Bullish On Boeing For Income And Price Appreciation

| About: The Boeing (BA)

Summary

BA has dropped to a low relative valuation despite its exalted status as a Dow 30 stock.

It has become friendly to income-seekers, with a high dividend payout compared to prior periods.

Given those considerations, its exact place in its business cycle is less important to me than usual.

I now see it as a strong candidate for steady and probably rising, and competitive, income.

In addition, BA may provide swing or other types of traders with nice price appreciation should Mr. Market see things my way in the next year or two (or sooner).

Background

One of the nice things about investing in DJIA (NYSEARCA:DIA) stocks and other well-known names is that one does not necessarily have to be an expert in their fields to want to own the stock. That explains how I look at a hot IPO shortly before the crash of 1929, Boeing Company (NYSE:BA).

Everybody knows Boeing, every investor in America has trusted their lives to their aircraft at least once, and some of our national defense comes from BA as well. Plus every investor who's been in the market as long as I have knows BA stock and has a certain comfort level with it.

BA is celebrating its first century of existence. It was formed in 1916 as the Pacific Aero Products Co., changing its name to reflect its founder the next year, to the Boeing Airplane Co.

As is the even older Deere (NYSE:DE), BA is one of an elite group of large companies at least 100 years old that continue to operate only in its original business or closely related ones.

Anyway, BA has accomplished something unusual, namely in one of its two major business lines, commercial aircraft manufacturing, it has remained dominant or codominant while remaining solidly profitable over a full cycle. This stands in stark contrast to another century-old single-business line company, Ford (NYSE:F) or obviously GM (NYSE:GM).

That leads to the investment theses.

The case for BA now for income-oriented investors or swing traders

I see two interlocking major arguments for BA.

One is that it is about the most attractive yield vehicle around (pun intended).

The other is that even though it is a cyclical with only a 35th percentile ranking for earnings predictability, over the longer haul, a growing world population will provide growing opportunities for BA's commercial operations; and the military and space systems business and servicing business is likely to grow, as well. Tied in with that are the concepts that while BA's financial position has some warts, it's generally strong; and the barriers to entry in its fields are formidable. Thus the long-term bull thesis is that BA can get away with 4% or less spending on R&D as a percentage of sales, thus allowing it to profit even with moderate operating margins around 10%.

The above reasoning suggests that BA can maintain its dividend in anything but the most severe recession (depression), and over time grow the dividend due to real growth and inflation.

The above arguments for BA are different from those for it that I can remember, so next I want to look at the stock somewhat differently than a traditional analyst would. For anyone unfamiliar with its basic earnings and balance sheet presentation, backlog, etc., its Q1 earnings news release is summarized as follows:

  • Revenue increased to $22.6 billion
  • Solid core EPS (non-GAAP)* of $1.74 after $0.24 KC-46 charge; GAAP EPS of $1.83
  • Strong operating cash flow of $1.2 billion; repurchased 28.6 million shares for $3.5 billion
  • Backlog remains robust at $480 billion with over 5,700 commercial airplane orders
  • Revenue, margins, EPS and operating cash flow guidance reaffirmed

As a purist in these matters, it's always nice to see GAAP EPS exceed non-GAAP. Probably, the most bothersome part of the entire presentation relate to the post-retirement significant liabilities, as shown in the balance sheet (p. 9):

Accrued retiree health care

6,614

6,616

Accrued pension plan liability, net

18,196

17,783

It's something to watch.

Assuming a terrible economy doesn't bite the company, next I want to make the case for BA as a timely investment for many investors. I may not be unique in that I loaded up on Treasury bonds some time ago, but just sold most of them in the past week for trading profits, given the pitiful fixed rate yields they have now descended to. Here's why I like BA as part of the foundation of a new strategy to generate total return alpha with reasonable safety.

BA as an undervalued yield and price appreciation play

I like investments where both the yin and the yang work. This looks like such a case.

In one scenario, BA at $130 has a current yield of 3.35%. This is 200 basis points above that of the 10-year Treasury bond and is roughly similar to the yield on a Microsoft (NASDAQ:MSFT) corporate bond going out to around 2039.

This yield advantage, reflecting BA's willingness to return cash to shareholders in greater amounts, represents an appropriate move in view of today's interest scenario and is atypical of BA. For example, at the peak of the last economic cycle (we may have passed the peak of the current one), BA had an average dividend yield in 2007 of only 1.5% (Value Line data). Probably the 10-year T-bond averaged around 5% for that year. No surprise, over the next couple of years, the bond far outperformed BA.

However, BA has solidly beaten a long-term T-bond fund (NYSEARCA:TLT) over the past 10 and also 5 years.

Now, with a strong yield advantage, BA should be well supported if global economies weaken further as investors have already bid up the usual yield stocks such as utilities (with no growth) and soap and soda stocks to vastly higher P/Es than BA.

Advancing the argument, it's not just that the yield is fully competitive with utilities (NYSEARCA:XLU), it's that the P/E is lower with higher prospective growth. So in a highly-valued stock market, for some reason BA, with its high investment-grade ratings, trades at a significant discount to the S&P 500 (NYSEARCA:SPY). The SPY is at about 24X TTM GAAP EPS; BA is at 17.6X. BA is also expected to earn about $8.50 per share this year, putting it at only 15-16X this year's expected earnings.

Per Value Line and other data, normal for BA is more like 18-20X EPS.

GAAP EPS to GAAP EPS, BA compares extremely well to every Big Pharma company on a P/E basis. It also has a stronger 10-year chart pattern, and a solid and comparable yield. And no one is complaining to his or her congressperson about the cost of airplanes the way they complain about the cost of drugs.

Strengthening the thesis that BA is relatively undervalued is the Value Line observation that since 2004, BA has tracked Value Line's measure of its cash flow per share at 11X. With Value Line projecting cash flow of about $12.40/share this year, BA is very slightly undervalued. Should Value Line and Street consensus be more or less on target for 2017, cash flow around $14/share next year suggests a trading price around $154.

Why $150+ is a reasonable price target for BA

Both technically and fundamentally, I like this goal, potentially for next year but if not, time should be on the side of the patient here.

Technically, BA burst to a high of $142 back in 2013, set a slightly higher the next year, then set its all-time high above $156 last year.

This year's dip as low as $102 on some negative news regarding its military refueling project and general bearish market sentiment not only undid 2 1/2 years of price gains, but brought BA below its prior cycle high just shy of $108 in H2 2007. The company only earned $5.26/share that year, though, on revenues of $66.4 billion.

This year, we are looking at EPS of $8.50 and revenues of perhaps $94 billion.

So, technically, BA at $130 is below a price it reached in 2013 when EPS were just reaching all-time high territory at $5.96/share. The record EPS expected this year and record revenues per share (though not record revenues) should be enough to allow the stock to ascend above its 2013 highs by next year, if not this year.

If current Street estimates for $9.50/share next year are more or less on target, a 15-16X P/E as a late cycle discounted P/E looks about right to me for a blue chip Dow 30 stock.

Longer term, here's why I think BA will "be there" to participate in global growth for years to come.

There's always more need for new planes

A news article over the weekend explains why I'm not overly upset by details such as write-offs from the KC-46A program, the usual "spy-vs.-spy" battles with Airbus (OTCPK:EADSY), a little competition again from Bombardier (OTCQX:BDRBF), etc.

Military, aerospace, and the higher-margined servicing business can grow endlessly. The competitive and perhaps (much) more cyclical commercial segment appears to be on to something very interesting that just might calm anxious shareholders if a downturn occurs. From Bloomberg News:

Boeing Sees Airline Thirst for New Mid-Range Jetliner Family

Boeing Co. is seeing strong airline interest in a new mid-range aircraft on its drawing board, bolstering the case for its biggest potential product development of the next 10 years.

Let me stop here and comment. What I see happening in this stock market cycle more than ever is support for great names such as BA. Meaning, this sort of headline can be key to the bulls who need something in their investment meetings in case business softens for BA due to recession or a bit of a price war. They can point to this sort of thing as a reason to stay the course; don't sell when the stock is down; it always comes back.

More details:

No current-generation aircraft are specifically designed for long flights within a region, like the seven-hour trek from Tokyo to Singapore, said Ray Conner, chief executive officer of Boeing's commercial aircraft unit, told reporters at a Sunday briefing ahead of the Farnborough International Airshow in the U.K.

"There is clearly a market desire or need," Conner said.

And it's not as if just any old company such as Bombardier can come in and take this business. Much as Apple (NASDAQ:AAPL) goes out and creates, or helps its suppliers create, special parts for its devices, so does BA. As the article continues:

For more than a decade, Boeing has studied a series of aircraft options for addressing the so-called middle of the market -- a relatively untapped segment where Europe's Airbus Group SE is starting to extend its reach. But after intensive conversations with leading airlines and lessors, the U.S. planemaker sounds increasingly confident that it's close to a solution.

Boeing would probably use carbon-composite wings, new flight systems and other leading-edge technology, while attempting to use a streamlined production system to churn out the aircraft on a scale large enough to cover its costs and keep pricing affordable.

When investors see that there is a problem needing a solution, I trust a name like BA to make it happen. Of course, at some point, reality may intrude adversely. The attempt "to use a streamlined production system" may flounder. Etc.

But my investment case is that on a relative basis, BA has been overlooked for partly ephemeral reasons.

That brings on an eclectic discussion of risks.

Risks to the bull thesis

A rising rate, rising inflation recessionary cycle a la the 1970s would "put paid" to this bullish thesis. So, of course, would a very severe recession or outright global depression. But then, countless bull theses would be destroyed, at least cyclically.

Most fundamentally, I do not love BA's retiree healthcare and pensions being actuarially unsound to the amount of around $25 billion. If the company earns $6 billion next year, those liabilities equal about 4X that record earnings.

Also, and importantly, I'm cautious about the stock market for the next couple of years, looking for a resumption of the Presidential cycle no matter how the election turns out. That cycle "works" more often than not and tends to churn out playable market bottoms in the summer or fall of the second year of the first term of a new President. That would make H2 2018 a target time to buy stocks aggressively no matter where they are trading. And with valuations stretched, we will just have to see what the actual price of the SPY and DIA are.

Of course, this is just a small summary of all the risks to this stock. The company's regulatory filing lists a much more comprehensive group of reasons to avoid this stock. No matter that it's a "blue chip," it's not dirt cheap and permanent loss of capital can accrue from purchasing it.

Summary - BA poised to come back into favor

This stock has underperformed TLT the past 1 and 2 years. That's very interesting given it has beaten it the past 5 and 10 years, and now out-yields TLT by perhaps the greatest amount ever, perhaps leaving aside the bottom of a crash such as late 2008. In addition, BA has a notably lower P/E than the SPY and a notably higher dividend yield. So there are a number of valuation metrics that could snap back toward their prior, seemingly more "normal," relationships.

Under normal monetary circumstances, I wouldn't be owning BA at this valuation and planning to buy more as soon as Monday with some of the cash generated by selling Treasuries. However, no matter how much we do not like owning cash or investment-grade bonds at today's yields, well, here we are. I do like extra cash with a patient approach here on a 1-2 year basis, but it's not good to over-time a market.

I would see BA as having strong investment attributes both for buy-and-hold investors. These investors can simply "put it away" and hope/plan for the dividend growing at a reasonable rate. Eventually a large chunk of the value of the stock will come back as dividends, and the stock could be trading (much) higher as well at this unknown future date.

I also like BA for shorter-term investors who are looking for a swing trade. If my thesis is correct, then investors in the wild utilities sector will trade out of it into BA. There are higher-yielding names such as auto stocks, but there is no duopoly in auto manufacturers as there is in commercial airliners. Plus, the enterprise value of F and GM is much higher than their market cap; they are not nearly as cheap as they appear. BA, meanwhile, has an enterprise value very similar to its market cap.

I'm prepared for the DIA and SPY to reverse downward as they have done in the 8th year of the last two President's terms. P/Es in the 24X range have never been sustained before, and if they come down, probably BA's P/E will come down as well. However, if that happens, the dividend will likely be safe and eventually, the market and the business cycle will turn. Then, a rising dividend could be enjoyed and eventually a strong total return can await. That's at least the thesis.

In conclusion, BA may be an attractive substitute for bond investors given its yield advantage, and its potential for a generally upward pace of profits and dividends for many years. Unlike a bond, it can prosper and grow its profits and dividends if inflation comes back sooner than the bond market "thinks." Thus it can be much more than a bond substitute, should a rising rate scenario finally become reality, not merely transitory.

So I see several ways for this stock to do well for investors able to hold it should the market head south but the general investment thesis does not change much on a company-specific basis.

Thanks for reading. I look forward to your views should you care to share them.

Disclosure: I am/we are long BA,AAPL.

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.

Additional disclosure: Not investment advice. I am not an investment adviser.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.