The commercial aviation industry is a long term growth no brainer, whereas the threat cautiousness at national levels have positively affected the defense sector. Companies like Lockheed Martin (LMT), General Dynamics (GD) and Northrop Grumman (NOC) display a declining backlog. The Boeing Company (BA), on the other hand, posted its record backlog of $415 billion in earning announcement of 3Q13.
Since the earnings announcement, the stock has gained almost 9 percent in the stock market. Some analysts are still bullish on the company while others argue that this price hike has made Boeing unjustifiably expensive. I am aiming to dig into the company's fundamentals in order to analyze the source of this growth and the sustainability of this positive performance.
A cushion for the company
Boeing has a distinct client base that has helped the company to report a positive surprise. 48 percent of the company's revenue is sourced from the U.S, whereas 70 percent of Boeing's Defense, Space and Security (BDS) revenue is sourced from the United States. Given the U.S defense budget cuts for 2013, the company should has incurred a bigger loss than evident in the financial statements. Luckily for Boeing, a significant portion (by value) of the company's commercial planes is delivered to the clients outside the U.S. This is just one of the reasons why Boeing was able to post better results than the overall industry.
To highlight a few aspects of the earnings announcement:
- Boeing's revenue growth exceeded the industry average of 9.6 percent. The company's revenues witnesses a YoY increase of 10.6 percent
- Net margins grew by more than the industry average; however they were lower than the S&P index. Net margins increased by 12 percent, from $1,032 million in 2Q13 to $1,158 million in 3Q13
- Net operating cash flow increased by more than 75 percent YoY, reaching a level of $2,808 million
The rise in cash flow is a result of a higher commercial airplane production and strong core operating performance, hence surpassing the industry average cash flow growth of 16.87 percent. The combined effect of these events jumped the company's EPS by almost 11 percent in the recent quarter.
Is the growth unjust?
"The program accounting quantity (or block) simply represents the number of airplanes for which we can reasonably estimate revenue and cost as we look ahead. It is not a breakeven number (it wasn't for 1,100 and isn't for 1,300)."
During Q3, Boeing increased the production block for the 787 Dreamliner from 1,100 to 1,300, due in part to the launch of the larger 787-10 version back in June. In other words, Boeing now assumes that it will sell 1,300 Dreamliners over the life of the product, which resulted in most of the growth incurred by the company. The program accounting method allows the company to capitalize its expected gains from its new version launched. By adding 200 planes to the end of the production batch (when the 787 will be at its most profitable), Boeing increased its expectations for the 787's total profit. While development of the 787-10 also increased Boeing's costs, the net result was still an increase in the company's profit margins.
The growth is still to come
Boeing recently acquired an order of 200 new 737 MAX airplanes worth $20.7 billion from China, along with an 11 airplanes order of $3.7 billion by Korea, adding more workload and revenue for the future. Adding a cherry on top, Boeing further adds that its new plane 777X under design is expected to make its debut at the end of the decade. According to Bloomberg, Boeing anticipates that the new orders from 777X will bring $87 billion in revenue from the four airline deals.
As for the program accounting discussed previously, it allows the company to incorporate its expected market share and make adjustments accordingly. In fact, Boeing has estimated the total market for 787 size range aircrafts to be 3,300 aircrafts from 2011-2030, and expects to capture more than half of that demand. So we can expect that Boeing's estimates for adding 200 aircrafts in its production block are conservative and more growth should be achieved in the future.
However, with the current production of 1.7 planes per day, it will require Boeing seven and a half years to complete orders it still has. With so many orders in backlog, Boeing adds danger of customer non satisfaction by failing to provide delivery on time. Sharks like Airbus and upcoming regional airlines are on the round to steal away orders. Over the last 10 months, Boeing has lost 131 of its 737 orders due to customer cancellation. That is more than 14 percent of new orders taken over.
20 Percent Increase in price target
Recently, Deutsche Bank increased Boeing's price target to $156 from $130. Deferred production equivalent to adding 17 new aircrafts in inventory was the reason withheld. An increase in the deferred production predicted for the coming years, despite the current high production, indicates strong future orders already in place (thanks to Boeing's Dreamliner, 737 MAX and 777X).
The majority of company's returns came from its commercial segment. Q3 2013 marked its highest-ever backlog, with the company achieving $415 billion worth of orders received from its customers still waiting to be filled. The bulk of this work resides in Boeing's commercial airplanes business, where customers have placed orders for nearly 4,800 airplanes, amounting to $345 billion in value, or 83 percent of the total backlog. The commercial department reported an increase of 210 basis points since Q312 taking profit margins to 11.6 percent.
The only poorly performing segment was the Defense, Space and Security. The segment declined owing to the current US defense policy. Beginning 1st March 2013, the Budget Act planned to reduce the defense spending by $500 billion over the coming nine years. This has started to affected Boeing as its operating margins fell from 10.5 percent in the third quarter of 2012 to 8.4 percent in third quarter of 2013.
Fly with Boeing
Boeing has a huge amount of orders and that's what matters. High backlog, strong demand from emerging markets and an introduction of new planes mean that Boeing will keep jumping the price stairs in the future. The good problem of having too many orders should not make a big difference as majority of the customers are likely to wait than cancel orders, given Boeing's strong reputation for providing cost efficient aircrafts.