Boeing Fixes Its Engine Trouble
11/18/2011 4:00 pm EST
Short of a global depression, I think developing-economy airlines are going to add planes, as air travel in those economies expands with income. Also, in developed economies, airlines have a huge backlog of older planes (especially for US airlines) that need to be replaced with newer, more fuel-efficient planes with up to date passenger amenities such as seat-back, multi-channel in-flight entertainment.
Yesterday brought evidence of exactly that, with a $21.7 billion order from Indonesia’s Lion Air for 21 737-900s and 201 of Boeing’s announced-but-yet-to-be produced 737 Max (production scheduled for 2017).
But why the big disappointment on the stock’s target price? Two reasons for this, I think.
First, the stagnation of the general market since I picked these shares on September 30, 2010. That day the S&P 500 was at 1,141. On November 17, it closed at 1,216. That’s a very modest 6.6% gain in 13 and a half months.
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Of course, Boeing hasn’t even matched that number. The shares are down 0.09% since I picked them. Which brings me to…
Second, this has become a very tough stock to value. So much time went by in developing the 787 Dreamliner, and so many deadlines were missed (and so many delivery penalties were incurred).
Now that Boeing is finally producing and delivering planes, it is not making any money on the planes currently rolling off its assembly line, according to GAAP standards. (GAAP stands for general accepted accounting practices. It’s the low-trick way to report earnings.)
Which creates an interesting problem for an investor. Boeing is pretty clearly making money on these planes on a cash basis—but it won’t make show GAAP earnings on them until the company has delivered hundreds and hundreds of them. An estimated 1,000 in fact. Good thing the company has an order book of about 1,100 at the moment.
By GAAP standards, 2011 earnings will be $4.41 a share, Credit Suisse calculates, and $4.70 in 2012. But cash earnings per share will be $7.06 in 2012, according to Credit Suisse.
Why do you care? Well, the costs that GAAP accounting considers are certainly real costs—the company did spend all that money on research and development for the 787, and it did incur all those penalties.
But while those costs are being spread over the life of the 787s still to come for accounting purposes—which is why Boeing didn’t show an ocean of red ink when it was spending that money, but not producing any planes—in actual cash terms, that money is spent and gone, and Boeing will harvest cash from each sale that isn’t reduced by that accounting treatment.
And when it comes to things like buying back stock (Boeing is likely to resume buybacks in 2013), or paying dividends (current yield is 2.5%), or investing in the next line of more fuel-efficient narrow-body 737s, it’s cash that counts.
But you do see how unlike the usual P/E times earnings per share calculation of a target price this is. And how many difficult issues valuing a company with this kind of long tail of cash flow might be.
For example, Boeing’s 787 backlog amounts to about ten years’ worth of production. How certain are you of continued demand over that period—airlines can cancel orders if there’s a more attractive alternative, for example? How about costs over that long a time?
If you use cash earnings per share and the average ten-year average multiple of 12—the method that Credit Suisse uses to get its target price—you come up with a 12-month target price of $85 a share. (Standard & Poor’s uses a different method, but comes up with a very similar 12-month target price of $86 a share.)
I’d trim that a bit, because of uncertainties surrounding the speed with which Boeing can accelerate production on the 787 (remember that Boeing has had problems with the big percentage of outsourced content on this plane) and because of Boeing’s exposure to the current uncertainties of the defense budget.
I’d set my target at $82 a share by November 2012. That’s roughly a 24% potential gain from the November 17 close—plus that 2.5% dividend yield.
Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund, may or may not now own positions in any stock mentioned in this post. The fund did own shares of Boeing as of the end of September. For a full list of the stocks in the fund as of the end of September, see the fund’s portfolio here.