Boeing: Stabilizing Operating Margins Through Timed R&D Expenses?

Aug.10.14 | About: The Boeing (BA)

Summary

R&D is up in quarter 2 after a strong downwards trend.

Operating margin is incredibly consistent if we believe the timing of R&D.

More shares were repurchased in the last 2 quarters than the previous 3 years.

Boeing (NYSE:BA) was a great stock to own in 2013, but is it really that much better now than it was in 2012? Can it justify the price increase? To get a better feel for the stock, I'll break it down with a 5 step DuPont Analysis and then dig into the capital structure to see how the business is operating at a structural level.

Click to enlarge

Tax Burden

The tax burden is clearly fluctuating significantly. Rather than relying on EPS / Net Income, I'd normalize for taxes. The jumps up and down in the tax margins are too large to rely directly on the income statement. However, the average tax rate of Boeing is not low, except in the most recent quarter in which it was absurdly low. That's not going to last.

Interest Burden

The interest Boeing is paying out (netted against other income) is decreasing as a percentage of operating income. It won't keep going down forever, and you wouldn't want it to. Some debt in the capital structure is healthy.

Operating Margin

The operating margin looks very steady, but it isn't. It's just timing expenses through the magic of accrual accounting. You should notice two things in this next table.

Click to enlarge

First, you can see that operating margins are not as stable when we calculate them without R&D factored in as an expense. If R&D was being capitalized, the operating margins are not stable. Instead, the good periods for operating margin are assigned a significantly higher portion of the R&D costs. It could be a coincidence that R&D spending happens to spike in the same time periods as operating margins, but I doubt it. I think they are keeping the R&D expense off the income statement until they have a good period and then passing a large chunk of R&D through it. That way the margins look stable and they are still recognizing the costs.

Second, you can see that prior to this period, R&D was trending down. Unfortunately, we can't tell if R&D actually picked up in this quarter as the company decided to seriously invest in it, or if this was just the quarter with the good margins that could eat the expense.

Asset T/O

The levels of turnover aren't bad, and they've been pretty steady except for a first quarter that was light on sales. No major concerns here.

Leverage Ratio

The leverage looks absurd, but it's just the results of accounting with book value. We do notice immediately though that there is substantially more equity on the books now than a few years ago. Looking a little deeper into the leverage, we can examine the shares outstanding and their relationship with cash and book values.

The number of shares outstanding has been trending down. Cash has also been trending down. In 2013 they spent 2.8 billion on share repurchase. In the first quarter of 2014, they spent 2.5 billion. In the second quarter, it was just shy of 1.5 billion. On one hand, I think this is good for their capital structure. On the other hand, if management really knows what will impact their business, they could have repurchased these shares at dramatically better prices a couple years ago. If you look at their financial statements, you'll find they are very stingy with the information about how many shares they have repurchased. Weighted averages are much more accessible than precise amounts from the balance sheet date. Most companies make both readily available.

How much leverage do they really have?

Using the market cap as a proxy for equity, instead of book value of equity, it appears they are running about 14 to 15% of their business on debt. I'd prefer a little more, but perhaps they are using equity rather than debt because they don't want more fixed costs. That would make sense if the operating margins are volatile and they are just controlling them by timing their expensing of R&D. Here's the table using market cap:

Click to enlarge

Conclusion

Aside from the tax rate spiking all over the place and the potential timing of R&D expenses, the interest burden and asset turnover ratios have been fairly steady. It may be hard to believe that they were in such a rough position only a few years ago. The forward P/E (based on forecasts) is about $14.1, while the trailing P/E is at $20.65. In short, analysts are projecting a significant amount of growth. If you believe that those growth forecasts are accurate, the company is a great buy. Without the growth, the company does not even come close to justifying its price. The trends haven't given me sufficient evidence to believe the analysts, but they also aren't disproving them. I have a slight bearish slant for one reason. The growth in dividends feels too large. To me, it feels like the company may have run out of good things to invest in. If they are paying that money out in dividends, I don't think they will have enough money left to fund the growth needed to justify the stock price. On the other hand, if this was part of a long-term strategy to increase borrowing and modify the capital structure through financing the growth with low interest rate debt, I could get behind that. For now, I'm not convinced.

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.

Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from either Yahoo Finance or the SEC database. If either of these sources contained faulty information, it could be incorporated in our analysis. The analyst holds a diversified portfolio including mutual funds or index funds with long exposure to the stock.