* Defense revenue slips but margins improve
* Profit $1.35/share vs Street view $1.13
* Revenue $20 billion vs $17.7 billion a year earlier
* Shares close lower after rising 3 percent
By Alwyn Scott
Oct 24 (Reuters) - Producing more airplanes and cutting costs in its defense business helped Boeing Co post stronger-than-expected profit for the third quarter, and the company notched up its earnings forecast for the third time this year.
Boeing is churning out cash as it delivers more jets to customers, and it took the opportunity on Wednesday to say that "first and foremost" it intends to give money back to shareholders through dividends and share buybacks.
But the solid report was tempered by pension costs that appeared to be rising more than expected. Boeing forecast that pensions will cost $3.5 billion next year, 40 percent more than in 2012, as its obligations rise largely because of low interest rates.
"That's going to be a cash-consuming item, and it probably caught some people by surprise," said Russell Solomon, a credit analyst at Moody's Investors Service. "This is a problem that's not going to get better unless interest rates start to rise."
Boeing raised its full-year earnings forecast to a range of $4.80 to $4.95 a share, compared with $4.40 to $4.60 previously.
It said revenue should reach $80.5 billion to $82 billion this year, driven by more sales in the defense, space and security businesses. Revenue in 2011 totaled $68.7 billion.
The company said it was on track to deliver up to 600 commercial jets this year, compared with 477 in 2011.
In the quarter, it earned $1.0 billion, or $1.35 a share, compared with $1.1 billion, $1.46 a share, a year earlier. Revenue rose to $20.0 billion from $17.7 billion.
Analysts surveyed by Thomson Reuters I/B/E/S had expected earnings per share of $1.13.
"Boeing is getting pretty good at this," Robert Stallard, an analyst at RBC Capital Markets, wrote in a note to clients. He called it "another trouble-free quarter with no execution issues."
But he added: "If there is one dark cloud it is the looming increase in pension expense next year, which we doubt has been fully reflected in consensus estimates."
Boeing shares ended 0.2 percent lower at $72.71 on Wednesday after rising as much as 3 percent earlier in the session.
The commercial aircraft business delivered 22 more jets in the third quarter than a year ago, due in large part to 787 deliveries, opening a second 787 assembly line, and ramping up output of 737 and 777 jets.
The delivery increase drove revenue in the commercial airline business up 28 percent to $12.2 billion.
But Boeing earned less from the jets because many were newer aircraft, which tend to have lower profit margins. The business also earned less from aircraft services, which tend to have higher margins. Overall margins contracted to 9.5 percent from 11.4 percent.
The commercial airplane business "was a little soft on the top line and slightly softer on the margin, but not as weak on margins as feared," said Ken Herbert, an analyst at Imperial Capital LLC.
The defense business performed better than expected in the quarter. Although revenue fell slightly from a year earlier, the margins improved, showing Boeing's ability to cut costs as defense spending is contracting in the United States and Europe.
"They're ahead of the curve compared with their peers," Herbert said.
PENSION EXPENSE RISES
Boeing said that excluding pension costs, earnings rose 5 percent from a year earlier, to $1.89 a share from $1.80.
Boeing Chief Financial Officer Greg Smith said the company made $1.5 billion in discretionary contributions to pensions this year, prompting analysts to question how that builds shareholder value.
Boeing said that pre-funding the pension lowers the long-term expense. Smith said Boeing was committed to rewarding shareholders and would give more details on the cash deployment strategy - share buybacks and dividend increases - later this year.
"When it comes to cash deployment, first and foremost, (the) priority is returning cash to shareholders," Smith said, according to transcripts of a conference call with analysts.
Despite "pension headwinds," the defense, space and security business "maintained double-digit margins in a challenging environment, while commercial airplanes continued to build momentum with 787 deliveries and 737 MAX orders," Chief Executive Jim McNerney said in a statement.
Defense revenue fell 4 percent to $7.8 billion in the third quarter, but margins improved to 10.5 percent from 10 percent. The higher margins surprised most analysts, but left questions about whether they can be sustained.
"I am encouraged by the improved margin trends," said Carter Leake, an analyst at BB&T Capital Markets. "But we'll see if these margins can be continued into 2013."
Analysts said they were focused on whether Boeing can continue to speed up delivery of 747 and 787 jets, which currently drag on earnings, and arrive at the point where they are contributing to cash flow.
"The question is when they get to cash-flow break-even" with the 747 and 787 jets, Leake said.