2023-05-19 08:00:18 ET
Summary
- Boeing's long-suffering commercial jets division has finally shown signs of a turnaround in recent quarters.
- Free cash flow is likely to recover to $10 billion by 2026, in line with management's guidance.
- Boeing will need to apply nearly all of its free cash flow to debt reduction for the next five years, limiting its ability to return capital to shareholders.
- With free cash flow more likely to dip than grow in the late 2020s and early 2030s, Boeing stock looks overvalued at 12.5 times projected 2026 free cash flow.
After four tumultuous years marked by the 737 MAX grounding, the COVID-19 pandemic, severe supply-chain constraints, and numerous quality control issues, Boeing ( BA ) has finally started to get back on track in recent months. The aerospace giant generated over $3 billion of free cash flow in Q4 2022, giving it positive cash flow for the year after burning nearly $30 billion between 2019 and 2021. Boeing continues to project that aircraft production, revenue, profitability, and cash flow will improve steadily over the next few years.
This growing sense of stability has enabled Boeing stock to rebound to trade above $200 for most of 2023, after sinking as low as $113 last year. Still, even after this rally, Boeing shares remain more than 50% below the all-time high of $430.35 they notched in early 2019.
Furthermore, management projects that free cash flow will recover to $10 billion by 2025 or 2026. On that basis, Boeing stock trades for just 12.5 times future free cash flow. That has many analysts and investors bullish about the stock.
However, Boeing will need to use the bulk of its cash flow over the next five years to fix its balance sheet. Moreover, while free cash flow may recover to $10 billion within a few years, that is more likely to represent a cyclical peak than a base for future growth. As a result, Boeing stock continues to look unattractive.
Signs of Stabilization in Commercial Airplanes
Boeing operates in three main business segments: commercial airplanes; defense, space, and security; and global services. The services business is a fairly steady performer, typically earning mid-teens operating margins. It even turned a small profit in 2020.
The defense business also used to be a reliable source of earnings and cash flow, but quality issues and cost overruns have plagued it recently. In 2022, the segment recorded a $3.5 billion operating loss, largely driven by a slew of charges (see pp. 36, 86-88) related to cost overruns on fixed-price government contracts. The defense business continues to struggle in 2023. It reported another loss last quarter, and Boeing expects the segment to burn cash again on a full-year basis.
The commercial airplanes division has been the biggest source of trouble for Boeing in recent years. Between 2019 and 2022, it booked cumulative operating losses of over $29 billion. A massive inventory buildup also sapped cash flow. This division is finally starting to make progress towards a turnaround, though.
Boeing delivered 480 commercial jets last year: well below the record of 806 set in 2018 , but up from 340 in 2021 and just 157 in 2020. That caused segment revenue to recover to $25.9 billion: up from a nadir of $16.2 billion in 2020.
The commercial jets business is still recording operating losses, mainly due to producing aircraft at lower rates and the cost of fixing jets with initial quality problems. However, cash flow has turned positive, as Boeing has started to work through its backlog of undelivered 737 MAX and 787 Dreamliner jets. During 2022, Boeing reduced its 737 MAX inventory by roughly 85 units and its 787 inventory by approximately 10 units.
Deliveries should continue to recover in 2023. Boeing anticipates delivering 400-450 737 MAX jets and 70-80 787 Dreamliners this year, up from 387 and 31, respectively, in 2022. That would enable the commercial airplanes segment to generate $2.5 billion-$3.5 billion of operating cash flow for the full year.
Source: Boeing Q1 earnings presentation (link above), slide 9.
Boeing expects the commercial airplanes division to continue leading its cash flow and earnings recovery over the next few years. By 2025 or 2026, Boeing envisions delivering around 800 commercial jets annually (roughly in line with the 2018 high) with a low-teens segment operating margin and about $9 billion of segment operating cash flow. The company's forecast also calls for gradual earnings and cash flow growth from the services business and a modest recovery to high single-digit margins and $2 billion of segment operating cash flow for the defense unit.
Not Much Excess Cash
Boeing's mid-term targets look achievable. There is a lot of pent-up demand in the commercial aviation market, due to the prolonged slump in deliveries that has been driven by the 737 MAX grounding, the pandemic, and recent supply-chain and quality issues. As the supply chain continues to recover and management addresses the remaining quality problems, the commercial jets division is poised for a steady recovery. That should enable Boeing to hit its revenue, earnings, and cash flow goals by 2026 (2025 is probably too optimistic), including its goal of generating $10 billion of free cash flow.
However, this won't enable Boeing to return to its pre-2019 practice of showering investors with big dividends and share buybacks. For the next few years, Boeing will need to devote substantially all of its cash flow to debt reduction.
At the end of 2018, Boeing had just over $5 billion of net debt, consisting of $13.8 billion of debt against $8.6 billion of cash and investments. (A year earlier, net debt was barely more than $1 billion.) By contrast, net debt now exceeds $40 billion, due to Boeing's severe cash burn over the past few years.
Management has indicated that it intends to return the company to its historical capital structure and will prioritize debt reduction over returning cash to shareholders for the next few years. Even if the company were to hit its cash flow targets and put all of its cash towards paying down debt, net debt wouldn't reach historical levels until sometime in 2027.
Once its debt reduction plans are on track, Boeing could potentially resume paying a modest dividend in late 2025 or 2026. But meaningful shareholder returns won't begin until 2027 or 2028, making Boeing stock a pure capital appreciation play over the next several years.
Not a Base for Sustainable Growth
Bulls think Boeing's market cap could grow enough over the next few years to justify buying the stock even with no dividends or share buybacks in the cards. But for Boeing stock to return 10% annually over the next three years, it would have to trade for approximately 17 times the company's medium-term free cash flow guidance of $10 billion by 2026.
If Boeing were likely to grow free cash flow from that base beyond 2026, this would be a reasonably attractive valuation. But aerospace is a cyclical business, and the current cycle seems likely to peak in the late 2020s.
In its most recent commercial market outlook, Boeing estimated that airlines will need 18,405 new planes over the coming decade, excluding regional jets. At first glance, that might seem bullish. With over 1,800 new jets needed annually (on average), Boeing could deliver 800 or more aircraft annually with a 45% share of the market (below its historical average for the past 25 years).
Source: Boeing 2022 Commercial Market Outlook (link above), slide 18.
However, Boeing probably won't be able to sustain more than 40% market share going forward. In the narrowbody market, which represents the vast majority of demand, Airbus (EADSY) has nearly twice as many orders in its backlog as Boeing. To meet this demand, Airbus plans to boost A320neo-family production to 75/month by the end of 2026 . It is also on track to increase A220 production to 14/month by 2025.
This would have Airbus building roughly 1,000 narrowbodies annually by 2027, against 600 for Boeing (based on current plans). Meanwhile, China's Comac hopes to ramp up production of its C919 jet to 150 units annually within five years .
Pent-up demand could probably support global narrowbody production at these rates for a few years, but not indefinitely. In particular, commercial jet production sagged between 2001 and 2005, due to the impact of the 9/11 attacks on aviation. That will undercut replacement demand towards the end of the current decade, based on the typical lifespan of a narrowbody jet.
Making matters worse for Boeing, Airbus is likely to expand its A220 lineup with a larger A220-500 model by the end of the decade. Whereas the current A220 variants don't compete closely with the 737 MAX, an A220-500 would directly challenge the top-selling 737 MAX model (the 737-8) while offering lower operating costs .
In the widebody market, Boeing is the clear leader, but its demand projections seem too optimistic. Whereas existing firm orders cover more than two-thirds of Boeing's projections for global narrowbody deliveries over the next decade, airlines haven't ordered even half of the widebodies (including freighters) that Boeing expects to be built during this period.
The impending arrival of Airbus' A321XLR makes Boeing's demand projections especially suspect. The A321XLR will offer enough range to cover many routes currently operated by widebodies with generally more attractive economics. That will cannibalize demand for the 787 Dreamliner in particular, making it hard to sustain production at the planned 2025/2026 rate of 10/month for more than a few years.
Look Elsewhere for Value
Three years ago, I argued that Boeing stock would likely be worth $200-$250 by the mid-2020s, based on annual free cash flow recovering to $10 billion.
Now, Boeing has confirmed $10 billion as its target for free cash flow by 2026 (or 2025 at best). Meanwhile, Boeing's share count has increased due to share-based compensation and pension contributions. And if anything, higher interest rates would put downward pressure on the company's valuation compared to my 2020 analysis.
Thus, barring another bout of irrational exuberance in the market (which is always possible) Boeing stock has little if any upside over the next few years. Even in 2026, investors shouldn't be willing to pay more than 12 or 13 times free cash flow for Boeing, given that cash flow is more likely to decrease than grow in the late 2020s and early 2030s. Shareholders should consider selling any rallies in Boeing stock and reallocating their capital to more promising companies.
For further details see:
Avoid Boeing Stock: It's Fool's Gold