Boeing: Shares Are Rising Faster Than Fundamentals Warrant (NYSE:BA)

Conceptually speaking, I am a huge fan of the aviation industry. Truth be told, I have only flown a handful of times in my life. Flying is still a bit scary to me, even at the age of 34. But I find it to be a fascinating industry that connects the world in ways that were previously not possible before the advent of the plane. In the past, I have been bullish on some companies in the aviation market, with the most notable and successful being General Electric (GE). But one company that I decided to take a more neutral stance on earlier this year is the behemoth in the space known as The Boeing Company (NYSE:BA).

After having been bullish on the company, to great effect, since 2020, in July of this year I downgraded Boeing from a ‘buy’ to a ‘hold’. In that downgrade, I mentioned that the company’s recovery is imminent. But because of how so that recovery was and how shares were priced, I made the claim that it was not an attractive opportunity for investors to consider at that time. Since then, the market has disagreed with me to some extent. The S&P 500 is up about 4.8% since the publication of that article. By comparison, Boeing has seen an upside of 15.5%. But when you really dig into the numbers, and you see how the picture is changing, I have to wonder just how much additional upside shareholders might experience. Even if current forecasts are correct, the stock looks to be rather pricey. So because of that, I’ve decided to keep the business rated a ‘hold’ for now.

Pain is letting up some

There have been multiple factors that have negatively impacted Boeing in recent years. The biggest, by far, was the COVID-19 pandemic. But there were others. For instance, the global grounding of the Boeing 737 MAX aircraft in 2019, which occurred after 346 people died across two different crashes, resulting in a significant loss of faith in the company and ultimately cost the business a great deal. It’s no surprise, then, when you look over a fairly short window of time of, say, three years, with the end of that three years covering the early stage of the recovery of the airline space following COVID-19, that you might get some sense of optimism.

As you can see in the chart above, revenue, profits, and cash flows, largely improved for Boeing from 2020 through 2022. Backlog for the business started recovering nicely as the commercial backlog rebounded. This general trend makes sense when you consider the rebound scene in commercial air travel. Back in 2019, there were about 9.16 billion passengers transported globally in the airline industry. To be clear, this is not and unique individual passengers. If somebody has flown 10 times, they would be counted as 10 passengers for the purpose of this data. But I digress. The total passengers transported ended up collapsing to 3.55 billion in 2020. This year, the industry is expected to see about 8.61 billion, meaning that we have largely recovered after years of pain. Moving forward, we should see nothing but upside. In 2024, for instance, it’s estimated that there should be about 9.37 billion people transported by plane. If this comes to fruition, it would mark the single greatest year in the history of the airline industry.

Clearly, this is good news for a company like Boeing that prioritizes the creation of aircraft for commercial purposes. And by prioritizes, I think it’s worth noting that, as of the end of the most recent quarter, which would be the third quarter of the 2023 fiscal year, a whopping 83.6% of the company’s backlog involved commercial airplanes. That dwarfs the 12.3% involving the company’s Defense, Space & Security segment. The financial results seen so far this year do truly show this recovery in action. Revenue in the first nine months of this year has totaled $55.78 billion. That’s 19.6% above the $46.63 billion generated only one year earlier. This comes on the back of backlog shooting up to $469.2 billion compared to the $381.3 billion it stood at the same time last year.

With the improvement on the top line has also come improvements on the bottom line. For the first nine months of this year, Boeing generated a net loss of $2.20 billion. That’s a little more than half the $4.30 billion generated during the first nine months of 2022. Operating cash flow went from $55 million to $2.58 billion. If we adjust for changes in working capital, it managed to swing from negative $954 million to positive $906 million. And finally, EBITDA for the company went from $364 million to $2.10 billion. When it comes to the 2023 fiscal year in its entirety, management did say that operating cash flow will be between $4.5 billion and $6.5 billion. That would mark a nice improvement over the $3.51 billion reported for last year.

Purely from a pricing perspective, this does make Boeing a difficult company to get excited about. As of this writing, the company has a market capitalization of $141.5 billion. If we assume that operating cash flow will come in at the midpoint of guidance, then this translates to a price to operating cash flow multiple of 25.7. That’s a lot to pay for a company that is still generating net losses. A big part of the firm’s problem is that, while backlog and revenue are both growing nicely, costs still remain out of control. Back in 2018 when the firm generated a hefty $15.3 billion in operating cash flow, its cost of products totaled 72.1% of all revenue while its cost of services came in at 8.4%. In 2022, these numbers had grown to 81% and 13.7%, respectively. Using data from last year, even a 1% change in margin works out to $666.08 million on the bottom line on a pre-tax basis.

Until we start to see some more meaningful improvements, I think that a neutral stance is still appropriate. It doesn’t help that the company had a rather poor showing at the Paris Air Show. Earlier this year, that show resulted in bookings of $72.4 billion for the aviation industry. However, Boeing landed only 316 aircraft orders at a time when rival Airbus landed orders for 821 aircraft. To put this in perspective, industry orders came in at 1,303 units, with firm orders of 1,160 units notching the highest in the history of the event. This follows a rather rocky 2022 fiscal year in which Airbus beat out Boeing when it came to certain high-value orders. For jumbo and super jumbo aircraft, Boeing reported 774 net orders last year. That compares to the 820 seen by rival Airbus. And for the more narrowbody aircraft like the Boeing 737 MAX and A320neo, the firm fell short with orders of 561 compared to the 770 reported by Airbus.

High levels of competition are not a good thing to experience at a time when a company needs to cut costs. But this isn’t to say that everything regarding Boeing is bad at this time. One bright spot for the company recently has been its Global Services segment. This is the part of the business that provides services to both commercial and defense customers globally. It basically offers products and services such as supply chain and logistics management, engineering, maintenance and modifications, upgrades and conversions, spare parts, pilot and maintenance training systems, and more, to its customers in exchange for a fee. From 2020 through 2022, revenue for this segment has grown from $15.54 billion to $17.61 billion. Profits over the same window of time have skyrocketed from $450 million to $2.73 billion. And so far this year, we continue to see improvements. Revenue in the first nine months of the year totaled $14.28 billion. That’s up from the $13.04 billion reported the same time last year. Profits associated with the segment have jumped from $2.09 billion to $2.49 billion. You can tell, in the chart below, just how margins associated with this segment have improved as well. At the end of the day, it’s this set of operations that stands the best chance of growing the company’s bottom line further.

Now, to be clear, my mindset on the business could change based on new data. Recently, for instance, management has announced some nice wins for the company. This includes one order for up to 100 737 MAX Jets. This came only days after another order for 40 of the same aircraft from a different customer. But to become really comfortable with the picture, I need some clarity on the bottom-line impact for the company. Margins are improving and as the industry recovers, the company should see its pricing power improve. But I would like to see more of that in action before thinking that shares can outperform the broader market moving forward.

Takeaway

If I were to be able to see 10 years into the future, I would imagine that I would see a Boeing that is thriving. By that point, the company can work out its weak spots. The airline industry will have continued growing and the pains of the past few years will have been long behind it. I fully suspect that shareholder returns between now and that distant time will be positive. At some point, I imagine that my rating on the stock would turn from a ‘hold’ to a ‘buy’ once again. But the risk that I am talking about has less to do with a positive return versus a negative return and more to do with a return that trails the broader market. For now, there is a substantial risk of underperformance for shareholders. Yes, the picture is improving and there are some really bright spots for investors to point to in order to comfort themselves about the long haul. But for those who want to capture strong returns in the market, I would make the case that there are definitely better prospects to be had right now.