Boeing Stock (NYSE:BA)
Following four turbulent years defined by the 737 MAX grounding, the COVID-19 epidemic, significant supply-chain constraints, and various quality control difficulties, Boeing (NYSE:BA) has recently begun to get back on track. After burning roughly $30 billion between 2019 and 2021, the aerospace company generated over $3 billion in free cash flow in Q4 2022, giving it positive cash flow for the year. Boeing expects aircraft production, sales, profitability, and cash flow to steadily rise over the next few years.
Because of this increased sense of security, Boeing has recovered to trade above $200 for the majority of 2023, after falling as low as $113 last year. Even after this comeback, Boeing shares are still more than 50% below their all-time high of $430.35 set in early 2019.
Furthermore, management expects free cash flow to reach $10 billion by 2025 or 2026. Boeing trades for only 12.5 times the anticipated free cash flow on that basis. As a result, many analysts and investors are positive on the stock.
Boeing, on the other hand, will need to use the majority of its cash flow over the next five years to repair its balance sheet. Furthermore, while free cash flow may return to $10 billion in a few years, it is more likely to be a cyclical peak than a foundation for future growth. As a result, Boeing stock remains unappealing.
Commercial Airplanes Showing Signs of Stabilization
Boeing’s main business segments are commercial airplanes, military, space, and security, and global services. The services industry is a very consistent performer, with operating margins in the mid-teens. In 2020, it even made a little profit.
The defense industry was once a solid source of revenues and cash flow, but recent quality difficulties and cost overruns have afflicted it. The division generated a $3.5 billion operating loss in 2022, mostly due to a spate of charges (see pp. 36, 86-88) relating to cost overruns on fixed-price government contracts. In 2023, the defense industry is still struggling. It recorded another loss last quarter, and Boeing expects the segment to lose money for the full year.
Boeing’s commercial aviation segment has been the most troublesome in recent years. It lost more than $29 billion in operating losses between 2019 and 2022. A significant inventory buildup drained cash flow as well. However, this split is finally beginning to show signs of life.
Boeing delivered 480 commercial aircraft last year, significantly below the previous year’s record of 806 but up from 340 in 2021 and just 157 in 2020. As a result, segment revenue recovered to $25.9 billion, up from a low of $16.2 billion in 2020.
The commercial jet industry is still losing money, owing to lower aircraft production rates and the cost of repairing jets with initial quality issues. However, cash flow has improved as Boeing begins to clear its backlog of undeliverable 737 MAX and 787 Dreamliner jets. Boeing cut its 737 MAX inventory by approximately 85 units in 2022, and its 787 inventory by around 10 units.
In 2023, deliveries should continue to improve. Boeing expects to deliver 400-450 737 MAX jets and 70-80 787 Dreamliners this year, up from 387 and 31 in 2022, respectively. This would allow the commercial airplanes segment to earn $2.5 billion to $3.5 billion in operating cash flow for the entire fiscal year.
Boeing anticipates that the commercial airplanes division will continue to lead the company’s cash flow and profits recovery over the next few years. Boeing expects to produce around 800 commercial aircraft per year by 2025 or 2026 (roughly in line with the 2018 peak), with a segment operating margin in the low teens and about $9 billion in segment operating cash flow. The company forecasts moderate earnings and cash flow growth in the services industry, as well as a slight recovery to high single-digit margins and $2 billion in segment operational cash flow in the defense sector.
Not Much Extra Money
Boeing’s mid-term goals appear to be attainable. Due to the lengthy drop in deliveries caused by the 737 MAX grounding, the pandemic, and current supply-chain and quality difficulties, there is a lot of pent-up demand in the commercial aviation sector. The commercial jets industry is positioned for a steady comeback as the supply chain continues to heal and management handles the lingering quality issues. This should allow Boeing to meet its sales, earnings, and cash flow targets by 2026 (2025 is probably too optimistic), as well as its free cash flow target of $10 billion.
This, however, will not allow Boeing to resume its pre-2019 pattern of lavishing investors with large dividends and share buybacks. Boeing will need to allocate a significant portion of its cash flow to debt reduction during the next few years.
Boeing had slightly over $5 billion in net debt at the end of 2018, with $13.8 billion in debt versus $8.6 billion in cash and investments. (Net debt was scarcely more than $1 billion a year ago.) Due to Boeing’s tremendous cash burn over the last five years, net debt currently surpasses $40 billion.
For the next few years, management has stated that it plans to return the company to its original capital structure and will prioritize debt reduction over distributing cash to shareholders. Even if the corporation meets its cash flow projections and devotes all of its funds to debt reduction, net debt will not reach historical levels until 2027.
Boeing could resume paying a tiny dividend in late 2025 or 2026 if its debt-reduction measures are successful. However, real shareholder returns will not start until 2027 or 2028, making Boeing shares a pure capital appreciation investment for the foreseeable future.
Not a Foundation for Long-Term Growth
Bulls believe Boeing’s market cap will expand sufficiently over the next several years to justify buying the company even if no dividends or share buybacks are planned. However, in order for Boeing stock to return 10% each year over the next three years, it would have to be valued at around 17 times the company’s medium-term free cash flow projection of $10 billion by 2026.
This would be a reasonable valuation if Boeing was anticipated to generate free cash flow from that base beyond 2026. However, aerospace is a cyclical industry, with the current cycle expected to peak in the late 2020s.
Boeing estimates in its most current commercial market outlook that airlines will require 18,405 new planes over the next decade, excluding regional jets. That may appear bullish at first look. With approximately 1,800 new jets required annually (on average), Boeing could supply 800 or more aircraft per year with a 45% market share (below its historical average over the last 25 years).
However, Boeing is unlikely to maintain a market share of more than 40% in the future. Airbus (OTCPK:EADSY) has roughly twice as many orders in its backlog as Boeing in the narrowbody market, which accounts for the vast majority of demand. Airbus intends to increase A320neo-family manufacturing to 75 per month by the end of 2026 in order to meet this demand. It also plans to raise A220 production to 14 per month by 2025.
Airbus would produce around 1,000 narrowbodies per year by 2027, compared to 600 for Boeing (based on existing plans). Meanwhile, China’s Comac wants to increase C919 aircraft manufacturing to 150 units per year within five years.
Pent-up demand might keep global narrowbody output at these levels for a few years, but not indefinitely. Commercial jet production, in particular, fell between 2001 and 2005 as a result of the 9/11 assaults on aviation. Based on the normal lifespan of a narrowbody jet, this will reduce replacement demand near the end of the present decade.
To make matters worse for Boeing, Airbus is expected to expand its A220 lineup by the end of the decade with a bigger A220-500 aircraft. Unlike the current A220 variations, which do not compete directly with the 737 MAX, an A220-500 would directly compete with the top-selling 737 MAX model (the 737-8) while offering lower operating expenses.
Boeing is the undisputed leader in the widebody industry, but its demand predictions are overly optimistic. Whereas existing firm orders cover more than two-thirds of Boeing’s projected global narrowbody deliveries over the next decade, airlines haven’t even purchased half of the widebodies (including freighters) that Boeing intends to build over this time.
The expected arrival of Airbus’ A321XLR casts doubt on Boeing’s demand predictions. The A321XLR will have enough range to handle many routes currently served by widebodies while providing usually better economics. This will cannibalize demand for the 787 Dreamliner in particular, making it difficult to maintain manufacturing at the projected rate of 10 per month in 2025/2026 for more than a few years.
Look for Value in Other Places
Based on annual free cash flow rebounding to $10 billion, I predicted that Boeing shares would be valued at $200-$250 by the mid-2020s.
Boeing has now established a free cash flow target of $10 billion by 2026 (or, at most, 2025). Meanwhile, due to share-based remuneration and pension contributions, Boeing’s share count has climbed. Higher interest rates, on the other hand, would put downward pressure on the company’s valuation in comparison to my 2020 analysis.
Thus, unless the market has another bout of irrational enthusiasm (which is always conceivable), Boeing has little to no upside in the next few years. Even in 2026, investors should not be willing to pay more than 12 or 13 times free cash flow for Boeing, because cash flow is more likely to decline than increase in the late 2020s and early 2030s. Shareholders may consider selling any Boeing stock rallies and reallocating their wealth to more potential companies.
Featured Image: Megapixl
