Boeing (NYSE: BA) is one of the most exciting investment propositions in the market today. As one of two major global airplane manufacturers, the company’s business moat is significant, and it has a multiyear backlog in place. It’s a compelling opportunity, but investors must consider a few things before buying the stock.
When management gives medium-term targets, investors tend to price them into their valuations. As such, the target of $10 billion in annual free cash flow (FCF) at some point between 2025 and 2026 laid out in the investor conference in November 2022 is an excellent place to start on valuations. Based on Boeing’s current market cap of $116.7 billion, it would put the company at 11.6 times FCF — an excellent valuation for a company with solid long-term growth prospects.
Naturally, the critical question is, what confidence do you have in Boeing hitting its target? I will get to that subject momentarily, but it’s essential to consider when Boeing might hit the target.
For example, let’s say you are pricing a fair value for Boeing at 20 times FCF, so the $10 billion in FCF means a market cap of $200 billion, a 71% premium to the current price. If Boeing hits the figure at the end of 2025, it’s an annual return of 30.1%. But if it hits it at the end of 2026, it’s an annual return of 19.6%.
As such, when Boeing comes up against headwinds to the plan, most notably from struggling to ramp airplane deliveries on the 737 MAX and return its defense business to profitability after working through problematic fixed-price development programs, investors should also consider a potential push-out of the target.
Boeing has suffered from both of these issues in 2023, but CEO Dave Calhoun maintained, “We still plan to be in the guidance range for the year as well as the $10 billion target by 2025 and 2026.” Given that he also pointed investors toward the low end of the $3 billion to $5 billion in FCF guidance for 2023, it’s reasonable to assume the $10 billion target might be hit closer to 2026 than 2025, and that should adjust investor expectations in terms of returns — as discussed above.
We all love thinking about returns, but there’s also downside risk to consider. Boeing could miss its target in several ways. The commercial aerospace industry might slow dramatically, causing order cancellations, or there could be ongoing issues with manufacturing quality. The list goes on.
Unfortunately, the downside risk of Boeing falling behind on its target is significant. Due to the 737 MAX debacle and the devastation wrought on the airline industry by travel restrictions, Boeing has racked up debt in recent years. And repaying debt is a vital part of its FCF allocation plans. I’m not arguing that Boeing could go bust, but I am arguing that a failure to pay off debt will increase its interest payments and eat into FCF generation.
In addition, even though Boeing doesn’t plan to deliver a new plane model for another decade, it will take years of investment and development. Boeing will need cash to invest in new planes, or it risks falling behind Airbus or even potential regional competition from China or Russia.
As noted above, management is pointing investors to the low end of its 2023 FCF target, and that’s because it’s had to downgrade its 2023 delivery target on the 737 MAX to 375-400 from an initial target of 400-450. The main reason is a manufacturing issue with fuselages supplied by Spirit AeroSystems.
As previously discussed, I think it makes sense to wait until management issues its guidance for 2024. While it’s intimated that FCF will be higher than in 2023, it’s unclear what that means numerically. Moreover, an update on the timing of the $10 billion target, as well as Boeing’s delivery expectations for the 737 MAX and 787 programs in 2025/2026, will also be keenly followed.
That said, the case for buying Boeing stock is still a strong one, but the company hasn’t had a great year, and investors might need some more reassurance before buying in.
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