Boeing (BA), the leading US commercial aircraft manufacturer, reported impressive earnings in its third quarter's earnings release on October 24. The company topped the earnings estimates. What has recently gained investors' attention is the company's plan to gradually shift its resources from its Defense segment to its Commercial segment. In an environment where the future of US military spending remains ambiguous, investors have appreciated this decision. Not only that, investors are also excited about the production increases that the company has recently announced, in order to tackle its backlog. Boeing's book/bill ratio has improved and the stock has a tendency to move higher with an improving book/bill ratio.
Though earnings fell by 6%, the company still managed to top analysts' estimates. The revenues are on a rise because of rising commercial airplane sales and deliveries, which are discussed below. The company also raised its 2012 revenue guidance to $80.5-$82 billion from $79.5-$81.5 billion. Also, the EPS guidance was pushed to $4.80-$4.95 from $4.40-$4.60. This has sent a positive signal to the market, as most of the companies are still unsure of the impact that the fiscal cliff will have on the economy by the end of this year.
The company also reported a robust cash flow position, which ensured that it has the financial muscle to keep up to its promises of ramping up production. The company, this July, announced that it will ramp up its production according to the following schedule:
Deliveries are important, from the perspective of revenues as well as cash flows. The company states in its revenue recognition policy that it employs contract accounting to record its revenues, cost of sales and, therefore, profits. Also, it is an industry norm that 40% of the cash is paid at the time of delivery. That is why the stock has moved, not with the news of new orders, but with the news of deliveries, and with a ramp-up in the production process. We have been pressing on the idea that investors should use production capabilities as the foremost indicator of an industrial stock's performance.
The ramp-up is expected to shorten the lengths of the bars shown in the following graph, which was taken from 10-Q:
The big bar for 787-9 has been a big concern for investors. That is why the stock moves on any news of the production of this jet.
The following chart shows the historical book/bill ratio for Boeing:
Both charts show how the stock has been moving with the book/bill ratio. The dip in the book/bill ratio in 2009 caused a dip in BA's stock price in 2009 as well. In 2009, the book/bill ratio bottomed before the bottom in Boeing's stock.
During 3Q2012, the overall book-to-bill ratio stood at 1.19x. This was better than what analysts had expected, but lower than the historic 5-year average of 1.35x. A segment-wise analysis reveals that the ratio for the Commercial Aircraft Segment (BCA) was 1.41x (better than 0.59x in the previous quarter but lower than the ratio of 1.81x for the last twelve months). The ratio for BDS (defense wing) was 0.76x (lower than 1.11x in the previous quarter and also lower than the LTM ratio of 1.17x). The ratio is expected to improve in the near future due to the planned ramp-up in production facilities. As a result of this, the revenue and operating cash flow forecast has improved.
The company delivered 149 commercial aircraft in 3Q12, up from 127 aircraft a year ago. The company delivered 12 787s, up from only one plane a year ago. Boeing stated in its conference call that it had delivered a total of 28 787s till October 24. Boeing has delivered 436 aircrafts YTD, up from 349 a year ago. The company's management also stated in its conference call that it expects its aircraft orders to be strong throughout the year, and cancellations/deferrals are at historical lows.
Despite a robust book/bill ratio, backlog still rose by $3 billion sequentially, to $358 billion in Q3. The sequential rise of $5 billion in the BCA (reaching a total of $306 billion) was offset by the $2 billion decline in the BDS backlog.
We have already discussed the book/bill ratio of different segments and their respective backlogs. Let's discuss this quarter's performance:
The revenue rose by 28%. Earnings of $1.15 billion were up 6% YoY. However, the operating margin declined by 1.9 percentage points to 9.5%. Higher costs associated with the new 787 and 747-8 were a drag on margins, but this is expected to improve over time. The following shows the revenue geography of Boeing:
The market knows that Boeing was able to post strong results for this quarter because of its improved commercial aircraft operations. The 737 Max Series introduced by the company was a great hit, as airlines were looking for a fuel-efficient single aisle jet. Boeing was late in starting to take orders and, as a result, lost much of the single-aisle market share to Airbus' A320 neo.
Reuters recently claimed that Boeing may take another year to offer a new version of 777, which would be later than what some airlines want, and, therefore, some potential sales could be lost to Airbus' 350-900 and 350-1000. Currently, the 777 is the most profitable jet for Boeing.
As depicted in the pie chart above, BDS is composed of three sub-segments, namely, Boeing Military Aircrafts (BMA), Network & Space Systems (N & SS) and Global Service & Support (G & SS). The revenues of BDS declined by 4.4% YoY; a large chunk of that decline came from the N & SS segment (-12.3%). The operating earnings of $827 million were flat on a YoY basis. Margins were up 0.5 points YoY to end up at 10.5%, a good sign in a declining revenue environment.
The decline in BDS revenues is evident from the fact that the Budget Control Act was passed in 2011, which reduced the US Department of Defense's (DOD) top line budget by $490 billion over 10 years, starting FY 2012. Also, the future remains ambiguous as further budget cuts are expected to be implemented in 2013, which are expected to be near $500 billion in the next nine years. However, in his election campaign, Obama surprised everyone by announcing that he will do whatever it takes to stop the sequestration, and, that is why, the future of the Defense segment is ambiguous and uncertain.
Recently, the company announced that it would restructure its Defense segment, and cut back jobs by almost 30 percent from the 2010 level. The company is the second largest supplier to the Pentagon, after Lockheed Martin (LMT). The company has already achieved cost savings of $2.2 billion and plans to save another $1.6 billion through 2015. According to defense consultant Loren Thompson, this restructuring was required to keep Boeing's operations profitable. Boeing is not the only one cutting its costs. LMT, Northrop Grumman Corp (NOC) and Raytheon Co (RTN) have also been cutting costs in order to survive in the upcoming weak and challenging environment.
Dwindling defense budgets have been responsible for Boeing's gradual shift from BDS to BCA. The following graph shows how the company's revenue base has transformed over the years:
The recent sharp surge in this quarter as compared to 2011 levels shows the impact of budget cuts.
The stock pays a healthy dividend of 2.51%. The dividend has been on the rise during the last five years. The dividend has risen by 4.6% in the last five years. The decision to cut down defense jobs has sent a bullish signal to the market. The bullish and bearish targets for the stock price are $100 and $68, respectively. The stock's earnings are expected to grow by 12% per annum for the next five years. Most of the growth hinges upon the ramp-up in production, as planned by Boeing.