Boeing (BA) had an unpleasant surprise for its investors when reporting its fourth quarter results. The plane maker issued a cautious guidance for 2014 as the company is not immune to recent foreign exchange volatility with a huge portion of its backlog located in emerging countries.
Despite a recent 10% sell-off and long term headwinds I remain cautious given the relatively high valuation and short term headwinds.
Key Numbers For Fourth Quarter
Boeing reported revenues of $23.78 billion for the final quarter, up 6.6% on the year before.
Reported GAAP earnings rose by 26.1% to $1.23 billion. GAAP earnings rose by a similar percentage towards $1.61 per share.
There is nothing wrong with the top line growth as reported by Boeing driven by the solid backlog. Yet Boeing's final quarter was a bit of a disappointment with core operating earnings reported being stagnant.
As a result, operating margins fell by 50 basis points to 7.7% of revenues. Full year operating margins did see improvements, increasing by 30 basis points to 9.1% of total sales.
On a GAAP basis, the picture was even worse. Operating margins fell by 90 basis points to 6.4% as operating earnings fell by 7% to $1.52 billion. The only reason why GAAP earnings rose is due to lower tax expenses which fell from $557 million last year to $201 million.
Reasons for the margin pressure was a $406 million non-cash charge related to settle A-12 litigation, dated back as long as 1991. Adjusted for this operating margins were stronger, although the charge was the major driver behind the lower tax rates, limiting the net impact of the litigation to $0.06 per share.
Looking Into 2014
Boeing foresees full year revenues of $87.5 to $90.5 billion for 2014, up 9.0% at the midpoint of the guidance. While this looks impressive, analysts were looking for revenues of $92.7 billion.
Core earnings are seen between $7.00 and $7.20 per share, which is very disappointing. Keep in mind that Boeing reported core earnings of $7.07 per share for 2013 and analysts were looking for earnings as high as around $7.50 per share.
GAAP earnings are projected to come in between $6.10 and $6.30 per share, up slightly from reported earnings of $5.96 per share in 2013.
Commercial airplanes revenues are seen between $57.5 and $59.5 billion as deliveries are seen between 715 and 725 planes with operating margins seen around 10%.
Total defense, space and security revenues are projected between $30 and $31 billion, resulting in operating margins of 9.5%.
Besides issuing a disappointing guidance for revenues and earnings, the cash flow generation forecast came in below estimates as well. Operating cash flows are seen around $6.25 billion next year, far below estimates of $9 billion. As a result, the pace of repurchases and dividends will exceed the target of 80-85% of operating cash flows.
Investors Are Adjusting Expectations
Even when factoring in Wednesday's correction, shares are still up more than 70% for the year, despite a recent 10% correction. The continued growth in the backlog and stronger conversion into actual revenues pleased investors.
Yet this momentum pushed up expectations a lot and the guidance for next year is a bit soft, especially in terms of earnings. Momentum has also been pushed up by management itself, increasing payouts to its investors. The board recently hiked its dividend by 50 percent to $0.73 per share, for a yield of 2.2%. Repurchases of $2.8 billion last year provide investors with another 2.9% yield, for combined payouts of 5% per annum.
At $130 per share, the market values Boeing at $97 billion. Note that Boeing has a very solid financial position, with access to more than $15 billion in cash and equivalents, operating with a net cash position of $6 billion.
Based on 2014's guidance, with operating assets valued at $91 billion, Boeing is valued at 1.0 times annual revenues and 20 times GAAP earnings.
Takeaway For Investors
I concluded for a long time that Boeing is facing serious tailwinds in the coming years, with the backlog increasing to a record $441 billion after receiving net orders of $135 billion last year. Yet too much of a backlog is not great either as clients might become inpatient, cancel order or require greater discounts.
With the progress being made in converting backlog into actual current revenues investors were very happy over the past year. This is certainly the case as this was accompanied by solid margin expansion. High profile issues with the 787 Dreamliner over the past year did not change this.
The strong bargaining position of the firm in a still weak economy allows Boeing to play out States against each other to seek out the best incentives, tax discounts and subsidies for future factory builds.
Despite the strong payouts, equivalent to 5% of the current market capitalization, the strong financial position and long term headwinds, I remain cautious. The strong momentum pushed up the valuation to 20 times earnings for 2014 which is a bit steep, despite the long term favorable trends.
The soft outlook for 2014 is attributed to some as Boeing being conservative, yet notice that Boeing is not immune to recent foreign currency volatility, having about at third of its order book located in emerging markets. Severe currency swings have huge implications for the effective purchase price for the clients.
While the recent correction made shares a bit more attractive, I remain cautious and stay on the sidelines. There current valuation is still a bit too steep for me.