Boeing's transformation and shareholder value

BY JOHN MORROCCO

When Boeing says it's committed to increasing shareholder value, what exactly does that mean? And how is the company going about doing it?

Part of the answer lies in the strategy set in motion six years ago to transform Boeing into a broad-based aerospace company. But first, a reminder about what shareholder value is all about.

Owners of Boeing stock are looking for a good return on their investment. And that is largely a function of financial performance, particularly earnings per share and cash flow. Earnings are the amount of income a company generates after subtracting expenses, taxes and other costs. Earnings per share (EPS) is simply earnings divided by the number of outstanding shares and is used to measure a company's profitability. And share, or stock, price is the best aggregate yardstick of how investors assess a company's performance and outlook. Cash flow is the amount of free cash a company generates to make acquisitions, reduce debt, pay dividends or otherwise return to shareholders.

So how does all of this relate to Boeing's transformation?

Throughout most of its history, Boeing has primarily been a commercial aircraft company. In the early 1990s, roughly 80 percent of revenues came from the commercial sector and that percentage was on track to grow to 85 percent. As a result, the company's stock price was closely tied to the commercial aircraft orders cycle, which is largely driven by global economic conditions. The healthier the economy the more people would fly and thus the more aircraft airlines would order.

Over the years investors became conditioned to play the cycles of the commercial airplane market when buying or selling Boeing stock. With aircraft order rates as a leading indicator of earnings potential, investors would typically sell stock when orders were heading down and buy when they started moving back up. As a result, the stock has been a great trading play for savvy investors able to time the ups and downs of the commercial airplane market cycle. But those same peaks and valleys made Boeing shares less attractive for those seeking a long-term investment.

A major element of the transformation strategy set into motion in the mid-1990s was to make Boeing less dependent on a single and highly cyclical business. The addition of the defense and space businesses of Rockwell, McDonnell Douglas and Hughes, as well as several other acquisitions, brought more diversity to the company's portfolio. Commercial Airplanes now accounts for about 60 percent of total revenues.

That increased balance provides the potential to smooth out financial peaks and valleys. Now when one of Boeing's core markets hits a rough patch, for whatever reason, there are still opportunities for growth in other sectors. And that's a key consideration for investors. The stock market rewards companies that can show consistency in earnings and cash flow over time. And those indicators at Boeing have largely been improving (see chart), indicating that the strategy is starting to work.

The events of Sept. 11 validated the strategy of creating a more broadly based aerospace company. Boeing's defense, space and even its financing businesses have acted to cushion the financial impact of the downturn in the commercial airplane market. But at the same time, the repercussions of Sept. 11 have left a degree of uncertainty in the minds of investors, many of whom still recognize Commercial Airplanes as a key swing factor in overall financial performance. They are struggling to assess how deep and how long this unprecedented decline in the commercial airplane market will be and how Boeing will perform through a significant downturn in production.

Conditioned by years of historical data, many investors are still waiting for further proof that the transformation that has taken root within the company will result in more consistent performance over time. The stronger the financial performance of a company, as measured by key indicators such as earnings per share and cash flow, the greater its credibility to investors and the higher its valuation.