Bulls Onboard Boeing

By Stephen D. Simpson, CFA | October 31, 2011 AAA

The stock of American aircraft giant Boeing (NYSE: BA) seems to always be in "hurry up and wait" mode. Investors and analysts always seem to be more interested in the cycle to come than in the business today. Of course investing is a forward-looking endeavor, but it looks like the long-awaited good times at Boeing are in sight at last.

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A Respectable Third Quarter
The good times are close at hand for Boeing, but not exactly here yet. Revenue rose just 4% in the third quarter, as relatively better sales (up 9%) in commercial aerospace offset flat results in the defense business. Within defense, Boeing balanced increased military aircraft revenue with declines in space and service and support revenue.

Gross margin (including the capital operations) really didn't change much, but the company did post a large jump in reported operating income (up 24%). On a per-segment basis, Boeing saw commercial income rise 7% (with a slight decrease in margin), while defense profits rose 20%. (To know more about gross margin, read: A Look At Corporate Profit Margins.)

Just the Beginning of a New Delivery Cycle
Total commercial deliveries were almost unchanged with last year, but the company has just recently started deliveries of the vaunted 787 Dreamliner. Over the next few years, this new aircraft platform should be a major driver in Boeing's earnings and cash flow. Likewise, although the backlog did not increase notably, the company has $273 billion worth of commercial orders in its backlog, and nearly $60 billion more in the military product backlog.

Dragging the Sector with It
Like the auto companies, Boeing has a huge train of suppliers and component manufacturers. When Boeing's activity picks up, their activity picks up. It's not always a steady increase across the sector, though - General Electric (NYSE:GE), for instance, has made some gains on United Technologies (NYSE: UTX) in aircraft engines lately. Nevertheless, when Boeing is stronger, companies like Rockwell Collins (NYSE: COL), Wesco Aircraft Holdings (NYSE: WAIR), Precision Castparts (NYSE: PCP) and Honeywell International (NYSE: HON) get more attention from investors. Likewise, with increased advanced material content in new commercial planes, a strong aerospace market is good news for companies like Hexcel (NYSE: HXL) and Titanium Metals (NYSE: TIE).

Twin Threats of Competition and Budgets
While the commercial aviation market is getting better, the defense market has investors and analysts nervous. It seems hard to imagine that the federal government can continue to maintain its current spending levels on defense, so the question is which programs get cut. Boeing's communications and space businesses are probably fairly safe, but there is going to be all-out competition between Boeing, Lockheed Martin (NYSE: LMT), General Dynamics (NYSE: GD) and Northrop Grumman (NYSE: NOC) for other programs.

At the same time, Boeing is not beyond greater competition in the commercial aerospace market. Bombardier (OTCBB: BDRXF) and Embraer (NYSE: ERJ) have their own niches, but Boeing and European Aeronautic (OTCBB: EADSY), parent of Airbus, routinely play leapfrog with each other. Longer term, China's COMAC wants to get into the large-scale aviation business and that threat will carry some real weight, particularly if the Chinese government continues to heavily support that company. Still, these are long-term worries - it takes a long time indeed for airlines to switch over their fleets.

The Bottom Line
Boeing stock is reasonably cheap at these levels. While some of its biggest risks are unquantifiable (budget cuts and production difficulties being foremost among them), they are at least already in the mind of most investors. If there is a problem with the stock, it might be in that many analysts are already positive on this stock and pushing it to their clients. There should be substantial cash flow growth on the way from Boeing, but investors should realize that this is not exactly an undiscovered idea at this point.

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

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