As part of our process, we use a rigorous discounted cash-flow methodology that delves into the true intrinsic worth of companies. In Boeing's (BA) case, we found the firm is fairly valued at $76 per share, close to where it is currently trading.
For some background, we think a comprehensive analysis of a firm's discounted cash-flow valuation, relative valuation versus industry peers, as well as an assessment of technical and momentum indicators is the best way to identify the most attractive stocks at the best time to buy. This process culminates in what we call our Valuentum Buying Index (click here for an in-depth presentation on our methodology), which ranks stocks on a scale from 1 to 10, with 10 being the best.
If a company is undervalued both on a DCF and on a relative valuation basis, and is showing improvement in technical and momentum indicators, it scores high on our scale. Boeing posts a VBI score of 6 on our scale, reflecting our 'fairly valued' DCF assessment of the aerospace giant, its neutral relative valuation versus peers, and bullish techinicals. We use General Dynamics (GD), Lockheed Martin (LMT), Northrop Grumman (NOC), and Raytheon (RTN) in its peer group.
Our report on Boeing
Our report on Boeing and hundreds of other companies can be found here.
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Boeing earns a ValueCreation™ rating of EXCELLENT, the highest possible mark on our scale. The firm has been generating economic value for shareholders for the past few years, a track record we view very positively. Return on invested capital (excluding goodwill) has averaged 36.5% during the past three years.
The company looks fairly valued at this time. We expect the firm to trade within our fair value estimate range for the time being. If the firm's share price fell below $53, we'd take a closer look.
Boeing's cash flow generation and financial leverage are at decent levels, in our opinion. The firm's free cash flow margin and debt-to-EBITDA metrics are about what we'd expect from an average firm in our coverage universe.
The firm sports a very nice dividend yield of 2.3%. We expect the firm to pay out about 39% of next year's earnings to shareholders as dividends. We include the firm in our Dividend100 publication (click here for more info).
Recent quarterly results
The Boeing Co. reported fourth-quarter results that showed continued cost pressures as it relates to its pension obligations, but more importantly a surging commercial aerospace backlog. We'll be evaluating our long-term assumptions for Boeing, but we don't expect to make a material change to our fair value estimate at this time.
We have little interest in opening up a position in Boeing, given its fairly valued status and the substantial execution risk embedded in achieving its aggressive commercial delivery schedule (and its at-risk defense exposure due to impending budget cuts). That said, we are very constructive on the commercial aerospace supply chain, as parts suppliers benefit from the implicit backing of Boeing and do not need customers to actually receive delivery of an aircraft to recognize revenue and profit. We hold three aerospace suppliers in the portfolio of our Best Ideas Newsletter - Precision Castparts (PCP), Astronics (ATRO), and EDAC Tech (EDAC).
Boeing issued earnings-per-share guidance for 2012 that disappointed most investors due to higher pension expense, but we're most interested in Boeing's pace of orders and its ability to execute on higher production rates. Its commercial airplane segment booked 379 net orders during the quarter and 805 during the full year, pushing the backlog of unfulfilled deliveries to over 3,700 planes valued at $296 billion.
To put this in perspective, Boeing delivered 477 commercial aircraft during 2011, so its backlog of unfulfilled deliveries is nearly 8 times current production rates, providing increased visibility through the next economic cycle. In 2012, Boeing expects to deliver between 585 and 600 airplanes, nearly 26% growth at the high end. In fact, delivery slots for 2012 are sold out, and we'll likely witness the delivery of 35 to 40 787 Dreamliner deliveries to customers.
All things considered, we remain on the sidelines with respect to Boeing's shares and think the supply chain is a better way to play the coming upswing in commercial aerospace demand. Precision Castparts, Astronics, and EDAC Tech remain our top three aerospace picks.
Economic profit analysis
The best measure of a firm's ability to create value for shareholders is expressed by comparing its return on invested capital (ROIC) with its weighted average cost of capital (GM:WACC). The gap or difference between ROIC and WACC is called the firm's economic profit spread. Boeing's 3-year historical return on invested capital (without goodwill) is 36.5%, which is above the estimate of its cost of capital of 10.3%. As such, we assign the firm a ValueCreation™ rating of EXCELLENT. In the chart below, we show the probable path of ROIC in the years ahead based on the estimated volatility of key drivers behind the measure. The solid grey line reflects the most likely outcome, in our opinion, and represents the scenario that results in our fair value estimate.
Cash Flow Analysis
Firms that generate a free cash flow margin (free cash flow divided by total revenue) above 5% are usually considered cash cows. Boeing's free cash flow margin has averaged about 4.2% during the past three years. As such, we think the firm's cash flow generation is relatively MEDIUM. The free cash flow measure shown above is derived by taking cash flow from operations less capital expenditures and differs from enterprise free cash flow (FCFF), which we use in deriving our fair value estimate for the company. For more information on the differences between these two measures, please visit our website at Valuentum.com. At Boeing, cash flow from operations decreased about 29% from levels registered two years ago, while capital expenditures expanded about 44% over the same time period.
Our discounted cash flow model indicates that Boeing's shares are worth between $53 and $99 each. The margin of safety around our fair value estimate is driven by the firm's MEDIUM ValueRisk™ rating, which is derived from the historical volatility of key valuation drivers. The estimated fair value of $76 per share represents a price-to-earnings (P/E) ratio of about 14.3 times last year's earnings and an implied EV/EBITDA multiple of about 9.8 times last year's EBITDA.
Our model reflects a compound annual revenue growth rate of 9.7% during the next five years, a pace that is higher than the firm's 3-year historical compound annual growth rate of 4.1%. Our model reflects a 5-year projected average operating margin of 6.8%, which is above Boeing's trailing 3-year average. Beyond year 5, we assume free cash flow will grow at an annual rate of 2.1% for the next 15 years and 3% in perpetuity. For Boeing, we use a 10.3% weighted average cost of capital to discount future free cash flows.
Margin of Safety Analysis
Our discounted cash flow process values each firm on the basis of the present value of all future free cash flows. Although we estimate the firm's fair value at about $76 per share, every company has a range of probable fair values that's created by the uncertainty of key valuation drivers (like future revenue or earnings, for example). After all, if the future was known with certainty, we wouldn't see much volatility in the markets as stocks would trade precisely at their known fair values.
Our ValueRisk™ rating sets the margin of safety or the fair value range we assign to each stock. In the graph below, we show this probable range of fair values for Boeing. We think the firm is attractive below $53 per share (the green line), but quite expensive above $99 per share (the red line). The prices that fall along the yellow line, which includes our fair value estimate, represent a reasonable valuation for the firm, in our opinion.
Future Path of Fair Value
We estimate Boeing's fair value at this point in time to be about $76 per share. As time passes, however, companies generate cash flow and pay out cash to shareholders in the form of dividends. The chart below compares the firm's current share price with the path of Boeing's expected equity value per share over the next three years, assuming our long-term projections prove accurate. The range between the resulting downside fair value and upside fair value in Year 3 represents our best estimate of the value of the firm's shares three years hence. This range of potential outcomes is also subject to change over time, should our views on the firm's future cash flow potential change. The expected fair value of $97 per share in Year 3 represents our existing fair value per share of $76 increased at an annual rate of the firm's cost of equity less its dividend yield. The upside and downside ranges are derived in the same way, but from the upper and lower bounds of our fair value estimate range.
Pro Forma Financial Statements