Boeing: Worth $150 Despite Messy Earnings

Jul.24.14 | About: The Boeing (BA)

Summary

After a closer look, a tax item made Boeing's quarterly numbers better than recurring results, but it still raised full-year guidance.

Defense remains weak due to constrained defense budgets, and Boeing cannot let cost overruns continue.

Commercial aviation is very strong, and the backlog hit a new record high.

With solid growth and a large backlog, Boeing should trade towards $150.

With a backlog that extends for seven years, Boeing (NYSE:BA) is the ultimate buy and hold stock. Unless investors believe that there will be mass cancellations or that production costs are getting out of control, the best strategy is stay long Boeing through periods of turbulence, which is what investors have experienced lately. As of right now, the two doomsday scenarios seem unlikely. The economy is relatively strong, and the commercial airliners are more profitable than ever thanks to consolidation and capacity cuts. Boeing has also been cutting costs as it ramps production, which will lead to gradually rising operating margins. Still, Wednesday's, $3 drop was definitely a bit jarring, especially as headline results appeared solid. A closer look does show that report was flawed; nonetheless, this drop was a bit overdone, and Boeing remains a rock solid investment, even if near-term trading stays a bit volatile.

In the quarter (financial and operating data available here), Boeing earned $2.42 on revenue of $22.05 billion compared to expectations of $1.99 on sales of $22.5 billion. In other words, there was an EPS blow-out on light revenue. Whenever this happens, there is a good chance there were one-time items that are making numbers a bit less comparable. Boeing got $524 million in favorable tax settlements in the quarter while it had a one-time after-tax charge of $272 million ($400 million pre-tax), relating to a wiring problem on a government contract. Net these out, and one-time measures added $0.34 to EPS. That brings earnings to $2.08, which is much closer to consensus and a better indicator of income from core operations.

Within Boeing, there continues to be a tale of two cities with commercial strong and defense weak. As I prefer starting all things with the bad news, let's begin with defense. Defense revenue dropped 5% year over year to $7.7 billion with services the laggard down 8%. The fact is that government budgets are constrained by years of deficit spending. Additionally, the U.S. is in the process of ending wars in Afghanistan, which cuts the need for defense spending. While issues like the crisis in Ukraine are proof defense capabilities are important, budgetary pressures are likely to remain for some time. I expect this unit to continue to decline for at least 12 months.

The defense backlog is $63 billion, or about 2 years of revenue. 36% of this backlog comes from overseas, and 64% from the United States. While it is mildly diversified, Boeing's business is very dependent on U.S. defense spending, which will remained constrained for the foreseeable future. Investors should also not dismiss the $400 million charge on the government tanker project. This was a large charge for a program still in its infancy, and further cost overruns could eliminate the profitability of this revenue. Boeing insists it was a one-time problem and will not be like the Dreamliner 787, which faced years of delays and overruns before finally launching, albeit to massive demand that still made the 787 a great project. In an era of lower defense budgets, Boeing simply cannot afford to erode margins in the contracts it still has.

While the defense business is weak due to secular trends and an operational mishap, commercial continues to perform well thanks to the 787 and 777, which have taken market share back from Airbus thanks to fantastic fuel efficiency. Commercial revenue was up 5% to $14.3 billion and now accounts for nearly two-thirds of Boeing's sales. Earnings were up 7% thanks to a 0.1% increase in operating margins to 10.8%. Deliveries also climbed 7% to 181 planes. The company also booked 264 net orders during the quarter, bringing its backlog to a record $377 billion. Furthermore, Boeing performed well at the air show in July, which likely will push the backlog past $400 billion next quarter. Boeing continues to increase the rate of production, leading to margin expansion and revenue growth. Yet, its backlog continues to grow, and Boeing will likely be running at capacity for a decade in this business.

During the quarter, Boeing generated a solid $1.8 billion in operating cash flow and $1.36 billion in free cash flow. For the full year, Boeing is on track to generate $7 billion of cash, and it is aggressively returning capital to shareholders. The company repurchased $1.5 billion in stock, and it's quarterly dividend costs about $500 million. With $11.3 billion in cash, Boeing has the financial strength to continue returning capital while reinvesting in its business. Management expects to exhaust the remaining $6.8 billion in buyback authorization over two years. Frankly, I would like to see the company add a bit of debt and accelerate this program but respect its financial discipline.

Boeing did raise guidance for the full year to $7.90-$8.10 from $7.15-$7.35 while expecting to deliver 715-725 planes and 110 Dreamliners. In reality, the EPS increase of $0.75 is overstated as it received the $408 million tax benefit. Negating this, Boeing still increased guidance by $0.20. Excluding this item, core EPS will be $7.35-$7.55, and I expect the company to come in at or near the high end. This quarter was a bit messy, and defense is problematic, but commercial aviation continues to grow and 787 production is ramping. With its massive backlog, BA will generate 8+% earnings growth potentially through 2020. With its growth and revenue certainty, I would be willing to pay upwards of 20x or $150, and at current prices, BA is a great long-term investment.

Disclosure: The author is long BA. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.