On Wednesday, The Boeing Company (NYSE:BA) reported very strong Q4 earnings. Core EPS -- which excludes pension costs -- grew 20% for the full year to reach $7.07. However, investors sent the stock down more than 5%, perhaps due to Boeing's 2014 earnings guidance. The company is predicting core EPS of $7.00-$7.20 this year, well below the average analyst EPS estimate of $7.57.
Boeing shareholders should not panic about this guidance. First of all, Boeing is probably being conservative with its initial guidance, and so earnings growth may still be possible. Second, the low profitability of the 787 Dreamliner -- which is currently constraining earnings growth -- will improve over time as production becomes more efficient and more orders come in.
On top of all this, Boeing is in the enviable position of having an order backlog worth hundreds of billions of dollars. This guarantees a long-term revenue stream that will support profitable growth over the next several years.
Under-promising and over-delivering
While Boeing's guidance for 2014 implies that core EPS will be roughly flat compared to the final $7.07 tally for 2013, the company has a history of under-promising and over-delivering on earnings. In early 2012, Boeing projected 2012 GAAP EPS of $4.05-$4.25. When all was said and done, GAAP EPS was more than 20% higher than that guidance, at $5.11.
A similar story played out in 2013. At the beginning of the year, Boeing projected core (non-GAAP) EPS would increase from $5.88 in 2012 to $6.10-$6.30 in 2013. As the company's recent earnings report showed, that estimate was extremely conservative. Core EPS of $7.07 was more than 10% above the top of the guidance range, despite ongoing reliability problems with the 787 Dreamliner.
Of course, Boeing's outperformance in 2012 and 2013 is no guarantee that the company will perform similarly in 2014. However, it's definitely a good omen that Boeing has tended to low-ball its guidance. Barring a major setback, Boeing should be able to beat the guidance it offered this week.
Boosting Dreamliner profitability
Higher-than-expected costs related to the Dreamliner program have been a big factor holding back Boeing's profit margin (and earnings). Under the rules of program accounting, Boeing averages its expected revenues and costs over the life of an aircraft program like the 787. The total profit is then divided evenly over the total number of airplanes Boeing expects to sell as part of that program.
Production costs are at their highest in the early years of production, and then decline over time. Thus, the most profitable sales occur near the end of the production run. As a result, the total program profitability depends heavily on how many aircraft are ultimately delivered. Currently, Boeing is accruing profit for the 787 on the assumption that it will ultimately sell 1,300 Dreamliners.
However, this is a very conservative long-term projection. Boeing has estimated the market for Dreamliner-sized aircraft at 3,300 planes between 2011 and 2030, and the company expects to win more than half of those sales. That implies perhaps 1,700-2,000 total sales over the life of the program. With over 1,000 orders already in the bag, Boeing's order goals seem very achievable.
For investors, this means that Boeing is likely to raise its "accounting block" over time, as it becomes more confident that it will exceed its current projection of 1300 total deliveries. This will dramatically improve the profitability of the program as a whole, leading to immediate earnings gains. Boeing may not raise its accounting block this year (having just done so in 2013), but when it does, EPS should leap higher.
Upside outweighs downside risk
While Boeing's 2014 guidance appears weak on the surface, investors should keep in mind that the company's management team tends to be conservative at the beginning of the year. The improving profitability of the 787 program also promises to drive long-term-earnings growth, but that may or may not impact 2014 depending on when Boeing is able to raise the 787 accounting block beyond 1,300.
The one notable weak point in Boeing's business is its defense, space, and security segment, which is being negatively affected by defense budget cuts in the U.S. Boeing currently projects a high single-digit revenue decline in that business for 2014. Still, the defense business is gradually becoming less important overall due to the strong growth of Boeing's commercial airplane segment.
In short, while Boeing is unlikely to grow earnings by 20% this year (as it did in 2013), it is still well-positioned for earnings growth over the next several years. If Boeing stock continues to fall, long-term investors should consider investing in this solid company.
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