THE BOEING CO. $94 (New York symbol BA; Conservative Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 777.2 million; Market cap: $73.1 billion; WSSF Rating: Above average) is the world’s second-largest maker of commercial aircraft, behind Europe’s Airbus. This business accounts for 50% of its revenue and 60% of its profits.

Boeing’s other main business is its defense and space operations, which make advanced military fighters and helicopters, missiles and communication satellites. Sales to the U.S. Defense Department account for roughly 85% of this division’s revenue.

The stock fell below $25 in 2003, as 9/11 and the Iraq war cut air travel volumes plus demand for new aircraft. At that time, Boeing decided to go ahead with a new plane called the 787 Dreamliner.

Boeing hoped to deliver the first 787 in May 2008. But parts shortages and other problems at some suppliers have forced the company to delay this by six months.

Unlike its previous planes, Boeing has shifted more of the 787’s production such as wings to other companies. It then assembles the completed pieces at its own plants. This helps keep costs down, but increases the risk of production delays if a supplier runs into trouble.

Demand for new plane sets record

Boeing has over 700 orders (worth $100 billion) for the 787. This is a record for a plane not yet in production. However, it’s unlikely this setback will hurt future demand. Boeing can also use the extra time to fix any last-minute problems that might arise as the 787 goes through the test flight process.

Boeing’s revenue fell from $54.1 billion in 2002 to $50.5 billion in 2003, but rose to $61.5 billion in 2006. Writedowns cut earnings from $2.82 a share (total $2.3 billion) in 2002 to $1.00 a share ($809.0 million) in 2003. But profits jumped to $3.62 a share ($2.8 billion) in 2006.

787 doubled Boeing’s research costs

To develop the advanced composite materials and electronics for the 787, Boeing increased its research spending from $1.6 billion (3.0% of revenue) in 2002 to $3.3 billion in (5.4% of revenue) in 2006. The company is now applying some of the techniques from the 787 program to update its other models.

Research spending will likely total a high $3.7 billion in 2007. Boeing must immediately write off these costs. But spending in 2008 should fall as the 787 moves from the development phase to production, so earnings should improve as research spending returns to normal levels.

Military operations cut cyclical risk

The company’s military and space operations help offset the cyclical nature of its commercial aircraft operations. Boeing is currently working on several major contracts, including the F-18 Hornet fighter and the C-17 transport plane.

Although Congress may cut funding for new C-17s after the current contract ends in 2009, the company hopes to get new orders from other NATO countries.

Boeing is also designing a smaller version of the C-17 that can land on shorter runways or open fields. This project will cost $2 billion, but that’s 10% of the cost of designing a new plane from scratch.

Boeing recently finalized a deal to form a 50-50 joint venture with Lockheed Martin Corp. to develop new rockets for the U.S. government.

Rocketry is notoriously complex and expensive, so a joint venture will help cut Boeing’s risk. It also nicely complements Boeing’s commercial and military satellite businesses.

Balance sheet is strong

Boeing can continue to afford big investments in research and other operations. Long-term debt of $7.6 billion seems high at 1.2 times equity. But it’s just 1.5 times annual cash flow of $5 billion. The company also has $9.5 billion (about $12.20 a share) in cash.

Boeing will probably earn $5.07 a share in 2007, and the stock trades at 18.5 times that estimate. Earnings in 2008 could grow to $6.04 a share, which implies a p/e of just 15.6. The stock is also attractive at 1.1 times Boeing’s revenue of $83 a share. The $1.40 dividend yields 1.5%.

Boeing’s main competitor in the passenger airline industry is Airbus, which recently launched its new A380 plane.

787 has wider appeal than the A380

Depending on configuration, the A380 can carry between 500 and 850 passengers. The mid-sized 787, however, will carry between 210 and 330 passengers. Boeing’s previous flagship plane, the 747, carries around 400 passengers.

We feel that the prospects for the 787 are much better than the A380. Many airports would have to lengthen their runways and make other modifications to handle the A380. That limits its use.

Although smaller, the 787 is faster and has greater range than similarly sized planes. That cuts down on costly stop-overs on long trips.

Lightweight materials like titanium and carbon fiber also make the new plane more fuel-efficient than older models. That’s an important consideration for costconscious airlines, particularly as fuel prices continue to rise. The 787’s new “open architecture” design also cuts maintenance and repair costs.

Boeing is a buy.