- I exited my BA position at $229.75, locking in 69.4% profits.
- Prior to my sale, BA shares were up roughly 50% during the last week alone.
- This rally appears to be irrational and being that BA no longer pays a dividend, I was happy to take profits.
- This idea was discussed in more depth with members of my private investing community, The Dividend Kings. Get started today »
After a long, and rather volatile journey, I have completely exited my position in Boeing (NYSE:BA).
In March, I had trimmed my BA stake at $121 and $158 in response to the company's dividend cut. And now, in early June, I sold the rest of my shares at $229.75, locking in profits of nearly 70%, due to the irrational nature of the recent rallies that I've seen in the broad markets and BA stock, specifically.
Boeing has been quite the roller-coaster of late, hitting all-time highs in the $450 area in early 2019. Then, the 737 Max disasters occurred, causing the stock to fall and trade in the $320-380 range throughout much of 2019.
Throughout this period of time, I remained bullish on BA. I thought that the 737 Max issue would play out in a similar fashion to the 787 battery fire issues that we saw back in 2013. My assumption was that a software fix would come relatively quickly, it wouldn't take long for the 737 Max to fly again, and the public would quickly move past the fears associated with the 737 Max brand (as the public is prone to do in today's fast-moving world).
Well, with the benefit of hindsight, I'll be the first to admit that I underestimated the scale and scope of the 737 Max issue for Boeing. Thankfully, during this period of time while I remained bullish, I stayed true to my asset allocation rules and did not add to an already overweight BA position.
Although during 2017 and 2018 BA established itself as the free cash flow king, I knew that at the end of the day, this was a company selling goods with hundred-million-dollar price tags and therefore, it would always have a certain degree of cyclicality attached due to economic sensitivity. This risk profile meant that bullishness aside, I knew I could not get too aggressive with my BA position.
From a stock price perspective, I thought that strong demand for an efficient narrow-bodied aircraft, both in the short term and long term, would trump any negative short-term sentiment surrounding the 737 Max tragedies. Yet, as time moved on, more and more bad news came out, management changed, only to be followed by more mishaps, it became clear that the fix for the Max would not be a relatively quick and easy fix.
Yet, even so, I was content to hold onto my shares due in part to my low cost basis and my belief that eventually, cash flows would return to pre-Max crash levels. BA's strong FCF, growing margins, tremendous bottom-line growth, and ultimately, fast-growing dividend growth announcements made this a very easy stock for me to hold throughout weakness.
However, when COVID-19 struck in early 2020, causing all travel and leisure-related names to fall, things began to get tenuous for BA. With BA's customers fighting for their lives, it became clear that plane orders were not going to rebound in the short term and this cash flow crunch resulted in BA raising debt and cutting its dividend to deal with cash burn.
This, combined with the oil price dropping precipitously, led to a precipitous sell-off. BA hit 52-week lows of $89/share in March.
The new planes that BA is producing are expected to be 25-40% more fuel-efficient than the planes that the company is replacing. However, due to unforeseen low oil prices, demand for these fuel-efficient narrow-bodied planes has dried up.
BA just announced May order & delivery data, which included just 4 plane deliveries during the month, down from six in April. BA received 9 orders for planes (all wide-bodied and no passenger planes). However, cancelations were twice as large, at 18 (including 14,737 Max orders).
In response to these issues, BA has not only cut the dividend, but also laid off thousands of workers, stopped its buyback, and slashed management compensation, but even so, the cash flow outlook is dire in the short term.
During the Q1 conference call when speaking about the impacts of COVID-19 on his business, CEO David Calhoun said:
The latest IATA forecast projects full-year passenger traffic to be down 48% this year compared to 2019, as global economic activity slows down due to the COVID-19 and the governments severely restricting travel to contain the spread of that virus. Here in the U.S., passenger traffic at this moment in time is down 95% compared to a year ago. Airlines are cutting back operations dramatically. As they assess their businesses, they're making difficult decisions that result in grounding fleets, deferring airplane orders, postponing acceptance of completed orders, and slowing down or stopping payments."
What's more, airlines are retiring unused aircraft at a fast rate, which reduces the need for servicing. BA's services business has been a highlight in recent years, leading to increased margins and large cash flows; however, the bullish thesis surrounding this segment has been hurt badly as well. Government contracts have bolstered the services segment in recent quarters, yet management expects growth here to be flat moving forward, which is down significantly from the double-digit growth we've seen in recent years.
I continue to believe that over the very long term, BA will be just fine. Although the company's order backlog is at its smallest size since 2013, we're still talking about more than 4,700 planes. BA still occupies a strong position in the global aerospace market as a part of a duopoly with Airbus (OTCPK:EADSF). Sure, Chinese and Russian manufacturers are attempting to take market share in this space, but ultimately, those upstarts do not appear to be major threats. And most importantly, while the aerospace industry faces headwinds in the short term due to social distancing, I don't think that COVID-19 has changed the trajectory of its long-term secular growth potential.
Long-term growth prospects aside, I decided to begin trimming my position in the aftermath of the dividend cut because the stock no longer met my portfolio's primary goals. Being that fostering reliably increasing income is my #1 priority as a portfolio manager, BA shares without a growing dividend attached no longer seemed quite so attractive.
But being that my cost basis was in the $120 range, I was not interested in selling at the March lows because that would have involved locking in losses (which is something that I try to avoid at all costs). However, once BA shares bounced and I had the opportunity to reduce my stake by locking in profits, I jumped at the opportunity.
I made my first sale on 3/24/2020, reducing my BA exposure by 37.5%, locking in 2.9% gains at $121.71.
And, as BA's stock rose higher and higher, providing me with the opportunity to sell more shares with larger and larger profits attached, I decided to take those opportunities as well.
On 3/25/2020, I sold 40% of my remaining position (25% of my original stake) at $158.17, locking in 27% profits on those shares.
And most recently, on 6/8/2020, I exited the rest of my BA position entirely, selling my remaining shares at $229.75, locking in 69.4% profits.
While I'm certainly happy to lock in strong, double-digit profits on an investment, it's worth noting that these gains are a far cry from the 250%+ gains that I was sitting on prior to BA's recent downfall. Yet, times change and it doesn't make much sense to focus too much on the past and missed opportunities.
In recent articles I've harped upon my concerns regarding a bubble forming in the equity space. Frankly put, I cannot justify the recent "V" shaped rally that the broad markets have experienced and therefore, I've become interested in raising cash.
Raising cash within a dividend growth portfolio is a difficult thing to do, because selling shares typically results in harming one's passive income stream.
The compounding process that I'm relying on to reach financial freedom demands that my actions in the market increase my passive income, not decrease it. However, being that BA no longer pays a dividend, these shares rose to the top of my potential sell list.
BA's management recently highlighted the fact that it could take 3-5 years to restore the dividend due to the costs associated with keeping its supply chain up and running during a period of low sales and the pressure that new debt loads is putting on the balance sheet. Repaying debt appears to be a priority over re-establishing the dividend (which is a prudent decision, in my opinion).
BA roughly doubled its debt load in 2019, going from ~$13.8b at the end of 2018 to ~$27.3b at the end of 2019, to deal with the cash burn that it was experiencing. At the end of Q1, BA carried $38.9b in debt and had $15.5b of cash/marketable securities on hand. And, the day after announcing Q1 results, news broke that BA tapped the bond markets for $25b, adding even more debt to its balance sheet.
In a statement regarding the maneuver, management said that this would give the company the liquidity it needed to keep the business/supply chain up and running for the foreseeable future and therefore, it had no immediate plans to add more debt and/or take government aid.
Because of BA's expanded debt load and diminished cash flows, S&P recently downgraded Boeing's credit rating to BBB-. This still represents an investment grade score, but it is just one notch above junk status.
While I respect the fact that BA has avoided taking government aid, repaying this debt load will be a long road. Management expects to see large negative cash flows in 2020 and while analysts are expecting to see a strong bounce back in 2021 or 2020, when looking at BA's capex requirements and balance sheet, it appears that management's guidance of 3-5 years for a dividend is about right.
I have to admit that I feel a bit naked without exposure to BA in my portfolio.
For so long, I've viewed this company as the best of the best when it comes to American manufacturing. But, being that BA is an incredibly difficult company to evaluate right now (as you can see in the F.A.S.T. Graphs image below, earnings are expected to be negative in 2020 and the recent stock rally appears to be based upon future growth expectations which are expected to play out a couple of years down the road), I was happy to cut ties.
I have no desire to speculate on a turnaround without being paid as I wait. What's more, BA's recent rally has pushed the stock up to exceedingly high valuations, even using what I believe to be potentially overly bullish analyst expectations looking out to 2021 and 2022.
in the $230/share range, BA was trading for ~23.7x 2022 EPS expectations. BA's long-term average P/E ratio is just 19.7x. During such tumultuous times for the company, this premium valuation simply doesn't make sense to me.
BA shares have rallied roughly 50% during the past week alone. At the beginning of last week, I had no plan to liquidate my BA shares. However, I was happy to take advantage of the opportunity that the market presented.
This move has increased my cash position from roughly 6% of my portfolio to roughly 7%.
I have no plans to put the cash to work in the short term, due to the overbought nature of the broad market. I hope to use the proceeds from this sale to accumulate shares of a high-quality, dividend-growth stock to replace the income that I lost when BA slashed its dividend back in March.
However, I will say that I would also be willing to consider simply buying back the BA shares at a lower price should I be presented with one in the short term. BA shares are down more than 5% from my sale yesterday as I write this and while my plans are not to attempt to time the market and make a short-term trade, I will always be happy to take what the market gives me.
Even though BA's dividend is suspended, I am not opposed to holding a speculative position in BA due to my long-term bullish outlook. But to do so, I would have to believe that I am receiving a wide margin of safety. At $230/share, that was not the case.
This article was previously published for subscribers to The Dividend Kings.
*Since originally publishing this piece, BA shares have tumbled to $170. I have not re-initiated BA exposure yet because I am tracking the negative momentum in the market; however, I may end up doing so in the near future. If I were to buy BA today using the proceeds from my recent sale, I would be able to increase my share count by roughly 33%. Sometimes, in situations like these, I simply chuckle at luck and take what the market gives me. If I buy BA soon, I will keep everyone informed with an updated article.
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This article was written by
Nicholas Ward is a Senior Investment Analyst with Wide Moat Research and the former editor-in-chief and portfolio manager at The Intelligent Dividend Investor, The Dividend Growth Club, and The Income Minded Millennial.
Nicholas is a contributor to the investing group The Dividend Kings where he shares analysis on dividend growth stocks. The Dividend Kings is a group of analysts, led by Dividend Sensei, that teach members how to invest more wisely in dividend stocks. The focus is on helping investors safeguard and grow their money in all market conditions through the highest-quality dividend investments. Features include: 13 model portfolios, buy ideas, company research reports, and a thriving chat community for readers looking to learn how to invest more intelligently in dividend stocks. Learn More.
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in BA over 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.
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