Strong Quarter Makes Boeing Worth A Closer Look

Apr.23.14 | About: The Boeing (BA)

Summary

Boeing reported strong results, easily beating earnings estimates thanks to strong revenue growth and margin expansion.

The defense unit suffered a year over year decline but the pivot to Asia and a budget deal should help this unit stabilize next year.

Commercial aviation reported strong growth thanks to the 787 and is successfully ramping production.

The backlog stands at $440 billion, which will propel years of revenue growth.

Boeing's fair value is roughly 20x earnings or $144-$148.

After reporting quarterly earnings Wednesday morning, Boeing (NYSE:BA) shares popped nearly 3%. Boeing delivered strong results, which should alleviate some concerns after Boeing reported a mixed quarter in January. Boeing may seem a bit expensive at around 17-18x 2014 earnings, but this premium multiple is appropriate. Thanks to consolidation, airlines are finally consistently profitable, which increases their capacity to buy new planes. Amid this aerospace super-cycle, Boeing has developed innovative planes like the Dreamliner 787 that will generate significant fuel savings. As a consequence, Boeing's backlog extends for about five years. Boeing will be growing revenue and profits for several years thanks to its strong position in the aerospace market.

In the quarter, Boeing earned $1.76 compared to expectations of $1.56 on revenue of $20.46 billion, which was $100 million lower than estimates (financial and operating data available here). Still, revenue was up 8.3% year over year despite headwinds from its defense unit as the Pentagon cuts spending amid budget constraints. Core operating earnings were up 12% to $2.095 billion thanks to strong margins. Boeing has promised to expand margins, and we are seeing progress on this front with an operating margin of 10.2% vs. 9.9% last year. While defense faces secular challenges, Boeing's commercial division performed very well, growing revenue by 19% and operating profits by 23%.

The commercial unit now accounts for about 62% of Boeing's revenue and 72% of its operating profits. Boeing is increasingly focused on commercial aviation rather than defense contracts. Given strong airline profitability and constrained budgets, this is a positive development. Strength at commercial aviation will more than offset any weakness at defense. At the same time, 2014 will likely be the bottom for Boeing's defense unit. Last year's budget deal should give the Pentagon a bit more flexibility going forward, which should help BA.

Investors should have no illusions though. Defense spending over the next decade will not be as robust as it was over the past decade when the U.S. was engaged in two wars in the Middle East. Years of high growth from this unit are in the past. Still, Boeing should be able to weather budget constraints better than other contracts. With the winding down of Middle East involvement, the U.S. is focusing its military power on a pivot to Asia to contain a rising China. This theater will require an increased focus on naval and air spending rather than ground technologies. This strategic pivot will leave Boeing in a better strategic position than some other defense contractors. While I don't expect defense to contribute growth, it should cease to be a drag in 2015.

While defense is muddled, the news from commercial aviation is great. On top of the revenue growth, margins expanded from 11.4% to 11.8%. There has been some concern that Boeing would not be able to increase production to meet growing demand. Boeing has promised to expand its capacity and increase deliveries. We are seeing progress on this front with 161 deliveries compared to 137 a year ago. At the same time, Boeing booked a net 235 orders. Boeing continues to book more orders than deliveries, which extends its backlog even further into the future. Boeing's commercial backlog now totals 5,100 planes worth $347 billion. With continued strong order trends, Boeing is poised to be running its factories at full capacity for the next 8-10 years.

With margin expansion, delivery growth, revenue growth, and a growing backlog, Boeing reported great results that portend continued growth for several years. That backlog provides Boeing with stability and growth. Thanks to $19 billion in net new orders, the total backlog stood at $440 billion in the quarter. The biggest risk to Boeing is on execution in expanding production to eat away at that backlog. We are seeing progress on this front with 161 deliveries in the quarter. Thanks to a favorable tax item, Boeing is guiding to $7.15-$7.35 in the quarter, but analysts are looking for $7.38. This is the perfect example of management under-promising and over-delivering. After this quarter, I expect Boeing to earn at least $7.40 on revenue of $90-92 billion.

Boeing also has a pristine balance sheet with $12.2 billion in cash against $8.9 billion in debt. The company also generated $615 million in the quarter; investors should also be aware that the first quarter tends to have lower cash flow due to the timing of receivable payments and interest expenses. Boeing was also active in market, buying back $2.5 billion in stock. Boeing has $8.3 billion left on its authorization, which was planned to extend for two years. The pace of buybacks will likely be slower going forward, and Boeing also pays a nice $0.73 quarterly dividend. With a solid balance sheet and strong cash flow, BA will return significant cash to shareholders over the next few years. Boeing reported strong results and has years of revenue growth in the future. At $130, I would be a buyer. Boeing should trade 20x earnings or $144-$148.

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.