Trump May Bring Turbulence To Boeing

| About: The Boeing (BA)

Summary

BA's share of China's $1 trillion aircraft market is at risk.

A stronger US dollar makes BA aircraft less competitive.

Higher interest rates makes aircraft more expensive to finance.

Boeing (NYSE:BA) is an American brand that has the dominant market share in a duopoly with Airbus (OTCPK:EADSY) (OTCPK:EADSF). The Company, boasting a $93 billion market cap, is up 8.3% year-to-date. Since November 8 (immediately prior to the US election), BA has underperformed the S&P 500 by about 2%, increasing 5.5%. The DJIA, of which BA is a component, is up 4.5% during the same period.

Click to enlarge

Source: Yahoo Finance

The Company competes and is profitable both in the commercial airplane (68% of revenues and 43% of profits - 9 months ended September 30, 2016) and defense (32% of revenues and 57% of profits) segments. As such, the Company both has risks (higher dollar and interest rates, negative impact of anti-trade actions) and opportunities (expected higher defense spending) from the policies (real and perceived) of President-elect Trump.

BA's forward multiple is 16x and the Company's PEG (PE/5-Year Growth Estimate) is 1.65. These ratios are reasonable if growth continues and would be considered overvalued if growth falters. Earnings estimates have actually ticked up, to a projected $9.39 in fiscal 2017, from $9.37 30 days following the election. As outlined below, the lack of material change in these estimates suggests the negatives for BA associated with the Trump Presidency may not have been fully assessed.

Trade Barriers and Tariffs

While running for office, President-elect Trump's platform loudly called for tariffs and competitive retaliation against both foreign countries and companies. As has been widely reported, President-elect Trump has vowed to name China a "currency manipulator" and has threatened to impose 45% tariffs on imports from the country.

BA notes that it derives "70% of commercial airplane revenue (historically) from customers outside the United States." BA recently forecast that China (domestic airlines) is expected to purchase 6,810 ($1.0 trillion) planes over the next 20 years. Currently, as reported by Bloomberg, BA earns about 12% of annual revenue from China.

If the Trump administration follows through on its threats, China, would almost certainly retaliate against the US in general, and iconic brands like BA (and Apple (NASDAQ:AAPL)) would serve as highly visible scapegoats. The China Times, as reported in HotHardware.com, noted "China is willing to use the nuclear option with regards to trade... a batch of Boeing orders will be replaced by Airbus... US auto and iPhone sales in China will suffer a setback." These are not idle threats; in 2014, amid US charges of Chinese hacking, China aggressively retaliated against Cisco (NASDAQ:CSCO) and IBM (NYSE:IBM).

To placate Chinese authorities, BA announced a plan to open a plant in China (Airbus already has an assembly facility in China); Trump denounced this move. Speaking of the Trump risk to BA, aerospace consultant Kevin Michaels notes, "Boeing has to be as worried as anyone... it would be horrible and a huge boom to Airbus."

While the above discussion focuses on China, other countries are likely to use influence with their national carriers to shift aircraft orders if the US imposes tariffs on imports.

The impact on revenues from trade retaliation is hard to predict; it is almost impossible to envision a scenario where increased tariffs and/or a trade war would be anything but materially negative for BA.

While not strictly related to trade policy, BA's recently announced letter of intent with Iran, worth up to $25 billion, would also be at risk from changes in the US-Iran relationship. President-elect Trump has spoken frequently about his displeasure with the Iran nuclear deal. Iran would almost certainly retaliate against the US (and BA by extension) in the event the agreement is unilaterally changed.

Currency

While not as dramatic as the rise of the US dollar in 2014, the US dollar has appreciated about 4% and 6% against the Euro and Yen, respectively, as well as against other relevant currencies in the post-election period. While BA typically prices its aircraft in US dollars, foreign buyers must convert their currency into dollars, effectively making US dollar products materially more expensive in a rising dollar environment.

Source: Investing.com

Unlike other exporters, the impact of a strong US dollar on BA will be seen indirectly in the form of reduced sales (as prices rise) and/or lower margins (price cuts to hold market share) as opposed to a loss on currency translation.

The strong dollar is not expected to be a short-term phenomenon. As noted in the Wall Street Journal, multiple analysts, including Citibank and Brown Brothers Harriman, are projecting the US dollar to reach parity with the Euro within six-to-twelve months.

Interest Rates

As readers know, we have been in an extended period of historically low interest rates. Post-election, the yield on the US 10-year has already increased by about 50 basis points.

While BA is not a large borrower, almost all customers either finance or lease (indirectly financing) aircraft purchases. A 50 basis point increase in interest rates (assuming a 10-year loan, and a rate increasing to 5%) would increase payments by 2.5%.

Ex-Im Bank

The Ex-Im Bank, which helps finance US exports, was almost eliminated in 2015. It almost certainly will be killed by the Trump administration. While the impact of losing this financing conduit is uncertain, in April, BA noted "some airlines might not be able to accept new planes... in the absence of US Export-Import Bank support for aircraft and engine sales."

Potential Positives

There are of course, potential positives from President-elect Trump's likely legislative agenda.

Military Sales

While BA's public reputation is focused on commercial aircraft, as noted above, about 1/3 of sales and the majority of profits are garnered from military sales. President-elect Trump and members of the Republican legislative majority have loudly called for increased military spending. BA would be a recipient of the (future) rising tide in military spending. Unlike, commercial aircraft, the focus of higher tariffs would not cause the same level of retaliation by foreign buyers of BA's military/security products.

Higher Interest Rates

BA would benefit from higher interest rates with respect to the Company's underfunded pension liabilities. As of September 30, 2016, the net pension liability on BA's balance sheet was $18 billion. Higher interest rates will enable the Company to increase its assumptions regarding future returns and reduce the balance sheet value of the present value of future obligations. While these are non-cash changes, the changes in pension assumptions will be seen on the income statement.

Reduction in Corporate Tax Rate

BA used a 30% effective tax rate in its 2016 financial outlook. A decrease in the US tax rate would materially impact BA. A reduction to 22% (a level recommended by Barron's this week), would increase net income by $405 million or $0.58/share (diluted).

Conclusion

BA continues to be an American icon and a leader in commercial aircraft. I am concerned the current stock price (and lack of estimate movement) fails to consider the negatives associated with the Trump Presidency. Specifically, trade restrictions and a stronger US dollar will have material impacts on BA's earnings and hence its stock price. These negatives will be partially offset by pension benefits associated with higher interest rates and the potential for a lower US tax rate.

In the risks to earnings section, S&P does not mention the above risks, only commenting, "slower global economic growth, incremental US defense budget pressures and... cost overruns." It is my opinion that the market has not properly considered the highlighted negatives (as well as the positives) in the wake of euphoria about potentially lower US tax rates.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.