EADSY - Boeing: Not Everything Is So Perfect In The Aviation Powerhouse

2023-08-01 01:36:28 ET

Summary

• Boeing has seen a 50% rally in its stock this year due to the global return to service of the 737 and massive industry tailwinds.
• The management predicts significant growth in the addressable markets, including the world fleet, the aircraft services market, and the global cargo aircraft fleet, driven by factors such as passenger traffic growth and the popularization of e-commerce.
• The problems of the past haunt Boeing to this day, the company faces stiff competition from Airbus.
• I believe Boeing is a Hold after a 50% rally this year.

Main thesis

Amid massive corporate and regulatory challenges, Boeing ( BA ) has been demolished by the stock market for the last five years.

However, the removal of border restrictions and the realization of pent-up demand for travel help restore global passenger traffic and have a beneficial effect on the aircraft industry. In 2022, Boeing significantly increased its civil aircraft deliveries with the global return to service of the 737 and the elimination of deficiencies in the 787. As demand for civil aircraft has risen, the service division's commercial services volume has returned to pre-pandemic levels. At the same time, Boeing maintains a stable portfolio of orders in the defense segment. Thus, the massive tailwinds in the industry and the improvement in the company's financial position contributed to the 50% rally this year.

Addressable markets

• The management expects the world fleet would add 24,510 new planes (worth >$6 trillion) by 2042, as well as 20,105 upgrades and repairs, to fully support passenger traffic growth of an average of 11.2% from 2022 to 2026 followed by a slowdown to 4% from 2029 to 2040.

• One of the most promising areas for Boeing is the defense and space market , which is expected to reach $2.6 trillion by 2030, CAGR of 10.4%. At the same time, the main region of the company - the United States will account for 60% of the entire market.
• 5% CAGR of global trade by 2040 requires more logistics capacity. The Issuer expects the global fleet of commercial cargo aircraft to increase by 60% to 3,260 by 2040. As a result, the CAGR of air cargo traffic through 2040 will be 5%. The main growth driver will be the popularization of e-commerce and the need for fast cargo transportation over long distances.

The recovery & tailwinds

Commercial airplanes

The lifting of border restrictions and the realization of pent-up demand for travel is helping to restore global passenger traffic and positively influence the revenues of air carriers, which in turn are contracting for the supply of new aircraft, which gives a boost to the aviation industry.

The International Air Transport Association (IATA) estimates that in 2022, global passenger traffic increased by 64.4% year on year and reached 68.5% of the pre-pandemic figure, while the aviation industry's net losses decreased from $42 billion in 2021 to $6.9 billion. For 2023, IATA predicts a profit of the global aviation industry of $4.6 billion.

The 737 series is quickly recovering as commercial operations in China continue to resume. The in-service reliability has been 99% since November 2020, management says. The narrow-body airliners already make up more than 60% of the passenger aircraft fleet, due to their economy, ease of use and versatility. By 2040, the mark is expected to exceed 70% (more than 34,000 pieces). The biggest competitive advantage of the model is energy efficiency and environmental friendliness. The 737 MAX is equipped with new LEAP-1B engines, which, in addition to reducing fuel consumption per 1 km by 14%, have higher air compression ratios, which further improves combustion efficiency. The company has increased production of 737 aircraft to 38 units per month in Q2 and expects to reach 50 units on the horizon of 2025-2026. Management forecasts a 28% CAGR for model sales until 2025.

In 2022, Boeing's commercial airplanes division increased its deliveries by 41.2% YoY to 480 units. Management forecasts that Boeing will deliver 400-450 737s and 70-80 787s in 2023. In 2025-2026, total deliveries of civil aircraft should be about 800 units per year. Thus, the company confirms the long-term positive outlook for the segment.

The segment's revenue jumped 41% year-on-year to $8.84 billion last quarter thanks to aircraft deliveries, mainly the 787, which rose 12.4% year-on-year to 136 units. In April-June, the company received orders for 460 aircraft, 220 aircraft for Air India and 39 aircraft for Riyadh Air. In addition, Boeing signed a contract with Ryanair to supply 300 Boeing 737 MAX aircraft. Thus, the portfolio of orders at the end of June is more than 4,800 aircraft with a backlog of $440 billion ($334 billion at the end of the first quarter).

I expect the commercial airplanes to be Boeing's key growth driver in the coming years as pent-up demand will continue to support passenger flow, and the 737 model should regain lost ground.

Defense, Space & Security

The company is one of the largest contractors in the aerospace and defense industries. At the same time, 5 out of 7 programs of the company's segment are fully funded by defense spending.

The US' defense outlays are expected to reach $1 trillion by 2029 and grow through 2033 at a CAGR of 3%.

Boeing's customer base outside the United States continues to expand due to the challenging global geopolitical environment and the need to modernize aging military equipment. Germany's chancellor, Olof Scholtz, for example, said : "We are making it convincingly clear: Germany is ready to take on leading responsibility for the security of our continent". According to Reuters , Germany will buy 60 Boeing's CH-47F helicopters worth of $8.7 billion.

In addition, the company has progressed in the space industry - the unmanned flight of the Orion spacecraft on the SLS launch vehicle was completed as part of the first mission of the Artemis I lunar program.

The Defense Space Division's revenue fell slightly from $6.19 billion a year earlier to $6.17 billion due to higher costs and delays in order fulfillment for some programs. The division's order book was flat for the quarter and is valued at $58 billion, of which 31% comes from customers outside the US.

It is important to understand that in the current geopolitical situation, when the rhetoric regarding the ongoing war in Ukraine is only getting tougher, and the Taiwan issue can still escalate into an armed conflict, then reducing or even slowing down the pace of defense spending is simply impossible. Thus, I believe defense contracts for Boeing will remain stable this decade.

Global Services

During 2022, the division's commercial services volume returned to pre-pandemic levels, and the company's revenue in this segment is expected to continue to grow in 2023, driven by a further recovery in the aviation industry. In the long term, as the global aircraft fleet grows, the demand for aftermarket services will also grow as airlines seek to use flight and maintenance data analytics to improve their efficiency and reduce costs.

Demand for Boeing's service division from defense and space customers remains stable. According to the company's forecasts , demand growth will be provided by customers from the Middle East and the Asia-Pacific region, which will actively update their military equipment in the next 10 years. At the same time, management believes that less than 20% of the world's military aircraft fleet will be decommissioned and replaced in the next 10 years, which will lead to an increase in the demand for maintenance services for obsolete aircraft and an increase in their operational capabilities.

The service division's revenue increased 10% YoY to $4.75 billion in Q2, driven by an increase in the volume of services in the aviation segment. During the quarter, the division announced an expansion of its presence in Poland with the opening of a new parts sales site and signed an agreement with CAE (formerly Canadian Aviation Electronics) to collaborate on pilot training to improve flight safety. Later, Japan Airlines introduced the Boeing Insight Accelerator to its 787 fleet.

Reputation, Production & Competition

Airbus ( EADSF ) is a direct competitor of the company in the supply of passenger and cargo airliners. Since 2019 Airbus seized the advantage and overtook its competitor in net deliveries.

In the first half of 2023, Boeing reduced the gap from 37% to 19%.

The Netherlands-based manufacturer is now betting on the further development of wide-body series, the latest models of which (A350, A321neo, A330) are already capable of replacing the long-haul 777 and some 737 MAX. At the same time, the price for such airliners from Airbus is lower than that of Boeing, by ?20%.

The European competitor currently has no major technical problems with the aircraft and is also in a better financial position with a lower debt/equity ratio and more liquidity.

At the same time, Boeing still lacks production components. Since 2018, the company has been seeking to get away from intermediaries in the creation of key aviation systems, so contracts with Spirit AeroSystems and PPG Aerospace were terminated . However, massive logistical disruptions, FAA parts certification issues, and financial difficulties have left several of the company's manufacturing centers facing parts shortages . To date, Boeing has had to reinstate several contracts for the production of onboard electronics, air stabilizers and skins with Spirit AeroSystems at an inflated cost.

Thus, the management decided in just a couple of years to eliminate large-scale outsourcing, which they had been counting on for decades. The reorganization of production coincided with all the other problems of the company. Solving this problem will take a significant amount of time and money from Boeing, which will affect overall production in the coming years.

A serious obstacle to the purchase of Boeing jets for airlines is the fact that 7 models of the company (including passenger 767, 777-300ER and their cargo modifications 767-300 Freighter and 777F) do not meet FAA environmental standards. The company must completely cease production of non-compliant liners by 2026. Because of this, a number of major air carriers, including Flydubai, Turkish Airlines and United Airlines, are renegotiating long-term contracts with Boeing for fleet renewal. The company's reputation as a technical leader continues to decline rapidly, and customers are increasingly switching to analogs from Airbus - A350F (cargo) and A320neo (passenger).

Valuations

I valued Boeing on a comparative basis based on 2023 financial projections. Our valuation is defined as the arithmetic mean of EV/S and P/S multiples.

It appears that after a 50% rally this year, the company is fairly valued and, therefore, has minimal upside potential in my opinion.

Conclusions

On one hand, the situation has improved slightly compared to 2020-2021, thanks to management's actions and massive industry tailwinds. However, on the other hand, the failures did not go unnoticed for Boeing. Now, in addition to having a huge debt, the issuer is inferior to Airbus in the global commercial aircraft market and is also under pressure from massive regulatory risks and production problems. Due to the damaged reputation, a significant part of the large tenders has been lost. Now reaching pre-pandemic income levels is expected no earlier than 2025. Due to numerous negative factors, Boeing does not look attractive now, especially when the undervaluation relative to peers disappeared after this year's rally. Thus, I would stay away from Boeing and rate it as a Hold.

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