Absent Macro Shocks, Cash And Expenses Will Drive Boeing

By Stephen D. Simpson, CFA | April 24, 2013 AAA

A year ago I thought that Boeing (NYSE:BA) looked undervalued and ready to outperform as investors bought in to the company's considerable commercial ramp. Since then, the stock is up about 20% and although worries about batteries on the 787 did create some headaches, the company remains in good shape with respect to its market share and backlog. I still believe that Boeing should sport a triple-digit stock price and though I won't ignore the risks of a major macroeconomic slowdown, I think the biggest concerns for Boeing are now reaching cost/profit targets and how to use the considerable sums of cash it will generate.

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A Good First Quarter, But Not Quite Soaring
Boeing did have a good first quarter, but it wasn't quite as good as some early reports have seemed to suggest. Absent some non-operating items, it was more or less in line with what most analysts expected.

Revenue fell almost 3% this quarter, just slightly beating the average of Wall Street estimates. Both the commercial aviation and defense businesses saw revenue decline about 2%, with the decline in commercial about 80bp worse. In commercial, Boeing delivered the same number of planes this quarter as last year's first quarter (137), while military deliveries were up due to the delivery of 15 Apache helicopters.

Margin performance was not quite as strong, but it does matter which numbers you choose to use. GAAP gross margin declined about half a point, and GAAP operating income fell about 2% as operating margins held steady. Looking at segment profits, though, Boeing logged better than 12% growth, with nearly 13% growth in commercial aviation. Likewise, Boeing's own “core” operating income number showed 5% growth and nearly 80bp of margin expansion.

I don't want to go into a long tangential discussion about which numbers are the right ones to use, as there are merits to multiple approaches so long as investors understate the underlying assumptions. All in all, I'd say that Boeing's commercial margins are coming along and the defense margins are surprisingly good. That said, a big retroactive tax benefit did boost reported results this quarter.

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Boeing Should Largely Control Its Own Fate In Commercial
Boeing and EADS's Airbus dominate the large commercial aerospace market, though competitors like Bombardier, COMAC, and Sukhoi are trying to break into the market. Likewise, Embraer (NYSE:ERJ) is a significant player in regional jets, while companies like General Dynamics (NYSE:GD) and Textron (NYSE:TXT) compete in business jets. All told, though, I don't see serious competition threatening Boeing anytime soon – smaller airlines (particularly in emerging markets) may order a few jets from the commercial large-body newcomers on a trial basis, but it will take a long, long time to challenge Boeing and Airbus.

With that competitive security, Boeing needs to drill down on costs and make sure that it can produce its planes as profitability as possible on a long-term basis. Choosing to re-engine the 737 (as opposed to an expensive full redesign) was likely a solid move, but it will be imperative for the company to improve the margins on the 787 as schedules ramp up now that the battery issue is finished.

Assuming that delivery schedules do pick up as expected, that should help feed the aerospace supply chain and companies like General Electric (NYSE:GE), United Technologies (NYSE:UTX), and Honeywell (NYSE:HON).

The Bottom Line
I suppose there's still a risk that a major macroeconomic decline would wipe out chunks of Boeing's order book, but that's the sort of company-specific risk that I believe would be subsumed by much bigger worries about the global economy and markets. In other words, if Boeing investors ever need to worry about that, they'll have other, bigger, problems to worry about. While I do have some concerns about Boeing's defense business, including its position in satellites and the possibility of losing share to rivals like Lockheed Martin (NYSE:LMT), Boeing has been through these ups and downs many times before.

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As Boeing has done more or less as I expected over the past year, I'm not making major changes to my expectations or model. I still look for the company to generate about 4% long-term revenue growth, with slightly higher free cash flow. I do have some concerns about the consistency of the company's future cash flow, so I would expect the year-to-year ups and downs to create incremental trading opportunities along the way. At the bottom line, though, I think these shares are worth close to $110 today and still look like a worthwhile purchase candidate.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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