Boeing: Use The Noise To Your Advantage
Contributor since 2024 / 59 Followers
Summary:
- Despite some major missteps, Boeing’s business is difficult to disrupt.
- While the added inspections may delay deliveries in the near term, this should not impact the company’s business long term.
- A long-term investor can use the current negative environment around the company and stock as an entry point.
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sanfel
It just seems like these days, Boeing (NYSE:BA) cannot get out of its own way. Being a Boeing shareholder is not for the faint of heart, but I believe that if you have a long-term time horizon and the ability to weather the current issues, you just may be getting a steal on a company with a durable competitive advantage. Boeing’s business has major barriers to entry; a new competitor cannot just take advantage of Boeing’s recent missteps and take away significant market share. The main threat comes from Airbus (OTC: EADSY), but there are many reasons why customers are not going to put all their eggs in one basket.
Boeing’s Recent Struggles
The past few years have been a rollercoaster, ever since the two fatal crashes of the 737 MAX within a six-month period in 2018 and 2019. Even as those accident investigations faded and changes were made to the 737 MAX MCAS system, Boeing continued to run into supply chain delays, quality lapses at its major subcontractor Spirit AeroSystems (SPR), and issues with FAA certifications.
All of these problems, as well as the “minor” blip of the COVID pandemic, just decimated the stock and the earnings of a once powerful American company. Boeing hasn’t been profitable on an annual basis since 2018 and as a result has negative shareholders’ equity, a fact that is probably not lost on the many Boeing investors that have lived through the past 5+ years.
| 2018 | 2019 | 2020 | 2021 | 2022 | 2023 | |
| Net Income (Loss) attributed to Boeing Shareholders | 10,460 | (636) | (11,873) | (4,202) | (4,935) | (2,222) |
| Shareholders equity (deficit) | 410 | (8,300) | (18,316) | (14,999) | (15,883) | (17,233) |
Since mid-2022, however, momentum had been building. Planes returned to service, certifications were granted by the FAA and, importantly, as a shareholder, cash flow was positive. I believed that the momentum in the revenues and cash flows was going to continue and profitability would follow once production increased.
| 2020 | 2021 | 2022 | 2023 | |
| Operating Cash Flow | (18,410) | (3,416) | 3,512 | 5,960 |
| Cap Ex | 1,303 | 980 | 1,222 | 1,527 |
| Free Cash Flow | (19,713) | (4,396) | 2,290 | 4,433 |
That only made waking up on the morning of January 6th to news of the Alaska Airlines door plug blowout a day prior a hard punch to the gut. All that momentum gone in an instant – this was bad. As we learned more about the incident, it seemed very difficult to believe that this incident was anyone else’s fault other than Boeing’s. The plane in question was delivered only a few months earlier; even if the root cause occurred at a supplier, the buck stops with Boeing. Thankfully, Boeing has been very candid about taking responsibility and this could just be the wake-up call that they need.
So why would anyone in their right mind want to own Boeing with all these issues? For starters, it has a durable competitive advantage.
Boeing is in a duopoly with Airbus and has a backlog of planes on order well into the next decade. While customers may feel inclined to consider switching to Airbus given all of BOEING’S problems, it cannot happen at scale for two reasons:
- If Boeing goes away, Airbus has a monopoly and pricing becomes a massive problem to the airlines.
- Supply constraints have already pushed deliveries out for years. Removing supply (or just adding more demand to Airbus) is going to make it worse.
Boeing’s revenue growth on its commercial business is going to depend on its ability to increase its production numbers on its various aircraft. In my opinion, the most important model right now is the 737, with a current production pace of 38 per month. Boeing believes it can increase that production to 50 or even 60 a month, but clearly it may take some time to get there, with the recent quality issues and related inspections slowing down the process. The technology of Boeing’s business is complex, but the business model is pretty simple. Higher production levels leads to more deliveries, which mean more revenue and cash flow. But in addition, more production also spreads the fixed costs over more aircraft, which increases margins and profitability. The current production slowdown due to the increased inspections should impact production levels in the short term, but my opinion is this is only a temporary issue and production levels will increase over time.
Boeing’s defense business is in a similar position, as one of only a handful of companies that can act as a major prime contractor to the US Government and its allies along with Lockheed Martin (NYSE: LMT), Raytheon Technologies (NYSE: RTX), and Northrop Grumman (NYSE: NOC). If a major new platform needs to be designed and built, the Government only has so many choices.
Boeing’s defense business has underperformed lately. They continually report “abnormal charges” due to costs associated with developing new technologies on fixed-price contracts, something that they promised in their Q3 earnings call to never do again. But they assert that these same programs will be profitable when they move to production; they just have to get there first. The significant losses that have occurred in the past should not recur regularly in the future if they keep their promise of no more fixed-price development contracts (historically, development contracts are let as cost plus contracts in the government world given their uncertainty). Performing uncertain development work for a fixed price is very risky and those risks have turned out very unfavorably to Boeing recently. But if you buy Boeing now and they stick to their Q3 earnings call promise, the losses and sunk costs will have already been mostly incurred and you’ll be paying for the future margin.
OK – but so what? Many businesses have a durable competitive advantage. Why not just invest in Costco (NASDAQ: COST) or Nvidia (NASDAQ: NVDA) and not worry about all these issues?
That brings us to the next reason to own Boeing, and that’s the price of the stock. All these issues might not be great for my blood pressure, but they have seriously impacted the stock price, for good reason. But will this stop customers from buying from Boeing?
My belief is that the answer is a very clear no, despite whatever cynical barb you may read in the paper saying that Boeing is at the “last chance saloon”. The airlines just don’t have that many options, and no one wants to be beholden to one supplier.
Valuation
So let’s talk valuation. With the losses due to the production issues and abnormal charges, it’s very difficult to value Boeing based on an earnings multiple, so I like to use free cash flow to enterprise value as my metric. Right now, it doesn’t look all that cheap on that at 36x (using a $205 price), but that’s heavily influenced by the depressed cash flow levels due to all the issues described above. Boeing has forecasted $10 billion of free cash flow in 2025 / 2026, which yields what I believe to be a much more reasonable 16x multiple. Plus, with all that cash flow coming in, the Company can continue paying down the debt accumulated over the past few years or maybe even reinstate a dividend.
Risks
How much worse could it get, and where are my risks?
At this point, it seems the groundings of the 737-9 MAX are mostly behind us. However, Boeing realizes they are in the penalty box at this point and so they have shown a bit more humility with their regulators and dropped their recent exemption request on the certification of the 737-7 MAX. The major risk really lies in whether there’s another issue on another Boeing plane that was recently delivered. With all the scrutiny as well as stepped up inspections, it would be hard to fathom that happening. If you’re willing to take that leap of faith, this could be a great time to build a position in a company with a huge moat at a good price. Without question, another major issue that occurs in flight, such as the Alaska Airlines incident, would probably be the final straw for me and force me to abandon my bullish view.
In terms of competitive risks, in my view the business itself has a very wide moat and is very difficult to displace. We all witnessed that first hand a few years ago, when Bombardier almost went bankrupt trying to build an airplane that would be competitive in the large scale commercial aircraft space. They were eventually bailed out and acquired by Airbus. What about Comac you ask? If you believe that relations between the United States and China will improve, they are a legitimate threat. But that’s not a bet I would take.
I’m definitely monitoring that $10 billion free cash flow guidance for 2026 as a key metric to watch going forward. Management’s estimates can often be a moving target, but if they are not on the track to $10b in two years, I’d have to question whether they can grow from there and whether management has any handle on the business. That’s not to say that you have to wait until 2026 for this to play out though, as they are updating their expectations with regard to 2025 and 2026 every quarter. So keep an eye on this going forward.
Also one more caveat, you’re going to have to ignore the noise.
I can’t believe the stories that now appear daily in major news publications. “United jet diverted as Boeing jet had cracked windshield.” “Boeing planes collide at Chicago O’Hare sparking FAA investigation”. I understand the old adage “if it bleeds, it leads”, but some of these stories are just piling on and have nothing to do with Boeing’s manufacturing. How is it Boeing’s fault that two planes collided on the runway? They are just seemingly throwing Boeing’s name in there for the clicks.
Conclusion
Warren Buffett has often been attributed as saying “Invest in a business any fool can run, because someday a fool will.” I won’t go as far as to call Boeing’s management fools, but it’s clear that there’s been some major problems that fall squarely on the management of the business. Using the latest missteps by management to acquire what I believe to be a well-positioned business at a discount for the long term is a smart way to invest. Just ignore the noise and focus on this exceptional business.
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Analyst’s Disclosure: I/we have a beneficial long position in the shares of BA either through stock ownership, options, or other derivatives. 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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