Boeing: A fallen angel?

For a firm that gained a price increase of nearly 300% over 4 years, you’d need to blink twice when looking at the price chart performance today as it is hard to believe the freefall this stock has experienced (or considering the current market conditions, maybe it is not). The past 4 years is a great example of the artificial price inflation share buyback can cause to a firm share price but more importantly this inflation falsely representing value. Now, under great amount of distress, the true colours of the organisation come out and we will get to see what this giant is really worth.

The Story

This valuation is based on an American sweetheart that was a first class producer of planes during the war who then went on to be one of the most reliable provider of commercial airplanes who is decided to even reach out to the stars and provide for the US segment of the ISS and carry on providing military aircraft and rotorcraft to the army. A firm that over the last 10 years has gone off course, decided to outsource production, layoff elite engineers for cheap labour and having periods where up-to 90% of cash is returned to investors in the form of share buybacks. As you will know, this all decided to hit back when two of their 737 Max crashed, tolling a loss of revenues for the firm of $18.6B so far. Now the virus causing production to halt, it is a question of how this giant will survive this pandemic, restart its efficiency, restore its reliability of the aircraft.

Assumptions

Based on the economy and the forecast outlooks for the next months and years I decided to split up my timeline. The first two quarters are expected to be a reduction in the performance of the firm due to the factory closing due to the pandemic and the 737 Max still being delayed and only planned to resume production in May. In the recovery phase I expect a high growth in revenues for the first few quarters which then evens out over the years reaching the terminal growth rate.

The virus: According to the information I have right now, the pandemic is expected to reduce enough for businesses to go back to normal work by summer. Now I don’t hold the crystal ball and I have my doubts about when the virus will finally settle, but for now I have to follow with the information available.

The 737 Max: As you know the factory is shut during second half of March and therefore the firm will produce no value this month. Boeing also stated that they plan to resume production of the 737 Max by May. Now again, I have my doubts about this, and it’ll also depend a lot on the health situation, but I follow what is available right now.

Using these two major impacting factors I forecast the two quarters by each segment of the firm (aerospace, Defence/security/space and services). The majority of the decisions here are from the forecasts in the production of Boeings products. You’ll notice I have been very conservative in these predictions for 2020 and that was my aim. Since the situation for the next half year is very uncertain and unprecedented, I’ve been very cautious with my expectations of Boeing. At the end it is only 2 quarters out of 5 years of cash flows and I’d rather undershoot the revenue for FY1 than overdo it.

Next I looked at how Boeing will recover from this. Based on the fact that Boeing is one of the two firms making up about 90% of its industry , it can implement plenty of capital to come back from this hit. I assumed that the greatest recovery will be for the rest of 2020 (Q3&4) at a revenue growth rate that is near the highest Boeing has experienced. Very quickly this growth is reduced as it tends year by year towards the expected terminal growth rate.

For the operating margin I expected that over the 5 years Boeing will be able to improve it moving beyond the industry average by the terminal year due to Boeing being part of an Oligopoly and also because they are just simply better than most firms at what they do. The effective tax rate is moved year by year towards the marginal US tax rate as in the first years the taxes may be deferred simply due to EBIT losses which will catch up by the time the firm goes back to steady/mature growth. For the reinvestment rate I used the sales to capital ratio in relation to the changes in revenues that I predict to decide the amount of reinvestment that is required. This takes into account the firm efficiency and thus is why the sales/cap ratio is lower in Q1 and Q2. Finally, the calculated cost of capital moves towards the industry median as the firm goes back to mature growth and aligns with the standard cost of the industry.

Distress

There’s one important factor in this equation that you might be wondering why haven’t I included. It is the $60B Boeing asked from the governemnt to fund their payments to suppliers and the health of the supply chain. The firm has $28B debt outstanding and therefore it is no wonder that we are seeing signs of distress. Boeing has been around for a long time and won’t go anywhere. The government will bail them out as they are a significant part of the US economy. The question that I was asking is what the terms of this bail will be. If you heard about the GM bailout, it saved the company back in 2009 during the financial crisis but at a cost. The equity of GM was reduced to zero. To get the probability of faliure (or success) I used the corporate Boeing bonds to see the expected probability of faliure priced in by the market. This is done by adjusting by the required precentage that adjusts the valation of the bond to be equal to the current market price. The result was between 30%-40%. The proceeds after failure will depend a lot on the terms of the bailout and therefore it is very hard to predict. If you can’t decide here, I would just be very conservative and say that the proceeds will be 0%.

Conclusion

Boeing is a powerful entity and therefore is able to move large forces. It has been around for a long time and is not going anywhere any time soon. The government is in the backing and customers can’t easily switch as orders are done on a contract basis, years in advance. It’s most important to follow what Boeing learns from this slash in performance and how it will balance its reinvestment to  investor pay-out rates. Quality growth comes at a cost, for Boeing to steer away from pleasing wallstreet and producing high end reliable airplanes that are trusted by the public, a change in the strategy would be very important. I will re-value them again near the end of April when the Q1 financials come in where it’ll hopefully show a clearer image on how much of an impact there is on the firms’ long-term cash flows.


All recommendations in this valuation are for non-professional investing and is solely my opinion. The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance. Only invest money that you are willing to lose.