Boeing basks in glow of tanker win, but risks loom

CHICAGO Fri Feb 25, 2011 3:21pm EST

The Boeing 767-based NewGen Tanker is pictured simultaneously refueling two F/A-18 Super Hornet aircraft from the wing air refueling pods in this undated photo illustration, obtained on February 24, 2011. REUTERS/Boeing/Handout

The Boeing 767-based NewGen Tanker is pictured simultaneously refueling two F/A-18 Super Hornet aircraft from the wing air refueling pods in this undated photo illustration, obtained on February 24, 2011.

Credit: Reuters/Boeing/Handout

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CHICAGO (Reuters) - Boeing Co, its suppliers and investors had good reason to cheer after the company snared a $30 billion Pentagon order this week, but challenges loom as Boeing prepares to fill the historic order on what may be a tight budget.

There is also a chance that the contract for 179 U.S. Air Force refueling planes could be broken if Boeing's snubbed European rival EADS protests the award.

Boeing shares rose on the victory, but experts predicted a muted stock reaction in the longer term.

"We believe that the challenge for Boeing will be to build an all-new airplane within a fixed-price cost structure that may have been aggressively priced," said Sanford Bernstein analyst Douglas Harned in a note to clients.

"Boeing has stressed that it would only submit a bid that would make this a profitable program. But the track record for Boeing and others in producing large military transports within a fixed price structure has not been good," he said.

The win for Boeing came as a surprise to many industry-watchers who expected EADS to win the contract in a competition that began nearly a decade ago.

EADS can still file a protest, although some experts believe a protest is unlikely because of EADS desire to keep a foothold inside the world's largest arms market. Congressional backers of EADS also may attempt to block the award.

This is the Pentagon's third effort since 2001 to start replacing its 50-year-old Boeing-made KC-135 Stratotankers.

Neither Boeing nor EADS detailed their offers, but some experts believe Boeing kept margins tight to ensure a low bid.

"As with any development program, significant risks lie ahead and cost overruns will remain a major concern for Boeing," Heidi Wood, analyst with Morgan Stanley, said in a note late on Thursday.

Some analysts say they still expect Congress to weigh in and split the orders between Boeing and EADS, particularly if problems arise with Boeing's work on the program.

Boeing was years late in delivering four tankers to Japan, and has delivered just one of four tankers it is building for Italy, five years behind schedule, a program that has run into substantial technical challenges.

Britain's Cobham Plc, the world's leading refueling hose and drogue maker, announced earlier on Friday that it has been hired by Boeing to work on the U.S. tanker program, a possible sign of Boeing's determination to avoid the problems it has had with the Italian program.

Cobham, also an EADS supplier, estimates the lifetime value of the contract to be around $1 billion.

INDUSTRY OUTLOOK

The tanker deal will likely also pay off for subcontractors such as Goodrich Corp, engine maker Pratt & Whitney (a unit of United Technologies), and Spirit AeroSystems Holdings, analysts said.

J.P. Morgan analyst Joseph Nadol estimated that the contract was worth $1 billion to avionics maker Rockwell Collins.

Since Goodrich supplies parts to both Boeing and EADS, the contest "was definitely a win-win for us," spokeswoman Lisa Bottle said. Goodrich supplies landing gear, air data sensors and fuel measurement systems to the Boeing 767.

Spirit AeroSystems, a company that was spun off from Boeing, said in a statement that it would build the tanker's forward fuselage section, pylon, major sections of the nacelle, and the wing fixed leading edge.

The S&P Aerospace index was up 1 percent on Friday afternoon and shares of Boeing were up 2.9 percent at $72.80.

Stock analysts had predicted a mild run-up in the stock, but several anticipated no short-term financial benefits to Boeing from the award, as aircraft delivery is years away.

Boeing's business is split between defense and commercial airplane products, and its shares more closely track developments in commercial orders and deliveries.

RBC Capital Markets analyst Robert Stallard said in a research note late on Thursday that he expects "little near term impact on Boeing's earnings in 2011."

Option traders on Friday appeared to be taking profits on previous bullish call positions placed ahead of the announcement. As shares rise, the value of the calls increases.

(Reporting by Kyle Peterson, Karen Jacobs, Andrea Shalal-Esa and Doris Frankel; Editing by Dave Zimmerman, Matthew Lewis and Tim Dobbyn)

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