Catastrophe Strikes, But Boeing Remains Resilient

About: The Boeing Company (BA), Includes: EADSY
by: Valuentum

A version of Boeing's next-generation 737 MAX, the fastest-selling plane in its history, has crashed twice in the past six months (the 737 MAX 8).

Preliminary causes of the two crashes can only be speculated at the time, but the nature of the crashes suggests there may be a connection, in our opinion.

Many airlines and countries have already grounded the 737 MAX 8, and flyers are understandably concerned.

Boeing has faced considerable challenges in its long, storied history, with respect to production on the 787 Dreamliner. We do not expect widespread cancellations of the 737 MAX line-up, though we do expect some minor, immaterial degree of fallout.

Boeing's share price is now within our fair value estimate range, and we may look to add some aerospace exposure in the future once Boeing puts concerns with respect to this aircraft model to rest.

Image Source: pjs2005

By Brian Nelson, CFA

It's hard not to like the business economics at Boeing (BA). Commercial aircraft making is a long-term consideration. For example, when aerospace executives think about a new build, they are thinking about the consumer and competitive landscape 10-20 years into the future, if not longer. Such forward-looking thinking aligns well with long-term investors that may have even longer time horizons.

Boeing planned decades ago to develop the ultra-efficient, point-to-point, mostly-composite 787 Dreamliner while Airbus' (OTCPK:EADSY) continued struggle to drum up demand for its super-jumbo A380 is a classic case in effective long-term thinking. For those that may not know the story of Boeing well, the Dreamliner didn't have a smooth beginning. Delays after delays and cost overruns plagued the program for what seemed like an eternity. However, Boeing finally got it right, Dreamliners are flying off the assembly line and customers are happy.

On January 30, Boeing reported fourth-quarter 2018 results that were the best in its long, storied history. Quarterly revenue hit a record of $28.3 billion and so did operating profit, hitting a record of $4.2 billion. Both GAAP earnings per share and core earnings per share also came in at record highs, at $5.93 and $5.48, respectively. The full-year 2018 numbers were equally impressive. Record numbers almost across the board, including operating cash flow of $15.3 billion (free cash flow of $13.6 billion) and a total backlog of 5,900 commercial plans or $490 billion. That's about 7.3 years' worth of production at its 2018 run-rate of 806 commercial deliveries, speaking to incredible and unmatched visibility.

The company's outlook for 2019, released in late January, spoke to even better times ahead. Revenue growth is targeted in the range of $109.5-111.5 billion, higher than the 2018 mark of $101.1 billion, while GAAP earnings per share are targeted between $21.90 and $22.10 and core earnings per share is targeted between $19.90 and $20.10. That's significantly better than the $17.85 and $16.01 marks it achieved in 2018. What's more, operating cash flow is expected to expand nicely, too, to the range of $17-17.5 billion, reflecting a 14% improvement over last year's mark. The company has only a modest net debt position, too, even including that related to Boeing Capital, which has become a very small part of business these days.

Fast forward to March 11. Boeing is now facing what could turn into a severe public relations nightmare with respect to the next-generation version of its workhorse narrowbody aircraft, the 737 MAX (the dash 8 version). In late October, a flight by Lion Air from Jakarta to Pangkal Pinang (Indonesia), operating the 737 MAX 8 crashed into the Java sea just a dozen minutes or so after wheels up. Some 189 passengers and crew lost their lives, representing the first deadly incident related to the new MAX version and the worst in Lion Air history. A preliminary investigation of the Lion Air crash suggests that the plane's Maneuvering Characteristics Augmentation System (MCAS) pulled the nose down too fast as it thought the plane might stall.

On March 10, a similar occurrence occurred with Ethiopia Airlines, with another 737 MAX 8 crashing with 157 people on board, just a half-dozen minutes or so after leaving Addis Ababa, Ethiopia. If the events aren't linked by some common failure, we'd view that as very unlikely. Both airlines involved have strong safety records and both planes seemed to behave erratically after take-off and crashed shortly after take-off. The similarities of the crashes are too great to simply dismiss the causes as unrelated. The black box has been recovered, but it may be a long time before investigators have something definitive regarding the Ethiopia Airlines' catastrophe.

Many airlines, including those in China, have already grounded the 737 MAX 8 and the fallout could be even worse pending the investigation. With flyers understandably concerned, the move may impact the thousands of orders Boeing has on its books for this next-generation workhorse narrowbody aircraft. However, we expect only a minor degree of fallout. Boeing has been one of the most resilient companies in all of history. When 9/11 struck, for example, the markets collapsed and air traffic screeched to a halt, but customers stuck with Boeing and cancellations were minimal. When Boeing's 787 Dreamliner experienced delay after delay, customers still stuck with the company. We believe Boeing will eventually get to the cause of the failures of the 737 MAX 8 line and fix them, with hopefully no further loss of life. What has happened is absolutely tragic, but we think Boeing will set it right.

Image shown: Where Boeing's current share price lines up with our fair value estimate range, $256-404.

Our fair value estimate, derived by our discounted cash flow process, of Boeing is $330 per share. This is lower than where shares are trading, not because of the news these past few months but based on what we believe to be a reasonable trajectory of expected future free cash flows. Shares of Boeing, now trading at ~$390 at the time of this writing, fall within our fair value estimate range (see image above), and we think given the overhang of the 737 MAX 8 news, shares may stay range-bound anchored to this range for the foreseeable future. In the meantime, dividend growth investors get paid to wait. Shares yield about 2.1% at the time of this writing. We continue to like the aerospace industry, and we may look to add a company tied to the space to the newsletter portfolios once the dust settles across the group.

Disclaimer: This article or report and any links within are for information purposes only and should not be considered a solicitation to buy or sell any security. Valuentum is not responsible for any errors or omissions or for results obtained from the use of this article and accepts no liability for how readers may choose to utilize the content. Assumptions, opinions, and estimates are based on our judgment as of the date of the article and are subject to change without notice.

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.