A turbulent few years

Boeing, the world’s largest aerospace company, has faced significant challenges in recent years. From the grounding of it’s 737 MAX planes over safety fears, to pandemic-related disruptions, the company’s share price has declined by over 60% in the past five years. However, investing is often about going against the trend, and this substantial drop may present an attractive opportunity.

A discounted cash flow (DCF) calculation suggests that the shares are trading at approximately 40.1% below estimates of fair value. Of course, there’s no reason to suggests the current negative trend in the shares will change any time soon. But it gets me interested in the long-term potential of an investment.

Valuation estimates should of course be approached with some caution. I’d suggest such a large discrepancy between the current price and estimated value warrants caution. There’s plenty of potential, but plenty of risk for this to worsen if results fail to meet expectations.

Eyes on the future

Despite the firm’s recent disappointments, I think the future outlook appears more promising. Analysts forecast annual earnings growth of 67% for the next five years, surpassing many peers in the aerospace and defence sector. This includes Rolls-Royce, which forecasts a decline in annual earnings over the coming years.

Of course, it’s crucial to acknowledge the risks. The company carries a substantial debt burden, with it’s $57.7bn debt not well covered by operating cash flow. With a debt-to-equity ratio of -320.7%, this could pose challenges if the company faces further unexpected setbacks.

Additionally, shareholders have experienced dilution over the past year, which is generally viewed negatively by existing investors. Although the number of shares only increased by 2.1%, management will need to demonstrate improved financial discipline to regain investor confidence.

More appealing than Rolls-Royce?

While the Rolls-Royce’s share price has been impressive of late, I think it’s worth considering whether an investment in the stock still offers good value after such a significant run-up. Boeing, despite its challenges, could easily offer a more attractive risk-reward profile.

Boeing’s price-to-sales (P/S) ratio stands at 1.3 times, compared to Rolls-Royce’s 1.4 times. This suggests that investors are paying slightly less for sales compared to Rolls-Royce. Moreover, I’d argue that Boeing’s larger scale and more diversified business model provide additional layers of resilience and growth potential.

To me, both companies represent intriguing opportunities in the aerospace sector. Rolls-Royce has demonstrated an impressive turnaround, but much of this positive news may already be reflected in the shares. Boeing, while still facing challenges, could offer better value at current levels, with significant potential if the company can execute on its growth plans and operational improvements.

Many will continue to focus on Rolls-Royce, but I’ll be watching Boeing’s share price, and buying at the next chance I get.

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In the eight years that followed, Boeing achieved record deliveries and free cashflow grew consistently year over year. Investors benefitted from both annual dividends and share buybacks on top of share price appreciation.

From 2013 to 2018, Boeing shares rose by 160% from $135 to $350. 

Unfortunately, shortcuts taken by management lead to the famous Manoeuvering Characteristics Augmentation System (MCAS) issue resulting in two fatal 737 crashes in 2018/19. Boeing agreed to a settlement of $2.5bn for the airlines and victims’ families. Today Boeing faces different issues particularly supply chain restrictions and recertification of the 737 Max-10.

Boeing CEO David Calhoun told Aviation Week magazine that if the aircraft fails to meet the end-of-year deadline and congress doesn’t extend the 737 Max-10 exemption for installing the pilot warning system, he may cancel the programme. Such an event would be disastrous for Boeing, leading to significant asset write-downs, order book cancellations and customers moving to the likes of Airbus.

Turning point

The string of disappointing news over the last few years has left Boeing shares trading way below the $200 mark. Despite the current headwinds, Boeing’s 737 Max still has a lower fuel consumption in comparison to Airbus’s A320neo (according to Boeing) and the programme still has a 3,400+ order book.

In the event of a recession the backlog is unlikely to be entirely depleted, as production rates would need to exceed 2018 levels (800+ deliveries), which is not a realistic possibility. During the second quarter earnings call this week, management confirmed that they’re in the final stages of restarting 787 deliveries.

With this positive news, there are two key turning points I am focusing on:

1. Recertification of 737 Max-10 or congress extending exemption;
2. Supply chain issues abating.

Supply issues appear to be improving already as Boeing’s Q2 delivery numbers increased to 121 — of that number 103 were 737 aircraft. Only 86 737 aircraft were delivered in Q1.

Furthermore, airlines continue to place new orders with Boeing despite supply issues and certification uncertainty. If Boeing is successful in certifying 737 Max-10 before year end, the stock could easily exceed the $200 mark as free cashflow would be anticipated to recover to pre-pandemic levels ($12-13bn) in the coming years.

At the current valuation of $85bn ($156 per share), Boeing has room for share-price appreciation as free cashflow is estimated to reach $12bn by FY24 according to Wall Street. This would imply a two-year forward market cap/free cashflow (MC/FCF) of 7x. Historically Boeing usually trades at 18x MC/FCF — in other words, the stock is cheap.

Conclusion

It can be argued Boeing is approaching a turning point in the coming quarters potentially making Boeing a buy for me at $156. Demand is strong as the total order book value of the commercial airline business is $290bn with an additional $60bn in defence contracts waiting to be fulfilled. Two board members have purchased noticeable volumes of shares in the last six months demonstrating a vote of confidence.

I’ve added Boeing shares to my watchlist as I patiently wait on operational developments and investor updates, mainly what is happening with the 737 Max-10.

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Recent results and the Boeing share price

Between the 2017 and 2021 calendar years, results have been on a downward trajectory. Revenue for the period declined from $94bn to $62.2bn. Furthermore, a $10bn pre-tax profit in 2017 turned into a $5bn loss in 2021. Additionally, earnings-per-share (EPS) fell from $14.03 to a loss-per-share of $7.15. 

Over this period, the results underpinning the Boeing share price clearly may not give me much confidence. 

Compared with the 2020 calendar year, however, the most recent results did show signs of improvement. During 2020, the pandemic led to a $14bn loss and to reduced revenue of $58bn. By this comparison, therefore, things appear to be on a better footing. 

Additionally, a trading update for the three months to 31 December 2021 showed that operating cash flow was $716m. This is a massive increase from the same period in 2020, when this figure was negative $4bn.

A healthy order book

Boeing is active in the aviation market and its 737, 777, and 787 are popular aircraft. In February 2022, Qatar Airways signed a deal to purchase 34 777X, with an option to add 16 more. The airline also ordered 25 737 Max 10 jets, leaving open the option to purchase a further 25. This entire order is worth $34bn to Boeing, over half of its 2021 revenue.  

The firm also concluded a deal with the UK Ministry of Defence. It’s worth about £460m and will involve the provision of logistics support. It will last for five years.

Things have not been totally smooth, though. The 737 Max model was grounded for two years in many areas including the US and EU. This was to investigate two fatal accidents that caused the deaths of 346 passengers. These bans were lifted last year, but did the company a great deal of reputational damage. The crash this week in China of a 737-800 was both a human tragedy and another nightmare for Boeing.

The firm has a forward price-to-earnings (P/E) ratio of 46.51. By comparing this to the forward P/E ratio of a major competitor, this may indicate if the business is over- or undervalued. A major rival, Airbus, has a forward P/E ratio of 20.08, considerably lower than Boeing. This may suggest that the current share price is expensive.

What’s more, Airbus is actively competing for the market share, supplying 50 A350 Freighter and commercial aircraft to German airline Lufthansa in June 2021.

There’s no denying that Boeing is a giant in aircraft production. However, historical results and investigations into the 737 Max leave me feeling uneasy about this firm. While recent results seem to indicate a change for the better, I won’t be buying shares in this business.   

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The world is now in a Covid-19 lockdown that has airlines grounding planes and seeking taxpayer bailouts. easyJet has grounded all of its aircraft until June at the earliest, and its major shareholder is advocating the cancellation of a £4.5bn order for 107 aircraft. easyJet is trading at one-third of its 52-week high. Shares in IAG have fallen to £2 from a 52-week high of £6.57 in January. And shares in AerCap Holdings, the world’s largest aircraft leasing company (which leases over 1,000 aircraft to 200 airline customers in 80 countries), hit an all-time low of $15 on 18 March, down from a 52-week high of $64.

Are aviation stocks good value now?

Whilst all of these stocks now look like very good value, my view is that airlines and aircraft leasing companies face a future turmoil that makes them very risky buys. But I believe the short-term turmoil that OEMs will face will be short lived. So I have been incrementally taking a long position in The Boeing Company since its mid-March low. 

So why my optimism about OEMs? Firstly, because the worldwide macro trend is toward more air travel. Projections for commercial air travel remain optimistic across all regions of the world. The global aircraft fleet is expected to grow from 27,492 in 2019 to 39,175 by 2029, an increase of more than 11,600 thanks to burgeoning demand from high-growth populations in Asia, in particular from the new middle class in India and China. The bulk of this fleet expansion will be narrow body jets produced by the Boeing and AirBus duopoly.

The Boeing Company is a long-term play, because whilst the company has an order backlog of 4,300 planes, it also has plenty of unresolved headwinds. Its 737 MAX narrow body jet, which was supposed to be Boeing’s cash cow, has been grounded since March 2019 following two fatal crashes. Even before the Covid-19 crisis took hold, Boeing reported negative net orders in February 2020 after 46 cancellations. And airline customers such as Southwest Airlines, which has 310 narrow body planes on order, have said that they might slow or defer some orders in the wake of Covid-19. Others may also do the same.

Plane spotting

But in my view, even in the wake of Covid-19, long-term travel demand is not going to cease. The long-term growth trends will continue unabated. The airlines may change. We may see aviation stocks collapse and bailouts. We might even see new airlines. But the OEM duopoly of Airbus and Boeing should persist, especially if Boeing is able to get its 737 MAX back into the skies.

At its 52-week high, The Boeing Company might have looked like a poor investment. At its current price I believe it is a good value buy to hold for the long term. 

The same can be said about Rolls Royce. The company has been posting losses since 2018 after design glitches in its Trent 1000 engine meant that it had to put £2.4bn aside for repairs.  Yet much like Boeing, Rolls Royce occupies an entrenched position in the market.

It has endured a restructuring and has reduced its average loss on engine sales. What’s more, it has reduced its overall losses from £2.9bn in 2018 to £850m in 2019. It has an order back log of over 2,000 engines.  And even if orders slow in the near term due to Covid-19, there will be a day when Rolls Royce is past its Trent 1000 problems and exploiting its privileged position to provide engines for the 11,600 commercial aircraft that will enter service during the next decade.

Rolls Royce used to regularly post profits of £3bn to £5bn.  It should get there again.  And at its current price, Roll Royce looks like good value to buy and then hold until it does.  

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