Is Boeing Ready To Take Off?

The airlines are in trouble – no doubt about that. The airlines operating in the US are facing legacy costs in the form of pensions, rising fuel prices (fuel is 60% of operating costs for airlines), and a weakening consumer. Yes, things are bleak for the airlines of the United States, but I don’t buy the argument that things are as bleak for Boeing (BA). Ever since Goldman Sachs (GS) added BA to their conviction sell list on June 25, the stock has been in freefall – and at $65 I think it’s a darn good bargain.

 

Overview

Boeing is the world’s largest aerospace and defense company (second largest according to some sources). Moreover, Boeing operates in over 90 countries and is American’s largest exporter, according to Wikinvest.com. Boeing gets 50.3 % of its revenue from commercial airplane sales, 48.3% from integrated defense sales, and 1.2% from leasing small aircraft.

Commercial Planes

Boeing has one main competitor in the 100+ seat aircraft business, Airbus. The competition there has caused resulted in some margin compression, but I think that the introduction of the 787 Dreamliner – scheduled to test fly in Q 4 2008 and start deliveries Q3 2009- will give Boeing the competitive advantage to leave Airbus behind. Unfortunately, the 787 has been delayed three times so far, marred by the fact that 75% of the 787’s production is outsourced. But when the plane finally gets launched it is going to be awesome – this coming from someone who is afraid to fly.

Aside from looking cool, the 787 is a lot lighter than the competition and will consume 20% less fuel than the 767, making the 787 a far more cost-effective plane. There are already 892 unfilled orders for the 787 – which means Boeing will have its hands full for many years. All and all Boeing has a backlog of $346 billion in orders – and that is why I am not worried about problems with the Airline Industry. Several US airlines can cancel their orders before Boeing will have trouble selling their planes. A $300 billion-plus cancellation is not an issue for me – I simply do not believe it can happen to BA. Not when two-thirds of their orders come from foreign countries where the air travel industry is booming.

Throughout Asia and the Middle East, air traffic is on this rise and there are only 2 companies in the entire world that make 100+ passenger planes. The weak dollar makes BA more competitive.

Integrated Defense Systems

Boeing also receives about half its revenue from the IDS. The company sells a variety of planes (F-22), helicopters (Chinooks) and missiles (Harpoons) to the US. The war in Iraq has drastically increased the demand for BA’s products and this demand could wane if politicians try to cut defense spending. But I think that is unlikely given the current geopolitical situation and the strong lobbying of BA in Washington.

More interesting is the tanker deal that Boeing lost to an Airbus subsidiary and has consequently disputed. The deal is worth about $21 billion in revenue, and the decision is currently under review with a decision deadline of Aug 21. I think this ruling, if favorable for BA, could be a great catalyst for the stock. So keep your eye on news as this situation develops. I have a gut feeling that this ruling is going to be heavily influenced by Boeing’s very prominent team of Washington lobbyists and I want to profit from this pork. Hey, they are my tax dollars - I think I deserve some pork.

The Numbers

Boeing trades for about 11 times next year's earnings and sports a nice .80 PEG. Unfortunately the company has a relatively unattractive profit margin of 6.5%, but the margin has been increasing lately. The company does pay a dividend of about 2.5%, but I do not like BA as a dividend stock, I like BA for its EPS growth potential. Boeing also has a healthy $9.6 billion in cash and a market cap of $48 billion.

What the Company is Undervalued

Because Goldman added them to their conviction sell list and the herd got upset. But really, there has been some bad news recently, the tanker contract, the 787 delays, but I think that BA was sold off too much and people are unfairly worried about BA losing orders because of high oil prices. With a $300 billion backlog ($174 billion of which is commercial planes), the air traffic boom in Asia and a  fuel efficient plane launching, I think BA is fine and there has been too much panic selling. Also people take analysts at institutions way too seriously - when I heard Goldman downgraded BA I was ecstatic, because I knew I could get it much cheaper.

Conclusion

The 787 could flop, BA could lose the tanker contract, input costs could soar (aluminum), and the US could drastically reduce defense spending. But despite these risks I like Boeing's position in the commercial jet arena and I like Boeing's chances at winning the tanker contract. I think there could be a lot more downgrades on the way - especially if oil stays at $140 + - so don’t buy this one all at once (though at 65 it’s tempting). But I am not worried because I love the backlog and I love the potential of the 787. There are risks, but it’s called a risk premium for a reason and I think BA offers a very attractive risk/reward ratio.

 

If you have any questions/comments/just want to tell me to go to hell – feel free to e-mail me at [e-mail]

 

Also – never invest on someone else’s advice – do you own research.

 

Disclosures- At the time of this article I have no positions, but am planning to be long BA in the near future.

Comments

[BS Detector]

Re: the tanker.

First off, this is a much smaller piece of Boeing's potential future business than seems to be regularly stated.

Secondly, it is quite likely that the Air Force will reopen the competition, but not from the beginning; USAF has been trying to let a contract to replace this aging fleet for most of a decade, and I suspect the pressure to finish is huge. I expect a tweaking of the requirements to favor EADS (USAF has an interest in fostering competition in this market niche, and clearly still wants to punish Boeing for previous monkey business), and a short (90 day) proposal cycle.

[truthinvesting]

BA will turn around when gas does.If you ae going to get long here sell the puts.Nice report.peace

[Brahm]

A 20% saving in energy costs for airlines is a terrific advantage, difficult to overcome for a competitor airline without an efficient fleet. That is why orders will be certain for the 787. Of course, Boeing should ensure cost controls for its production. I am not nervous about Goldman's sell rating at this price level of Boeing shares at this time.

[User 153029]

If you believe BA has a good future, the better way to play it is to buy PCP and TIE in my opinion. Eventually all the energy inefficient planes will have to be replaced. PCP and TIE will benefit. The sell off in TIE is way overdone.

Edward Roche- Freedom Mountain Investments

[Brahm]

However, you must consider that TIE or PCP's (user 153029) orders/business is not exclusively derived from work for Boeing. Their orders are potentially only a modest or significant proportion from the 787. They need to perform as well with regard to the broader economy or the aircraft industry.

[ChandlerLutz]

Nice Article, but I am a little concerned about Boeing as a company. First of all, the company (especially in the defense industry) is not really producing quality products. They are a secondary contractor for the F-22, the border fence they built was a disaster, they lost the deal for the F-35 (which will likely end up being the largest military contract ever). As for the 787, yes I agree it has amazing potential, but as you said it has already been delayed three times. What happens when further delays arise? The stock will get hammered...

I like the growing backlog for the 787, but I'm not convinced that the "outsourcing"... model they employed will be effective in the long term.

The one thing I think Boeing really has going for it is that Airbus is even more of a train wreck then they are. Since airbus keeps botching every project it undertakes Boeing has become a winner in many areas by default

[kmanm]

It's a good news that no airline has canceled 787 orders but the bad news is that the cost of making 787 is going up drastically due to inflation.
I read an interview with a CEO of African/Asian airline why the airline is not canceling their 787 orders. His response was that the price of 787 has gone up so much since the airline put the order 2-3 years ago, it makes no sense for the airline to cancel their order at this time. I guess the only problem I see with the backlogs is that the profit margin on these orders may continue to shrink as materials to make those planes rise.

[Alex Garcia]

Nice writeup, but what makes Boeing attractive valuation wize? I hold a position based on Boeing appearing on the magic formula screen top 25 for companies with a minimum market cap of 1000 million. Heres the link to my article
www.contrarianvalueinv.../