Boeing: From Bad To Worse

Summary:

• I decided to sell Boeing due to the company’s ongoing cultural and financial challenges.
• Boeing’s inability to commit to key financial metrics and the negative cash flow expected in 2025 undermines the stock’s foundation.
• The ongoing IAM strike and potential shareholder dilution from equity issuance further complicate Boeing’s recovery and financial stability.
• Despite Boeing’s strong market position, the combination of workforce issues, balance sheet problems, and defense sector struggles make holding the stock untenable.

I have finally capitulated. Interestingly enough, it was writing this article following a full review of Q3 earnings that finally pushed me to sell. This article originally began as a follow on to my previous two articles that encouraged buying Boeing (NYSE:BA) despite the issues that it had. I had originally encouraged readers to “use the noise to your advantage” as difficult as that may be, and then stuck to my position in the face of what I saw were relatively frivolous news stories that were just piling on. But laying out my case to hold caused me to realize it just wasn’t strong enough, and I didn’t need to go on this difficult journey with the new CEO Kelly Ortberg. I don’t believe that this is just noise anymore. And while many have come to that conclusion far earlier than I have, I’ll lay out my reasons for selling below despite continuing to believe that Boeing has a durable competitive advantage.

New CEO Kelly Ortberg

For starters, I just wasn’t that inspired by new CEO Kelly Ortberg’s message. Granted, I empathize with the situation that he’s in as it’s almost an impossible task. But I don’t really see how he’s going to do what he says is priority #1, and that is change the culture. This is a massive undertaking and isn’t helped by the cash flow predicament they are in. I don’t know any cultures that get better by announcing layoffs. I also don’t believe that protracted strikes are typically forgotten quickly by the workers. In addition, Boeing will have to integrate Spirit AeroSystems when the transaction closes, likely in mid-2025, which will be another cultural challenge. Will Boeing’s second-tier leaders just change because a new CEO asks them to? Maybe, but that will take years, and I’m not sure I want to stick around to see if it works.

Secondly, he also wouldn’t commit to the $10 billion of free cash flow that the company had previously stated as its primary metric and expectation in the 2025 or 2026 timeframe. This was one of the key risks that I had identified in my first article that would cause me to revisit my thesis. The expectation that this would happen in 2025 effectively changed with the Alaska Air door plug incident, but as late as the Q1 2024 earnings call CFO Brian West was expecting this metric to be reached “later in the 2025, 2026 window.” With this metric now seemingly off the table for the foreseeable future, and Boeing now expecting negative cash flow in 2025, what is underpinning the stock?

Other Problems: When will the Strike End?

When the International Association of Machinists and Aerospace Workers (IAM) rejected Boeing’s latest offer, it extinguished the one glimmer of good news that was prevalent during Boeing’s Q3 conference call. With the union seemingly intent on righting what it perceives as past wrongs with Boeing, the strike that has already cost the Company an estimated $5 billion. But with the latest rejection, one has to ask when it will end? Each day that the strike continues is another production delay that costs Boeing money. CEO Kelly Ortberg acknowledged on the Q3 conference call that “it’s much harder to turn this on than it is to turn this off”, referring to the factories and supply chain, so what will that mean to production goals? The sad part about this is former CEO Dave Calhoun was asked directly about this possibility on the Q2 conference call, and he practically dismissed it by saying “well, we’re definitely not planning on a strike for starters.” Maybe they should have planned for it?

While it is clear that the strike is bad for Boeing, the resolution is also likely to be costly. The latest offer of a 35% wage increase over four years was soundly rejected, and it makes me wonder whether IAM would even settle for the 40% increase that they asked for originally. I’m not sure how many Best and Final Offers it will take, but it seemed to be a surprise to management that the current offer was not good enough. That’s a problem.

Dilution is Coming

Boeing has a cash flow problem right now that isn’t going to be corrected easily. Debt that piled up during the pandemic has pressured the company’s credit rating, and cash flow is now expected to be negative in 2025. I was never really concerned about the balance sheet because I expected cash flow to follow their projections. Even if they didn’t hit the magic $10 billion, $5-8 billion wouldn’t have hurt. But to now have 2024 and 2025 negative, cash needs have become a priority.

With the current credit rating on watch, issuing debt is not feasible, although they did double their currently undrawn credit facilities by a new $10 billion facility. CFO Brian West has stated that an equity issuance is a possibility and the Company just filed a universal shelf registration giving it the ability to issue $15 billion in equity, which would dilute current shareholders. In my opinion, this is the most likely scenario given the choices. The company also has to issue shares to pay for Spirit in 2025, so the current capital structure is expected to be much different a year from now. None of this is good for current stockholders, and this is much different than the situation six months ago.

The other possibility to shore up the balance sheet is the sale of some of its non-core assets, which currently consist of anything that is not directly related to the airplane (commercial or defense) business. Ortberg made this very clear when he stated in his prepared remarks that Boeing is “an airplane company”, which one could view as him saying that it’s not a global services or space company. The one business that has been doing well these past couple years has been Boeing Global Services (BGS). Could a disposition of BGS help the balance sheet? It sure could, but it might not be the best move to scuttle the only part of your business that is working.

Defense Woes

Maybe this is just a bad business; it certainly has been one for many years now. We’ve heard so many times over the past few years that there were significant write-offs due to about 25% of the portfolio, and that soon Boeing Defense Space & Security (BDS) will return to normal margins. Yet here we are again with another $2 billion write-down.

This should have been expected, and I’d predict that the pain is most certainly not over. Anytime the head of a business unit is fired, as Ted Colbert was in September, be prepared for a kitchen sink type result next quarter as the new person in charge tries to mitigate any risk and pave the way for future results. To be fair, that isn’t the entire reason for the charge in the current quarter, as the IAM strike has directly impacted some of these programs, an event that was likely unforeseen when making program estimates in previous quarters.

But the real reason for BDS’ struggles in recent years are lousy fixed price development contracts; contracts that likely should never have been bid on fixed-price basis. Anyone that has worked in or knows the defense business, understands that its number one client, the US Government, does not do well with budgets. As the former CFO of a defense business, I know this first-hand.

Programs that are under development, meaning the design and creation of a new platform or platform variant, have historically been contracted under CPFF contracts, or Cost Plus Fixed Fee. Essentially, the contractor would be paid back its costs, plus a fee on top. Obviously, this gives the contractor no incentive to work efficiently, but the structure made sense as the Government often likes to continuously tweak its requirements and ask for new features.

Federal contracting began to change more rapidly during the Obama administration, when President Obama pushed for more fixed-price contracts. This makes for a great sound bite, but the development process is typically much more iterative than a clean statement of work with a task for a contractor to execute. The only way for a contractor such as Boeing to recover costs are through change orders, which involves proving that the original scope has been expanded by the customer. That can be difficult to do, and many of the inefficiencies associated with these scope changes are difficult to capture.

To a large extent, this is the background for BDS’ struggles today, likely combined with a good deal of inefficiency and a dollop of mismanagement. Boeing has already recorded over $7 billion of losses on a $4.9 billion KC-46 tanker program over the last 13 years. Former CEO Dave Calhoun had already stated in June 2023 that they will no longer bid fixed-price development contracts:

“We have a couple of fixed-price development programs we have to just finish and never do them again. That fixed-price development world has to stop. It just doesn’t work. It doesn’t work for us, and it doesn’t work for our customers in my not-so-humble opinion.”

However, the contracts that they have are still in process, causing billions of write-downs almost every quarter and the pain just doesn’t seem to want to end. I also wouldn’t be shocked when the new head of BDS is announced and that new leader looks to clean its books with more write-downs. The bottom line on BDS is that it’s hard to expect the bleeding will stop anytime soon.

Reasons to Hold Boeing / Risks to Selling

The main reason to continue to hold this stock is the duopoly that exists and the massive backlog that extends well into the next decade. Commercial aerospace should continue to grow and Boeing is almost assured of getting a large part of that business, as no airline wants an Airbus monopoly to exist. Fast-forward 10 years, and would it shock me to see that Boeing is a dominant aerospace company? Of course not. Certainly, the US Government is going to do all that it can to ensure that Airbus (OTCPK:EADSY) or Comac does not turn Boeing into an afterthought in commercial aerospace. I don’t expect that Boeing is going away anytime soon.

In addition, Boeing also has taken care of its open CEO position, which should allow the Company to move past the Calhoun era and get back to its engineering roots. In the same vein, they finally announced the Spirit acquisition, which should allow it to move forward in solving some of the problems that it has with its supply chain. These are both positive developments in my opinion.

Conclusion

Unfortunately, in my mind, nothing overcomes all the problems it currently has. Sometimes putting this all down on paper is the only way to see that you’re mistaken. As I sat down to justify why I was continuing to hold, I realized it just didn’t make sense anymore.

The poor news cycle, or “noise” that has continuously battered Boeing over the first half of the year was really not impactful to the business. I still stand by that and believe if this was just about the door plug issue and FAA scrutiny, Boeing could overcome that.

The frivolous news stories I used to see about a tire falling off a Boeing jet weren’t really Boeing issues, but they have now been replaced by real problems. Problems with the workforce, problems with the balance sheet, and a real likelihood of dilution to the shareholder. The BDS issues were always real, but seemed to be manageable and likely to end, especially as the rest of the business was doing well. While Boeing can definitely overcome these issues, it will take a really long time and they will have to execute flawlessly.

I am not the CEO of Boeing. I don’t have to go along for this ride when it seems too hard, and therefore I have sold my position.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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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.

I sold Boeing following Q3 earnings.

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