The Rising Influence of Rising Affluence

[DewDiligence]

Boeing Is Set to Soar, Says Barron’s

[This article is apropos to this board insofar as TGDT will certainly increase the demand for air travel in emerging markets in a big way. What is less certain, IMO, is whether Boeing (BA) will be able to capitalize on this opportunity to make large amounts of money or whether it will encounter the kinds of mishaps that caused large write-offs in years past and made discussion of profitability an exercise in line-drawing. Comments welcome.]

http://online.barrons.com/article/SB50001424052970203598104576265613383559644.html

›APRIL 16, 2011
By ROBIN GOLDWYN BLUMENTHAL

Shares of Boeing, the aerospace behemoth, have been cruising at a low altitude for the past year -- amid fears that the company's vaunted but long-delayed new aircraft, the Dreamliner, will remain a dream instead of finally rolling off the production line this year. Investors worry, too, about competition from China, which is developing a narrow-body plane to compete with Boeing's workhorse, the 737. And, since a hole opened up earlier this month in the roof of a 737 flown by Southwest Airlines, there are now doubts about the 737 itself.

Wall Street's fears about Chicago-based Boeing look to be misplaced, however, and ignore a powerful upturn in the company's order cycle that historically has been accompanied by a surge in earnings and in the stock, a component of the Dow Jones Industrial Average. Boeing shares (ticker: BA), which have risen just 1.7% in the past 12 months -- sharply trailing a 13% gain in the Standard & Poor's 500 Index -- could rally 35% in the next year or two, to more than 100.

Initial shipments of the Boeing 787 Dreamliner, whose carbon-composite fuselage makes it lighter than traditional aluminum-bodied body planes, are scheduled—really—for this year's third quarter. The 737 incident is unlikely to dent Boeing's reputation or finances -- and could even spur more orders for newer aircraft. Nor are upstart competitors in any position to unseat the comfortable duopoly in passenger jets that Boeing enjoys with European Aeronautic Defense and Space, or EADS.

Even President Barack Obama's proposal to cut $400 billion from the Pentagon's budget in the next 12 years, announced Wednesday, wasn't as bad as shareholders expected when they knocked Boeing's stock down 1%, to 72.60, last week.

Ignoring interim takeoffs and landings, Boeing's shares are unchanged in the past five years. The stock is trading for just 0.79 times this year's estimated sales of $69 billion, and 17.7 times Wall Street's consensus earnings estimate of $4.08 a share, below EADS' current price/earnings multiple of 24. Boeing fetches 14 times next year's estimated earnings of $5.22 a share, well below the company's 10-year average annual P/E of 22.

Given Boeing's 7.3-year order backlog for 3,400 planes, valued at $256 billion, "somewhere out there is $7 [per share] of earnings power," says Melody Bryant, a partner at C.L. Kempner Asset Management in New York, which owns Boeing shares. Even based on today's P/E multiples, that implies a stock price of 100 or more. Besides, Boeing pays an annual dividend of $1.68 a share, for a current yield of 2.3%.

Some analysts see the stock spiking in late June, near the time of the annual Paris Air Show, when big orders often are booked.

Boeing's commercial and military businesses each contributed about half of last year's revenue of $64.3 billion. Commercial operations are expected to chip in 53% of sales this year and 57% by 2012. Its contribution to operating earnings could be even greater. The commercial business is in "the early part of a recovery," says Alex Hamilton, director of research at EarlyBirdCapital, a New York investment bank.

Annual orders for commercial aircraft peaked in 2007 at around 1,400 planes and bottomed in 2009, amid the global financial crisis, at 142 aircraft [that’s not a typo]. Last year, orders rebounded to 530 planes, and the company's book-to-bill ratio -- the ratio of new orders to orders filled -- again exceeded 1, after falling to 0.89 in '09. Hamilton predicts that orders will be flat this year, before rising to 685 in 2012.

Boeing has been winning new orders left and right, including for the 787. Despite eight production delays in the past three years, the Dreamliner has become the best launch ever in airline history, with an order backlog of 851 planes, and relatively few cancellations.

Since the beginning of this year, Boeing has scored $10 billion of orders from two Chinese airlines for 32 Dreamliners, six 777s and five 747-8s, the company's biggest passenger jet. It also received a $2.8 billion order from GE Capital Aviation Services for ten 777-300s, and a $1.08 billion order from FedEx (FDX) for four more extended-range twin-engine planes, among many others.

Boeing's military business isn't doing too shabbily either, despite cutbacks in recent years in U.S. procurement spending. The world's third-largest military contractor, behind Lockheed Martin (LMT) and England's BAE Systems (BAESY), Boeing won a $3.5 billion U.S. defense contract earlier this year for 18 aerial-refueling tankers, besting its chief contender, EADS.

If options for a total of 179 tankers are exercised, the U.S. contract would be worth at least $30 billion to Boeing. And if the Air Force extends the contract, it could be worth $100 billion.

Boeing generated some 41% of last year's revenue outside the U.S., with foreign customers accounting for about 80% of commercial sales. Only 17% of military sales came from international customers, but W. James McNerney Jr., the company's CEO, sees that rising to 25% in the next few years. The U.S. has approved Saudi Arabia's $60 billion purchase of Boeing' F-15 jets, helicopters, munitions and infrastructure improvements, and the company is bidding this year on an estimated $10 billion order from India for 126 fighter jets.

Russian President Dmitry Medvedev said last month that Russia will spend $700 billion in the next 10 years to modernize its aging military fleet, including the purchase of 600 new warplanes. South Korea, which has bought 60 of Boeing's non-stealth F-15 fighter jets since 2002, also announced recently that it plans to buy stealth fighter jets. Boeing is expected to bid on both countries' contracts.

"What intrigues us about Boeing is the multiyear ramp-building in earnings and cash flow," says John Raitt, a partner at Harris Associates, which advises the Oakmark mutual funds and others, some of which hold Boeing shares. Raitt notes that the 787 program will ramp up to $12 billion to $14 billion in annual revenue when production reaches capacity of 10 planes per month, targeted for the end of 2013.

Even better, by 2012 and '13, Boeing no longer will be expensing most of the hefty research-and-development costs it incurred in prior years to develop the plane. Thus, cash flow will increase at an accelerated rate. Cai von Rumohr, an analyst at Cowen, forecasts that the company will generate $8 a share of free cash flow in 2013, nearly double the $4.06 a share in operating cash flow that it produced in 2010.

Boeing traces its corporate roots back 95 years, to the dawn of the aerospace age. In 1916, just 13 years after the Wright brothers made their first flight at Kitty Hawk, N.C., William Boeing, a Yale-trained engineer, incorporated his young airplane-manufacturing business in Seattle. The company supplied seaplanes to the Navy during World War I, and B-52s to the Air Force during the Cold War years. It turned to building passenger planes in the mid-1950s, and today controls just over 50% of the market for commercial aircraft with 150 seats or more, with EADS, which owns Airbus, controlling the rest.

The two big companies' strategies couldn't be more different. While Boeing is betting on growing demand for midsized planes that travel overseas from regional hubs, EADS has staked its growth on superjumbo jets such as the A380, the world's largest passenger aircraft, with up to 800 seats. [In other words, the A380 is intended for point-to-point long-haul routes rather than hub-and-spoke systems that are better suited for smaller planes.] The plane was five years late on arrival, with the first A380 delivered last May.

Now, Boeing and EADS are facing increasing competition from smaller aircraft makers such as Canada's Bombardier and Brazil's Embraer (ERJ), as well as China, which is developing the C919, a competitor to the 737 and the Airbus A320. But Richard Aboulafia, an aviation analyst at industry consultant Teal Group, says that the Chinese are "working on a jet that could have been built in the 1980s," and won't catch up "this way."

Aboulafia sees several reasons to be bullish about the commercial-aircraft industry, beginning with the growth of emerging markets making up a rising percentage of end-users and demand. A "massive increase" in worldwide orders is now coming, he notes, from government-owned airlines that have ready access to funding.

Both EADS and Boeing have had their share of technical troubles lately. Last week, an A380 collided with a much smaller commuter plane on the tarmac at New York's Kennedy Airport. No one was injured, but the Airbus jet, which stands as tall as a seven-story building and has a wing span as wide as a New York City block, managed to spin the Bombardier CRJ-700 nearly 90 degrees. Late last year, Qantas Airways grounded all six of its A380 aircraft for several days after an engine exploded on a flight to Singapore. The problem was blamed on engine-maker Rolls-Royce, and quickly corrected.

Boeing got high marks for acknowledging -- after the jet with the hole was forced to make an emergency landing -- that the company's engineers had miscalculated the age at which 737s might begin to show stress-related risks. [I commented on this in #msg-61797472, but no one replied.] It has since recommended accelerated inspections of the planes after 30,000 flights. Although the cause of the rupture has yet to be determined, Southwest CEO Gary Kelly called Boeing "a great partner," and Standard & Poor's issued a report saying it didn't expect the incident to have a significant impact on Boeing, other airlines or aircraft lessors.

McNerney, 61, a former General Electric (GE) and 3M (MMM) executive, was recruited by Boeing in July 2005 to restore credibility after a series of scandals led to the departure of two prior CEOs in less than three years. Under his guidance, Boeing began investing heavily in research and development and saw earnings climb in 2007 to a new high of $5.26 a share.

Then the global financial crisis hit, curbing purchases of aircraft, along with almost everything else. Profits fell to $3.65 a share in 2008, en route to a low of $1.84 in 2009. That year, Boeing took $3.58 a share in charges to cover R&D costs related to the 787 and 747.

Last year, earnings rebounded to $4.45 a share, after a favorable tax settlement of 50 cents a share and a charge of 20 cents.

Boeing's latest guidance, given in late January, calls for the company to post 2011 earnings of $3.80 to $4 a share, after pension-related expenses of 58 cents. Management hasn't yet factored in deliveries of the 787, however. The typically conservative Boeing likely will have more to say about its earnings and Dreamliner shipments when it reports first-quarter results April 27.

The Dreamliner is billed as Boeing's new "flagship" of flight. It consumes 20% less fuel than similarly sized aircraft, and has a novel, lightweight construction. But even McNerney had to admit late last year that Boeing had been "overly ambitious" in the development of the plane, which retails for $157 million to $167 million. [A higher-priced long-haul version of the plane was recently scraped.]

The CEO said the 787 had too many technology "firsts" in its design to meet the company's original delivery schedule. Boeing also might have relied too heavily on outsourcing the manufacture of plane components [the word, “might” is preposterous here—BA itself concedes the point], some 35% of which were made in Japan. So far, the company has indicated that the earthquake and tsunami that hit Japan in March wouldn't create short-term delivery delays in parts and subassemblies.

Although Airbus has moved up by six months, to October 2015, the launch of its revamped A320neo, which competes with Boeing's successful 737, McNerney seemed unperturbed by the announcement at an investor conference in February. He allowed that the Neo "on paper closes the value gap" that has favored Boeing, and that the plane might put some pressure on Boeing's margins. But McNerney said Boeing is "going to do an all-new airplane at the end of the decade," and that he feels "pretty comfortable" that Boeing can defend its customer base. With the A320neo, he said, Airbus is "catching up to us, not going ahead."

Boeing hasn't said whether it will revamp the popular 737 model; it appears to be leaning toward launching a new aircraft. The company is expected to give customers some indication of its decision around midyear.

Whatever the decision, investors finally can celebrate the Dreamliner's imminent arrival, and the surge in Boeing's aircraft orders. It is time to fasten seat belts and prepare for liftoff.‹