Boeing (NYSE:BA) shares are trading down 5% Wednesday morning as investors are disappointed by the company's guidance after a solid quarter (press release available here). BA shares are still up 77% over the past twelve months, so Boeing really had to report fantastic figures to keep the stock moving higher. Boeing continues to profit from increased airline profitability and a strong product portfolio led of course by the 787 Dreamliner and 777x. Thanks to these planes, Boeing has a backlog of $441 billion. In other words, Boeing likely could run its factories at full capacity for 5 years without receiving a single new order. Of course, Boeing continues to receive new orders, and last year received $135 billion. In reality, Boeing will be working down its backlog for 8-10 years as new orders keep coming.
In the fourth quarter, Boeing earned $1.23 billion or $1.61, which was up 26% from last year's quarter. Core earnings, which exclude pension fluctuations and one-time items, totaled $1.88 compared to $1.46 last year. This figure was far better than the $1.57 that analysts were looking for. Revenue rose by 7% year over year to $23.8 billion while analysts were looking for $22.7 billion. Seeing these strong results, it may be surprising that shares are down 5%, which is why it is important to look at guidance.
Management is guiding to core earnings of $7-$7.20 in 2014 while analysts were looking for $7.57. In 2013, core earnings were $7.07, so BA is essentially predicting no earnings growth this year. Revenue is expected to be $87.5-$90.5 billion while analysts were looking for $92.7 billion. Revenue was $86.6 billion in 2014, so BA is predicting paltry revenue growth of 1-4%. Now interestingly, Boeing is predicting a significant increase in commercial airplane deliveries. In 2013, the company delivered 648 planes compared to the 715-725 it is predicting in 2014. With this 10% increase, one would expect earnings to be higher.
In 2014, Boeing expects its commercial airplane division to generate $57.5-$59.5 billion in revenue while maintaining a strong operating margin of roughly 10%. It Defense, Space, and Security division, which is tied in part to U.S. defense spending, should generate revenue of about $30-$31 billion. For comparison in 2013, commercial airplanes generated revenue of $53 billion (up 8% year over year) while its defense unit had $33 billion (up 2% year over year).
So if we look at Boeing's results by segment, we can better see why the company disappointed analysts. Using the midpoint of guidance, Boeing's commercial unit will grow revenue by 10% in 2014, which is actually an acceleration from 2013's pace. This revenue growth also matches the growth in Boeing's deliveries. On the other hand, Boeing's defense unit will see revenue fall 7-10%. The U.S. continues to cut defense spending, which is a headwind for the unit. The Pentagon used accounting measures to delay the impact of the sequester, but the impact was inevitable. Even with the Ryan-Murray deal, defense projects were going to face headwinds in 2014. With the U.S.'s decade of war drawing down, this unit will struggle to grow appreciably in the next few years.
Given the headwinds from defense, does this sell-off make sense? Frankly, I think a 5% drop is too steep, and I used this dip to finally buy shares. At the midpoint of Boeing's guidance, it is trading at 18.3x 2014 earnings. Now given the fundamental strength at its commercial unit, I do think Boeing will come in near the top-end of its range. I also don't believe its defense and space unit is doomed forever. While budget constraints certainly pose near term headwinds, the U.S. will continue to spend billions on cutting edge defense technology while much of the emerging world like China and India are interested in space technology.
Boeing is also a free cash flow machine as it generated $6.1 billion in cash, and it has a pristine balance sheet with $5.7 billion in net cash. It is returning its excess cash to shareholders with a 50% boost to the dividend (now yielding about 2.1%) and a $10 billion buyback that should be completed within three years. With growing capital returns and a trailing 16x free cash flow multiple, Boeing is an attractive stock on a cash flow basis, especially because free cash flow should improve in 2014 thanks to the stronger performance in its commercial segment.
Boeing has a long runway for growth. With airlines more profitable than ever and cost-saving technology, its planes have unprecedented demand that the company cannot keep pace with. As a consequence, the company has a truly unprecedented backlog that will lead to strong revenue figures for years. The driver of Boeing's growth is its commercial unit, which should report another record year in 2014 while defense issues will take some time to subside. I would be willing to pay 20x earnings or $140-$145 for BA thanks to long-term growth prospects. Today's dip is a bump in the road in this commercial aviation super-cycle. I would recommend buying half a position today, and if broader market weakness sends shares lower, I would buy more to fill the position. That's my strategy.
Disclosure: I am long BA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.