The Capital Raise Is Only A First Step In Turning Around Boeing
Contributor since 2018 / 1051 Followers
Summary:
- Boeing’s recent equity raise is likely to preserve the company’s investment grade credit rating, despite causing significant dilution of common equity.
- Being part of an effective duopoly for wide body and large narrow body commercial aircraft makes Boeing strategically important for customers and the US Federal Government.
- However, the same is not true for its shareholders.
- The ongoing strike will cost a substantial sum, as will presumably its eventual solution, the worst-case scenario being the return of defined benefit pensions.
- Beyond financials, Boeing faces a number of underlying problems, that cannot be fixed with money alone.
A Boeing 737 MAX – arguably the company’s most famous “problem aircraft”
Wirestock
Earlier this week, The Boeing Co. (NYSE:BA) conducted a substantial capital increase in an attempt to brace against the fallout from a strike as well as its pre-existing problems. While it results, 15 percent dilution of common equity, this step is, on the other hand, not unlikely to go a long way towards preserving Boeing’s investment grade credit rating.
In addition to the equity raise, Boeing is also considering the divestment of its space division, according to reports.
The Bright Side
There are, of course, a number of very good reasons to like Boeing. First and foremost, the company has an effective duopoly with Airbus SE (OTCPK:EADSF;OTCPK:EADSY) in wide body and large narrow body commercial aircraft. This means that despite groundings, delays and quality issues, the existing backlog cannot simply be cancelled. Customers simply have no alternative, since Airbus’ order book is just as full already. Travel, especially leisure travel, is in robust demand. For many consumers, it has become almost an essential item, in extreme cases to a point where they are more willing to incur personal debt than to forego a vacation. That, by extension, means commercial aircraft are a necessity. Meanwhile, there is no way around fleet renewals in order to be able to operate them in a profitable manner.
The widebody segment is Boeing’s trump card, especially the larger models. The upcoming 777X in its 777-9 variant has no direct competition. At least absent a hypothetical future Airbus A350-2000 – i.e. an elongated model offering about 40 more seats in comparison to the A350-1000 assuming a three-class layout. While Airbus might be able and willing to offer that kind of aircraft going forward, it does not do so at the time of writing. Notably, around 80 percent of existing 777X orders are for the 777-9 version.
Despite its advanced age, there seems to still be good demand for Boeing Defense’s flagship fighter jet, the F15. For example, Israel ordered additional aircraft of this type earlier this year. The backlog also contains orders for various air national guards. Recently, the aircraft originally designed for air superiority demonstrated its usefulness in the use against ground targets during Israel’s campaigns in Gaza, Lebanon and Iran (although it should be noted that the IDF uses modified aircraft). Versatility in conjunction with reliability and materially lower unit prices compared to multirole fighter aircraft such as Lockheed Martin Corp.’s (LMT) F-35, Dassault Aviation SA’s (OTCPK:DUAVF) Rafale or the Eurofighter Typhoon might make the tried and tested F15 increasingly attractive to nations seeking to upgrade their respective armed forces’ capacities in a cost-efficient manner.
On the financial front, Boeing seems to have secured enough liquidity for the foreseeable future. In addition to just shy of 10 billion in cash on the books as of September 30th, the company has $20 billion in undrawn credit lines and is set to collect about $21 billion from the equity raise. These funds should suffice to keep the light on for at least another year or two, even in the case of a prolonged strike and a very costly labor agreement to eventually end it.
Strike
Which brings me to the most pressing near-term concern: the strike organized by the International Association of Machinists at Boeing’s Washington plants. While the duration of the strike is inherently uncertain, there is certainty about two things. First, the strike is costly for Boeing. In fact, it virtually precludes profitability for as long as it continues. Second, ending the strike – while still preferable to the alternative -will be costly, too. The union workers are not stupid, they know that they have massive leverage. I assume that they have a rough idea of what the strike costs their employer. I am further convinced, that they are aware of Boeing’s strategic importance. Even if the company were to go bankrupt, its customers and/or the government would need to save its core business in order to preserve their own vital interests. In other words: the machinists’ jobs are relatively safe. If (hypothetically) the United Autoworkers overplay their hand, Ford Motor Co. (F) or General Motors Co. (GM) might go out of business and customers could switch to imported Chinese cars. If the same happens to Boeing, DC and the airlines need to organize a bailout as switching to COMAC or Sukhoi is no alternative. Investors, however, could end up with nothing regardless. For customers and the US government, every single Boeing shareholder is expendable. The workers, on the other hand, are largely essential, as without them assembly and delivery of aircraft is not possible. Provocatively put: if they could be replaced, they would have been replaced by now. The threat of shifting production to “right to work states” is arguably not a very strong incentive either, given that those plants are disproportionately ridden with quality issues. One might even make the point that there is at least correlation between non-union workers and quality issues. Somewhat ironically, South Carolina built 787s had to be taken to Everett for repairs.
So all in all, the union’s apparent confidence and resolve strikes me to be not entirely without merit. Last week, an offer including a 35 percent increase and higher contributions to 401(k) plans was rejected. The pay raise was not that far off the union demand for a 40 percent increase. The main sticking point seems to be not wages but pensions. More specifically, the striking workers demand the (re-)introduction of defined benefit plans.
Many readers will probably be instinctively baffled by the adamant demand for defined benefit plans in lieu of relatively generous contributions to a 401 (k). But if you are reading this, you are quite likely to be somewhat biased and like the idea of being able to increase your return. After all, that is probably why you are a SeekingAlpha reader in the first place. But it is important to keep in mind that different individuals tend to have different mindsets. There are a significant number of people who value security and predictability without personally being responsible for generating the necessary returns, higher than the chance to increase their overall returns. Some people do not desire to retire as millionaires, they desire to retire with someone else taking care of them for the remainder of their life.
From a financial perspective, the reintroduction of defined benefit pensions is probably close to a worst-case scenario, as it would lead to massive long-term liabilities and shift market risk back to the employer side. Now, to be clear, there is a more than decent chance that Boeing will be able to avoid giving in to this particular demand. So far, no major union has successfully campaigned for the reinstatement of pensions one they had been taken away. However, for the reasons alluded to above, Boeing workers are in the best position possible to force something like this through. To make matters worse, union workers would most likely be emboldened if successful, which does not bode well for future negotiations. And of course, seeing unions succeeding might make employees at other factories consider unionization, too. After all, it is only rational to copy a proven strategy.
Debt
While the strike certainly is the most pressing financial concern, it is far from the only one. Another perennial issue with Boeing is its indebtedness. Back in mid-2023, I described Boeing as held back by its debt. The overall situation has not been getting much better in the meantime (or prior to Monday, that is). As of September 30th, the company reported consolidated debt of $57.7 billion. Of course, the relative weight of debt will be alleviated by the equity raise, but the absolute figure is still substantial. Especially given that FY2024 is almost certain to end with a massive annual loss and profitability is likely to remain elusive for at least another few quarters.
The strike alone will presumably consume a material chunk of the fresh funds, as will, over time, its resolution. In this context, a possible reintroduction of defined benefit pensions could be a huge risk as it would create ever-growing balance sheet liabilities.
Boeing posted a Q3 operational loss of $5.7 billion, about 4 billion of which stem from the commercial aircraft division. And that, mind you, included only about 2 weeks of strike. By comparison, Q4 so far already includes twice that many strike days.
On a sidenote, Boeing’s acquisition of Spirit AeroSystems Holdings Inc. (SPR) may increase debt levels more than initially expected. The two companies’ businesses rely heavily on one another, and Spirit had to draw a $350 million credit line due to the strike.
When the transaction closes, Boeing is likely to have acquired Spirit with more debt than the $4 billion it reported at the end of FY2023.
Quality and Culture
Beyond the financials, Boeing suffers from deeper underlying problems. And unlike cash shortage, which can be addressed rather quickly, albeit at a cost to shareholders, culture does not change in a day. And the measures Boeing will need to prioritize in the commercial division – think more sustainable target times, less pressure on assembly workers, higher emphasis on quality control over cost-control – tend to have one thing in common: they are likely to increase unit labor costs. That, obviously, is not ideal for a company that is already struggling to breakeven.
The single biggest problem of Boeing’s defense and space decision are, in my assessment, pre-existing fixed price government contracts. Such programs tend to be long term by nature and are hard to impossible to get out of, So, while management is aware of the issue, there are no quick fixes. On top of that, governments are often prone to tweak requirements and request additional features. The starkest examples include the two 747-8 based Air Force One replacements ordered by the US Federal Government. Then-President Donald Trump not only negotiated the price down by a billion – he also requested various design changes, which were subsequently reversed by President Biden.
All in all, the new CEO, Kelly Ortberg, seems to be aware of what the problems are. I believe that one may be reasonably confident that new leadership will move in the right direction. That being said, getting there will take both time and money and often be in direct conflict with margin targets.
Conclusion and Valuation
All in all, Boeing is in better shape today than it was last week, but still in worse shape than it was a few years ago. Its cost basis is all but certain to increase materially going forward. To make matters worse, throwing money at the problems, while necessary, does not entail guaranteed solutions.
In 2023, my bull case estimate was in the range of $150 per share. At the time of writing, the stock price is close to that number. However, taking into account how the company has developed over the past few quarters and factoring in substantial dilution as a result of the capital increase, I am adjusting that figure downwards to somewhere in the range of $115 per share. Consequently, I view Boeing as a sell for the time being.
Analyst’s 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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