After a strong third quarter performance, Boeing (BA)  is optimistic that their favorable results will carry into the fourth quarter and 2016. The firm’s strong operating cash flows have allowed them to return nearly $8 billion to shareholders via dividends and share repurchases through the first three quarters of 2015. The 787 Dreamliner is nearing profitability, with Q3 deferred payments growth at $577 million (net of $28.3 billion). Management expects the Dreamliner to become profitable in 2016, with a current backlog of 768 orders. Below is Boeing’s performance over the last 12 months, plotted above the stock’s Relative Strength Index (RSI).
Boeing has seen its share price rise 4.2% to $147.18 since third quarter earnings were released last Wednesday. Their RSI has risen 6.1 points to a near overbought position during the same period, a bullish indication from investors. Prices have for the first time returned to pre-August 24th levels. With a high RSI, is Boeing too expensive? Let’s compare them to the Aerospace and Defense Industry:
Boeing is actually trading at a discount relative to the Aerospace industry, with a P/E of 18.7 (19.8 for the industry), and a Price to Sales of 1.1 (industry 1.2). The company operates at similar margins as its industry with an 8.6% operating margin (industry 9.0%) and a net margin of 5.8%. What separates Boeing from its competitors here is its returns: Boeing has nearly doubled the return of the industry the past five years (134.6% vs. 69.9%) and has more than 3.5x the industry return twelve months trailing. But who exactly are Boeing’s competitors?
Commercial Aircraft Manufacturing
Boeing operations can be roughly divided into two divisions: Commercial Aircraft Manufacturing, which accounted for 66% of revenues in 2014, and Boeing Defense, Space, & Security (BDS), which accounted for 34%. Boeing competes with Lockheed Martin, Northrop Grumman, and General Dynamics in the Defense industry. In the Commercial Aircraft Manufacturing industry, Boeing operates in an essential duopoly with Airbus (OTCPK: EADSF) (OTCPK: EADSY) and compete for aircraft orders in zero-sum fashion. Both companies have impressive backlogs: Boeing has 5,656 unfulfilled deliveries and Airbus has 6,755. At current production rates, it would take Boeing 7 years to produce all the orders in its backlog, and it would take Airbus 11 years. The backlog for both companies provides strong revenue visibility for the next five years, even when accounting for possible cancellations.
While Airbus has a larger backlog than Boeing (6,755 orders against 5,656), Boeing maintains two distinct advantages: the firm has a higher delivery rate than Airbus, allowing it to capitalize on its backorder; and it maintains an advantage in wide-bodied aircrafts, as the majority of Airbus’s backlog (5502 of 6755) is in narrow body/single aisle aircrafts. Through the first three quarters of 2015, Boeing has delivered 580 aircrafts to buyers, while Airbus has only delivered 446. A greater number of deliveries has allowed Boeing to maintain higher billed sales than Airbus. The top graph below is Boeing’s share performance over the last two years, with the share performance of Airbus as the baseline. The second graph shows both companies’ sales over the same period (plotted in millions of dollars).
Boeing’s second advantage is in wide-bodied aircrafts. Through the first three quarters of 2015, Boeing has delivered 205 wide bodied jets while Airbus has delivered only 94. Alternatively, Boeing has delivered 375 narrow bodied jets in 2015 to Airbus’s 352. With a forecasted demand for 38,000 new aircrafts in the next 20 years from replacement demand and air travel growth, Boeing’s higher production rates will create a substantial advantage.
Current production rates for the 737 are 42 units per month, with plans to increase production to 47 units per month in 2017. The 737MAX, the new engine model of the 737, has a massive backorder of 2,869 units and is scheduled to make its first delivery in 2017. Production of the 747 will be decreased from 1.3 units per month to 1.0 starting in 2016, as it is phased out in favor of the 787. The 787 Dreamliner is currently being produced by Boeing at a rate of 10 units per month, with project expansion to 12 units per month in 2016 and 14 units per month by the end of the decade. Expansion of current production capacities will allow Boeing to more quickly fulfill backlogs and substantially increase revenues by the end of the decade.
Of all their aircrafts, the 787 wide-bodied aircraft will have the most pronounced effect on Boeing’s bottom line going into 2016. The 787, with its modest 768 order backlog, has amassed a $28.3 billion deferred payments account, as Boeing has struggled to cut costs of production of the model at their previously projected rate. The deferred payments account for the 787 increases each period that the costs of producing a single aircraft exceed the revenues from selling it. When revenues exceed costs on a per unit basis, this account will decrease in size. A zero account balance is the breakeven point for the entire 787 project, and a break even in cash basis will allow future produced units to decrease the deferred payments account. So far, the deferred payments account has increased in size each period, offsetting firm revenues and cash flows from other aircraft models. In Q3 of this year, deferred payments for the 787 increased by $577 million, the lowest one quarter amount for the project to date. Management believes that deferred payments will continue to have declining growth rates in the fourth quarter of 2015, and the 787 should break even on a cash basis and become cash positive once Boeing starts producing 787s at a 12-a-month basis in 2016. By the end of 2016, the 787 should start contributing to earnings and cash flows, rather than offsetting them. This alone should have a significant positive effect on Boeing’s share price next year.
Management and Analyst Expectations
Management is not only confident in the 787 performance going into 2016, but also for the fourth quarter of 2015. After a strong third quarter, where revenues increased 9% to $25.8 billion and Core EPS increased 18% to $2.52, management revised its forward guidance upwards for year-end Core EPS and Revenue. Forward guidance for Core EPS was revised upwards by $0.25 from $7.70-$7.90 to $7.95-$8.15, and forward guidance for revenues increased by $500 million from $94.5-$96.5 billion to $95-$97 billion. Analysts have been similarly bullish on year-end EPS. Shown below, current average EPS estimates for 2015 are $8.25, up from the $8.03 estimate 30 days ago.
Operating cash flows in the third quarter were $2.9 billion, of which $1.5 billion was used to repurchase 11 million shares and the firm paid out $618 million in dividends. Year to date management has bought back 41 million shares for $6.0 billion, and has paid out dividends year-to-date of $1.8 billion. The figure below shows Boeing’s shares outstanding and quarterly dividend per share over the last 2 years. Over this period the firm has sent positive signals, consistently buying back shares, as well as returning an increasing amount of value to investors with growing dividends. Management is still authorized to repurchase $6.0 billion worth of additional shares under the current repurchase program.
No company operates without risk, and Boeing is not exempt. Any decline in US defense budgets could see Boeing’s Defense, Space & Security business suffer. Boeing also lost out to Northrop Grumman last week on a DoD long range bomber contract, which is worth an estimated $80 billion. In the Commercial Airline business, Airbus has been able to bring their A320neo narrow body aircraft to market faster than Boeing has been able to develop their narrow-bodied 737MAX. This first mover advantage has allowed Airbus to compile a significantly larger backlog for the A320neo (5502 orders) than the 737MAX (2869 orders).
Boeing posted strong third quarter earnings, and management revised both year-end revenue and Core EPS predictions upwards. This indicates that management is confident heading into the end of the year, and analyst estimates mirror this sentiment. The 787 is set to become cash positive in 2016 and will begin to contribute to Boeing’s already improving margins. Investors looking to get long in Boeing would do well to buy before 2016.