current production snags are being worked out and once plane deliveries begin in 2009, sales and production volumes will steadily increase.
In the last several years, Boeing’s CEO, James McNerney, has done a wonderful job of restructuring the company to operate more efficiently. This has substantially improved free-cash flow and the company’s financial strength. So with good fundamentals, a reasonable price and improving operating metrics, we think the stock offers good prospects for growth at a reasonable value. As a result, we have initiated the position with a 1 ½% weighting in our clients’ equity accounts.
Yesterday, we raised our investment weighting in Altria Group to 4% in anticipation of their long awaited spin-off of Philip Morris International (PMI). This new company will be based in Switzerland and will own rights to the Marlboro brand outside of the United States. The domestic Marlboro/cigarette business will continue to operate under the Altria entity and be managed to generate cash flow to investors through dividends and share repurchases.
Both entities have significant cost-cutting opportunities which should drive earnings growth for the foreseeable future. The international business has substantial growth opportunities, particularly in emerging markets where their competition, for the most part, will be large government monopolies.
With the stock spinoff behind these companies, we think they will refocus their efforts on their marketing and operating activities. We expect both stocks to generate solid returns in the months ahead as cost cutting activities lead to earnings growth. And with PMI, we think they can accelerate unit growth which could lead to good earnings-growth-driven returns in the future.
In many accounts, we sold a portion of Procter & Gamble (PG) when cash was needed to settle the trade. We had been over-weighted in PG to take advantage of the synergies from their acquisition of Gillette. With these synergies largely realized, we are cutting back the position to a more typical weighting.