Boeing (BA), the commercial and military aircrafts manufacturer, reported its earnings last Wednesday. The stock price has surged 4.8% since then, as the company was able to beat revenues and earnings by 3% and 13% respectively.
Boeing is expected to fly high this year after the rebound of commercial air jet operations and the necessary changes in production taken by the company to meet the demand. Not only this, the company surprised the market by increasing the outlook for revenues from Boeing Defense, Space and Security (BDS) due to high Saudi F15 sales. Therefore, the company increased the outlook for EPS from $4.15-$4.35 to $4.4-$4.6 and raised the revenue outlook by $1.5b to $79.5b-$81.5b.
The investor concerns are the margins for the 737 MAX and inventory and production technicalities for the 787, especially after the recent incident at the Charleston International Airport. This can mean a production halt of the 787 if a major fault is diagnosed in the General Electric (GE)-made engines.
The company expects increased revenue in the light of increased global aircraft demand, as the airlines resort to fuel efficient jets in a bid to cut costs. The company also raised the guidance for revenues from BDS by $1.5 billion after receiving abnormally high orders for the Saudi F15 jets. The outlook for operating cash flows remained unchanged at being greater than $5 billion. The margin for the commercial airline division is expected to be 9% whereas BDS is expected to yield a margin of greater than 9%. This year, 585-600 commercial airplanes are expected to be delivered, according to the company's already set plan.
Boeing operates in five segments, namely Commercial Airplanes, Boeing Military Aircraft (BMA), Network & Space System (N&SS), Global Services & Support (GS&S) and Boeing Capital Corporation (BCC). Its productions ranges from commercial aircrafts, manned and unmanned military jets , to a variety of support products that help in providing logistical support for military platforms (GS&S), surveillance and space exploration (N&SS). BCC is the financing wing.
Following shows the revenue generation from different segments:
*BCC accounts for less than 1% of the total revenue generated, and therefore has not been included in the chart.
The recent cuts in the U.S. defense budget have affected BMA's sales drastically. Also, N&SS has been on a constant decline since the past five years. This has been because of the termination of the Brigade Combat Team Modernization (BCTM) program and lower revenues from the Ground-Based Midcourse Program (GBD). United Launch Alliance - a joint venture between Boeing and Lockheed Martin (LMT) to provide spacecraft launch services to the U.S. government that also comes under N&SS - also reported lower earnings this quarter, which has led to a decrease in the operating margin for this segment.
Following shows the gradual shift of revenue generation from BDS to the Commercial Aircrafts Division:
The graph shows how the commercial aircrafts operation rebounded after a slight downfall in 2008-2009 when the economic crisis hit the global Transportation Industry. The share of revenue for BMA and GS&S has remained stable over time. However, the business of N&SS has been on a constant decline because of the factors already stated above.
The half yearly sales were up by 6.6% to $8.2 billion. However, the segment's profit declined by 6.3%
After the announcement of deep slashes in the U.S. defense budget, and some more to come in future, the company has already planned to overcome the situation by making "small tactical" acquisitions to gain a greater market share. Also, the company gets orders from outside the U.S., therefore it has been successful, to some extent, in showing resistance to the state's policy. A Saudi order of $29.4 billion early this year is a good example in this context. In the earnings conference call, the management claimed that currently 37% of defense backlogs represent sales outside the U.S.
Boeing has responded well to its increased forecast of commercial airplane for the next 20 years in its Current Market Outlook (CMO 2012) by ramping up its production. The forecast for this year's deliveries is 585-600 jets, 15% higher than its last year deliveries of 515 jets. The company has been slashing jobs in the BDS unit and increasing its workforce in the commercial jets business as it intends to raise the production rate by 60% in four years through 2014.
After having a successful air show at Farnborough at the start of this month, the company has been active in pursuing its unconfirmed orders. As a result, the rate of conversion from commitments to company orders has been faster than expected. Out of 1,200 commitments, 649 have already been confirmed.
The company's revenues from this division have hardly been affected by the slowdown in the U.S. and the Euro debt crisis, as the company supplies 2/3 of its total orders outside the U.S. and Europe, something the management claimed in the earning call conference.
Other important facts include:
- 40% of cash is received upon delivery of the plane. The 737 MAX, currently forming the largest portion in the company's backlog, is expected to be delivered from 2017 onwards. A large part of this announcement may not be priced in the stock, as the investors doubt the production facilities of the company. Therefore, as the company implements production expansion plans, the stock will go up.
- The company has finally declared that it will announce at the end of the year whether it will be releasing an extended version of the Dreamliner, named the 787-10.
- The margins, as discussed below, have declined for this division as the 737 is being sold at an introductory cheap price.
- The 787-Dreamliner has been a source of discomfort for the company. This model has already got the company involved in a law suit against AirIndia after its delayed production. Yesterday, its engine malfunctioning resulting in a blaze on the runway of the Charleston international Airport. General Electric , the engine manufacturer, is also involved in the investigation.
Margins, OCFs and R & D
The margins for the commercial air planes and GS&S have improved. However, for the rest of the operations, the margins have declined in the recent past and are expected to decline further as the U.S. defense budget shrinks. The margins for commercial airplanes may also decline given the pricing pressure of the 737 and its high proportion of overall demand for commercial airplanes. Following graph shows the historical trends:
The margins for commercial airplanes was negative in the recession of 2009. The chart also shows the overall declining margin of BDS as a segment.
Operating Cash Flow And R & D
Company's OCF improved by 4.7% YoY to $1.67 billion. OCFs took a hit in the 2009-2010 recessionary period when they almost halved, falling from $5.6 billion to $2.9 billion in a single year. However, the future guidance for this year gives an OCF figure greater than $5 billion, showing that the company has recovered quickly. Sell-side analysts expect that the company will use the increased cash balances to repurchase its shares, thus leading to an increase in the stock's value.
The R&D declined substantially as most of the proportion was allocated to the development of the 787 and the 747-8 jumbo jet. The R&D fell by 25% YoY on a half yearly scale.
The company has no liquidity problems. As the company rectifies the production glitches in the 787 Dreamliner, ramps up its production in accordance with the rising global demand and adequately manages its defense division, the stock is likely to soar high. The stock is likely to trade in north of $100 by the end of next year. Jim Cramer also thinks that Boeing's fair price is $90. Trading on a forward multiple of 13, and considering that now the stock has higher earnings visibilty, soon the market will start valuing BA on 2014/15 earnings.
The stock also offers a dividend yield of 2.3%.