Fair Value Estimates Matter – Case Study: Boeing
publication date: Oct 9, 2019
author/source: Brian Nelson, CFA
Image Source: Boeing’s share price converged to our estimate of intrinsic value in the summer of 2019. The plane maker continues to navigate tumultuous skies with its 737 MAX.
By Brian Nelson, CFA
The news for Boeing hasn't been this bad since the doldrums of the 787 Dreamliner build some years ago now. The 737 narrowbody, the line-up all over the news of late, is the workhorse of the industry, and Boeing's next generation 737 MAX has been the fastest-selling plane in the aerospace giant's history. Most countries around the globe, including the US, have now grounded the airplane. The crashes at Lion Air in October 2018 and at Ethiopia Airlines this month are a huge black eye on the platform, but this plane is the short-route, point-to-point option for many airlines.
What we're saying is that we doubt that many airlines or lessors will cancel the plane in any sort of magnitude, and those that do cancel will only be replaced by new customers that want delivery slots earlier. Boeing has been making planes for a long time, and the company simply will fix the problem, and we applaud regulatory bodies for taking the step to prevent any further loss of life. When it comes to Boeing's equity valuation or order book, the events of the past several months aren't that material, even though they are tragic. Our thoughts and prayers go out to the families impacted by both tragedies.
That said, we doubt that Boeing's outlook will change much for 2019. In late January, management targeted revenue growth in the range of $109.5-111.5 billion, higher than the 2018 mark of $101.1 billion, while GAAP earnings per share was targeted between $21.90 and $22.10 and core earnings per share was targeted between $19.90 and $20.10. That's significantly better than the $17.85 and $16.01 marks it achieved in 2018. What's more, operating cash flow is expected to expand nicely, too, to the range of $17-17.5 billion, reflecting a 14% improvement over last year's mark. The company has only a modest net debt position, too, even including that related to Boeing Capital, which has become a very small part of business these days.
The reality for Boeing's shareholders is that the company's equity was getting awfully pricey heading into the events of the past few months, with shares peaking at over $440 earlier earlier this (year). The equity has come tumbling down to the high-$370s, but we still don't think shares are that cheap. The high end of the fair value estimate range has been $404 for some time, so right now, we think shares are priced reasonably, even if they reside above our point fair value estimate of $330. The news regarding the Boeing 737 MAX 8 has been nothing short of tragic, but Boeing has endured just about everything that has been thrown at it from World Wars to the Great Depression to 9/11 and beyond. Boeing, too, will fix the problem it finds itself in.
When it comes to headline noise, however, Boeing's troubles with its 737 MAX 8 may be just beginning given the scrutiny it will be under in the coming months, but long-term holders of the equity should be less concerned about recent developments than they should be about the underlying valuation of the equity, which we think doesn't offer much of a bargain. We had added Boeing to the Dividend Growth Newsletter portfolio in January 27, 2017, and we removed it in mid-March of last year, with the stock roughly doubling over that time period and producing a return 5 times that of the S&P 500's performance. We still like Boeing, but it just doesn't make the cut to be included in our newsletter portfolios after its tremendous contribution already.
Fast-forward to today, October 9, and not much has changed since we penned that article in March. Boeing’s shares are in the $370s, and the aerospace giant continues to grapple with getting the 737 MAX back into service, with no firm date. Though Boeing’s year-to-date deliveries have been cut in half as a result of the 737 MAX debacle, the plane maker still has years and years of unfulfilled deliveries in its backlog, so the current troubles can still be largely viewed as a timing issue, as we inevitably expect Boeing to get things “right.” That said, given our experience covering Boeing during its 787 Dreamliner build, we would not be surprised if there are further delays in the return to service of the 737 MAX, despite ongoing optimism.
In early 2019, we thought shares of Boeing were severely overpriced, and they aggressively converged to our fair value estimate by summer, only to bounce a bit since then. We’re still huge fans of the company but working through the 737 MAX issues will take some time to get “right.” We expect more headline risk as it relates to contingent liabilities associated with the disasters, but nothing so punitive to shake the plane maker to the core. Boeing is an investment-grade credit with a huge backlog, and while we expect shares to be range-bound in the near-term, investors get to collect a nice juicy dividend as they wait for Boeing to sort things out. Shares yield 2.2% at the time of this writing.
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Brian Nelson does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.
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