Boeing Has Declined Significantly, But The Outlook Has Not Improved

May 24, 2022 3:53 PM ETThe Boeing Company (BA)ITA, PPA, DFEN, XAR, DJIA, DIA, XLI, NDJI, ROKT, EDOW, DDM, UDOW, VIS, FIDU, SURE19 Comments
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Summary

  • The air transportation market is in the process of recovery; we expect air traffic to regain pre-COVID-19 level by 2024.
  • Due to problems with existing aircraft models, Boeing is incurring abnormal costs that are putting pressure on the company's margins.
  • Delays in FAA approvals and aircraft deliveries put additional pressure on the company's quotes.
  • Despite good upside in the medium term and a significant quotes decline in May, we change our recommendation on the stock from SELL to HOLD.

Boeing"s 737 Max 10 Takes First Flight

Stephen Brashear/Getty Images News

Investment thesis

The post-pandemic recovery of air travel and international tourism demand provides good earning opportunities for companies hit hard in 2020, and The Boeing Company (NYSE:BA) is one of them. However, the broad economy is not the only thing to shape Boeing's valuation. Despite the opportunities, the company is still not making money due to production line stoppages and delayed shipments.

In the previous article, we highlighted Boeing's questionable short-term outlook, and our expectations of the stock's performance have been borne out. After the recent collapse of Boeing's Q1 2022 financials, Boeing's quotes have dropped, and, according to our calculations, the stock is now trading at its fair levels.

Boeing stock is still far from the entry point due to several factors. The main issue is uncertainty about the 777x model, whose sales have been moved from 2023 to 2025. It is also possible that Boeing will start to attract debt or dilute the stock again because of the company's unprofitability.

Air travel market keeps on recovering

The air travel market keeps its recovery to pre-pandemic levels. Despite the COVID-19 outbreak in China, which had a significant impact on air travel in Q1 2022, we do not revise our outlook assuming full market recovery by 2024. Boeing is a direct beneficiary of this phenomenon - airlines will increase their CapEx programs and acquire aircraft into their fleets to meet growing demand, so as the broad airline market grows, Boeing could significantly improve its performance in Commercial Airplanes and Global Services segments.

Global air traffic

IATA

Commercial airplanes segment

Commercial airplanes production is the largest Boeing segment by revenue and continues to be challenged by regulatory actions by the FAA and delays in production of new models. At the end of Q1, the company announced one more shift in its forecast for new model supplies. Particularly, one of the most anticipated models, the Boeing 787, whose sales were halted in Q2 2021, is likely to be available for supply only in Q3 or Q4 2022. Sales of the 777X model (cargo aircraft) have been postponed from late 2023 to early 2025 due to FAA approval, despite recent successful testing and demonstration in the UAE.

The company's best-selling model, airliner Boeing 737, has recently been the subject of intense debate from aircraft companies and regulators. The plane crash in China, which is still under investigation, has created doubts about the reliability of the model supplied. Thus, some Chinese airlines have scaled back plans to buy new Boeing models for their fleets. Nevertheless, the company's products have not completely left the market despite reduced demand in China, but the epidemiological situation in the region also creates additional challenges. Lockdowns have disrupted the resumption of the B-737 MAX model supplies to China, a deal almost agreed upon, according to the management. In 2023, Boeing competitor Comac C919 may press the Boeing 737 in Asia. However, complete replacement of the 737s, let alone the entry of a new airliner to broad markets, is unlikely in the near future.

Boeing Commercial Aircraft supplies

Company data, Calculations by Invest Heroes

Commercial airplanes segment

The U.S. government is the main customer of Boeing in the defense segment. The company supplies the Department of Defense with military aircraft and works closely with NASA.

Despite expected increase in total U.S. defense budget, aircraft purchases in 2022-2023 will decrease compared to 2021. NASA will also not receive significant additions to its annual budget, with only 3% y/y increase in 2022 and 8% requested increase in 2023, which could be reduced depending on the government's decision.

US Defense Air Budget

USA Department of Defense

As per our calculations, the effect of the 2022 defense budget reduction on the aircraft budget will hit Boeing's segment revenue by -9.6% y/y.

Boeing business margin

In addition to declining revenues, Boeing business margin is also affecting its investment prospects.

The company's main problem now is the costs caused by the shutdown of production lines. Management estimates about $2 bln is the irrecoverable part of the losses, mostly caused by the freeze in B-787 production. The company hopes to write off costs by the end of 2023 - that is, about $300 mln per quarter. Q1 margin was also negatively impacted by higher development costs, but we don't think this will be long-lasting due to the size and nature of Boeing's business.

Another equally important aspect is the macroeconomic component. In Q1 2022, aluminum prices and labor shortages were the most significant contributors to financial results. We do not believe the effect will last too long due to the cyclical nature of the economics, but Boeing could return to historical margin levels by 2024, by the time the airline market is fully recovered and the commercial vehicle supply chain is stabilized.

Therefore, we change our 2022 EBITDA forecast from $6,912 mln to $2,207 mln and from $10,787 mln (+56% y/y) to $9,683 mln (+340% y/y) in 2023.

New BA's EBITDA forecast

Company data, Calculations by Invest Heroes

Valuation

Boeing is a beneficiary of the recovering demand for airline services, but the company's internal problems related to constant postponements of aircraft supplies and losses related to the same reason are already reflected in the market value.

Factors that will affect the acceleration in the value of securities over the next 12 months:

  • Resumption of the B-78 supplies in volumes above consensus;
  • Signing of significant contracts for aircraft supplies;
  • Models yet to develop (777X. 777-9) approval faster than market expectations.

We estimate our target price for Boeing stock at $154 per share and believe the market is now fairly valuing the company from a fundamental position. HOLD rating, upside - 23%.

Boeing's valuation on a 2025 horizon

Risks

  • Increase in Boeing aircraft accidents, which would affect demand for Boeing aircraft and create additional challenges with regulatory authorities; and
  • It is also possible that Boeing will start to attract debt or dilute the stock again because of the company's unprofitability.

This article was written by

Invest Heroes profile picture
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Invest Heroes LLC is a CIS-based research firm founded in 2018. Since then, we provide equity and fixed income research services which become more and more well-known locally among both professional investors and private clients. Here’s what we do: - Cover top 120+ Russian, US and Chinese stocks - Cover 200+ Russian bonds (corporate, SOE’s) Provide our research as a paid service to several institutional clients, a couple dozen of asset managers/PM’s and about 3000 private clients Our team consists of 2 strategists as well as a team of analysts (equity market team & 1 fixed income). 9 analysts are currently working in our team, which has achieved global professional recognition. In the first year, we got into the Refinitiv and Factset, in the second year our estimates began to participate in the Refinitiv consensus, in the third year we are the best analysts in the Refinitiv rating for a number of Russian companies and we are in a process of signing with S&P Market Intelligence. Our forecasts are often ahead of the market, because of detailed business model built for each company. Contact details Sergey Pirogov CEO +7 (919) 762 76 64 s.pirogov@invest-heroes.ru Aleksandr Sayganov Head of Research +7 (708) 1238294 a.sayganov@invest-heroes.ru

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

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