Valuentum has a lot of experience covering Boeing's (BA) shares. In fact, our President Brian Nelson had made one of his many great equity calls while he was an senior equity analyst at Morningstar back in 2008. He called for a fair value estimate of $110 at that time, more than 50% upside from those levels. Look at the share price today.
Let's see what the Valuentum team thinks of Boeing now.
Our Report on Boeing
• Boeing earns a ValueCreation™ rating of EXCELLENT, the highest possible mark on our scale. The firm has been generating economic value for shareholders for the past few years, a track record we view very positively. Return on invested capital (excluding goodwill) has averaged 32.9% during the past three years.
• Boeing is the largest manufacturer of commercial jetliners and military aircraft combined. Boeing also makes rotorcraft, electronic and defense systems, missiles, satellites, launch vehicles and advanced information and communication systems. The firm is a major service provider to NASA.
• The aerospace giant is benefiting from a benign operating environment. Global economic growth continues (albeit modestly), air passenger traffic is healthy, defense markets are firming with renewed threats, and commercial aviation remains a long-term growth market.
• Boeing's massive commercial aerospace backlog of unfulfilled deliveries gives it excellent visibility and a growth trajectory better than most other firms of similar size. Its revolutionary 787 has changed the economics of air travel, and we expect deliveries to surge in coming years. Still, technical concerns with the plane are a big risk.
• Boeing earns an 'A' rating from the credit agencies, and the firm's cash and marketable securities were comfortably higher than both Boeing's and Boeing Capital Corp's debt. We think the firm has learned from the recent global financial crisis.
Economic Profit Analysis
The best measure of a firm's ability to create value for shareholders is expressed by comparing its return on invested capital (ROIC) with its weighted average cost of capital (WACC). The gap or difference between ROIC and WACC is called the firm's economic profit spread. Boeing's 3-year historical return on invested capital (without goodwill) is 32.9%, which is above the estimate of its cost of capital of 10.5%. As such, we assign the firm a ValueCreation™ rating of EXCELLENT. In the chart below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid grey line reflects the most likely outcome, in our opinion, and represents the scenario that results in our fair value estimate.
Cash Flow Analysis
Firms that generate a free cash flow margin (free cash flow divided by total revenue) above 5% are usually considered cash cows. Boeing's free cash flow margin has averaged about 4.4% during the past 3 years. As such, we think the firm's cash flow generation is relatively MEDIUM. The free cash flow measure shown above is derived by taking cash flow from operations less capital expenditures and differs from enterprise free cash flow (FCFF), which we use in deriving our fair value estimate for the company. For more information on the differences between these two measures, please visit our website. At Boeing, cash flow from operations increased about 154% from levels registered two years ago, while capital expenditures expanded about 52% over the same time period.
Our discounted cash flow model indicates that Boeing's shares are worth between $89.00 - $148.00 each. The margin of safety around our fair value estimate is driven by the firm's MEDIUM ValueRisk™ rating, which is derived from the historical volatility of key valuation drivers. The estimated fair value of $118 per share represents a price-to-earnings (P/E) ratio of about 23 times last year's earnings and an implied EV/EBITDA multiple of about 12.6 times last year's EBITDA. Our model reflects a compound annual revenue growth rate of 8.2% during the next five years, a pace that is higher than the firm's 3-year historical compound annual growth rate of 6.2%. Our model reflects a 5-year projected average operating margin of 9.8%, which is above Boeing's trailing 3-year average. Beyond year 5, we assume free cash flow will grow at an annual rate of 3.3% for the next 15 years and 3% in perpetuity. For Boeing, we use a 10.5% weighted average cost of capital to discount future free cash flows.
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Margin of Safety Analysis
Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $118 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future was known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values. Our ValueRisk™ rating sets the margin of safety or the fair value range we assign to each stock. In the graph below, we show this probable range of fair values for Boeing. We think the firm is attractive below $89 per share (the green line), but quite expensive above $148 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.
Future Path of Fair Value
We estimate Boeing's fair value at this point in time to be about $118 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart below compares the firm's current share price with the path of Boeing's expected equity value per share over the next three years, assuming our long-term projections prove accurate. The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change. The expected fair value of $153 per share in Year 3 represents our existing fair value per share of $118 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.
Pro Forma Financial Statements