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Boeing Wins $55.5 Million KC-46 Modification Contract

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Amid ongoing troubles with its 737 MAX aircraft and rising US-China trade tensions, Boeing (BA) recently received some positive news. The aircraft company won a $55.5 million contract to implement modifications in the KC-46 Pegasus refueling aircraft from the US Air Force.

On August 2, the U.S. Department of Defense released details about the deal between the Air Force and Boeing through a notice on its website last week. The contract requires Boeing to make certain modifications in the telescopic boom of the KC-46 tanker aircraft.

According to the DOD notice, “This modification is for the system level hardware and software critical design review of the boom telescope actuator redesign.” According to the terms of the deal, Boeing would implement the modifications at its Seattle factory by February 2021.

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Boeing KC-46 Pegasus aircraft

After a one-and-a-half-year delay, the USAF included the KC-46 in its unit in February 2019. Developed on the Boeing 767 jetliner mainframe, the tanker is a military transport and aerial refueling aircraft. The twin-engine aircraft is powered by United Technologies’ (UTX) PW4062 engines, developed by its wholly owned subsidiary Pratt & Whitney.

The defense equipment manufacturer received an order for 179 KC-46 aircraft by the USAF in February 2011. According to the agreement, the company had to deliver the first jet in August 2017.

However, the model didn’t get final approval for more than two years due to several technical glitches found by the USAF. After Boeing made the required changes, the refueling aircraft finally received acceptance approval in January 2019.

In its latest 10-K filing with the SEC, Boeing disclosed that the delays and fixes had cost billions of dollars. The defense equipment supplier revealed that the total cost overrun between 2016 and 2018 reached $3.6 billion on a pre-tax basis.

On an after-tax basis, the cost overrun reached $2.4 billion. In 2018, the company recorded $736 million in reach-forward losses related to the delay in the KC-46 approval. The expenses included increased costs associated with flight testing and certifications.

The KC-46 refueling tanker has been tested with several jets, including the F-16 and the C-17 Globemaster. In early June, the Pegasus aircraft completed the Phase II receiver certification test on Lockheed Martin’s (LMT) F-35 Lightning II fighter, according to Airforce Technology.

Boeing needs major defense boost

Boeing needs a significant boost from its defense segment as its commercial aircraft division is underperforming due to the 737 MAX fiasco. Notably, shipments for its MAX planes have ceased since mid-March following two deadly crashes within five months. As a result, the company’s overall commercial jet deliveries fell 54% YoY to 90 units in the second quarter of 2019. Notably, the segment’s total revenues plunged 66% YoY to $4.7 billion.

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Nonetheless, the Defense division’s second-quarter sales increased 8% YoY to $6.61 billion. Increased volumes across derivative jets, satellites, and weapons mainly drove the segment’s revenues higher. The division ended the quarter with an order backlog of $64 billion, of which 31% originates from international customers.

Although the latest USAF contract amount is relatively small, it demonstrates that Boeing’s defense business unit should continue doing well. As the KC-46 tanker deliveries are expected to accelerate in the next few months, Boeing should see additional revenues and cash flows, boosting its margins.

Stock performance

Boeing stock has lost significant market value in the last four months due to the grounding of its fast-selling 737 MAX jets. The stock was further subdued following the escalated trade dispute between the US and China. Notably, Boeing delivers one of every four aircraft it builds to Chinese air carriers. Therefore, this significant business exposure makes Boeing stock vulnerable to rising trade tensions.

Following the Ethiopian Airlines crash on March 10, Boeing stock has fallen significantly. Its year-to-date return has eroded to 2.7% as of August 5 from nearly 31% on March 8. The stock has underperformed the iShares U.S. Aerospace & Defense ETF (ITA), which has risen 21.6%. The ETF invests in companies that assemble, manufacture, and distribute aerospace and defense equipment.

Boeing stock’s YTD return is also significantly lower than the gains of its industry peers. Year-to-date, shares of Lockheed Martin, United Technologies, and General Dynamics (GD) have gained 38.2%, 19.0%, and 13.2%, respectively.

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