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Summary

  • Boeing is a highly profitable, financially sound business that has the potential to be a strong income play.
  • It holds its own compared to sector peer, Northrop Grumann, although Northrop has better growth prospects and more income potential.
  • The current valuations of the two companies indicate that Boeing is overpriced relative to its rival and could underperform Northrop going forward.

In this article, we focus on the strengths and weaknesses of Boeing (NYSE:BA) and compare it to Northrop Grumman (NYSE:NOC). We decided to compare Boeing to Northrop because they share the same GICS sector of industrials as well as the same GICS sub industry of aerospace and defence. Although there is a sizeable difference in their market caps (Boeing's is $88 billion while Northrop's is $26 billion), they are two of the biggest defense companies in the world and, with defense remaining a popular space for investors, a comparison seems worthwhile. We also know that many investors apportion their capital based on sector classification, so we thought it would be a useful comparison. We hope you enjoy the article and are always open to your suggestions on future companies to focus on and their respective comparisons.

Profitability

When researching Boeing, the standout feature for us is just how profitable the business is. Indeed, last year Boeing was able to deliver return on equity of 46%. That's a highly impressive number and what makes it even more so is the fact that Boeing utilizes only moderate leverage on its balance sheet, with the company's debt to equity ratio being just 63%. Therefore, we feel that there is scope for more leverage to be used - especially when interest rates are so low - so as to further improve the company's profitability.

While Northrop's return on equity looks rather low compared to Boeing's at 21%, it edges out its sector peer based on operating margins and return on assets, having 13% operating margins versus 7% for Boeing and 9% on return on assets versus 4% for Boeing. Despite the impact of sequestration, both companies are still able to turn a tidy profit for their shareholders.

Strong income plays?

Indeed, making a profit isn't all Boeing is good at. It's also good at retaining it and using it to reinvest in the business on research and development activities, with 62% of profit being retained within the business. So, with a payout ratio of just 38%, we were surprised to see that Boeing yields 2.2% at the moment, which is higher than the S&P 500's yield of 2.1%. Clearly, there is scope for Boeing to increase dividends per share, so while it doesn't hit the 3% level that many income-seeking investors look out for, it could be a promising income play.

Northrop, meanwhile, pips Boeing on the yield front as its yield is 2.3%. However, its payout ratio is even lower at 27%, which tells us that it has the potential to become a much more obvious income play as it continues to mature.

Surprising growth prospects

Although neither company is particularly viewed as a strong growth play - especially since we're in the midst of sequestration - they are both forecast to deliver earnings growth next year. On this front, Northrop impresses again as its EPS is due to increase by 7% next year. This is higher than Boeing, which is forecast to see the bottom line push upwards by 4%, and shows that a little more investment from Northrop (as mentioned) could be aiding the company in its search for bottom line rises.

Valuation issues

Turning to valuation, we're slightly surprised to see that Boeing trades on a much higher P/E (TTM) than Northrop. Sure, both companies are highly profitable, have reasonable growth prospects, are only moderately leveraged and yield roughly the same amount, but we didn't expect Boeing's P/E to be 21 versus Northrop's 14. That means that Boeing's P/E is 50% higher than its sector peer, which in our view, seems rather too much. We do concede that Boeing may prove to be more stable due to its traditionally greater focus on civil aviation, which is performing far better than its military cousin, but Northrop's growth rate forecasts are higher than Boeing's. As such, we feel that Boeing could underperform Northrop going forward, as the market reacts to a potential mispricing between the two companies.

Conclusion

We feel that Boeing has a number of merits, including strong profitability, reasonable growth prospects, a sound balance sheet, as well as the potential for a higher yield. However, we find it difficult to justify the current P/E premium versus Northrop, which is also highly profitable, has a higher yield, better growth prospects and an equally resilient balance sheet. As a result, we feel that Boeing could underperform Northrop going forward as investors react to what we feel is a mispricing in the valuations between the two companies.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.

Source: Why We Think Boeing Could Lose Out To This Sector Peer