Boeing Achieves Liftoff

Boeing practiced its own form of stealth by quietly adding 100% to its market value over the last nine months, almost perfectly opposing the moves by the Nasdaq Composite. With revenues that are lower than last year's, this sudden warming to Boeing seems odd. But a look at rapidly improving gross margins and cash flows paints a picture of a company that is creating value for its shareholders.

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By Bill Mann (TMF Otter)
November 2, 2000

It's interesting how some of the biggest companies in the world can, at times, slip under the radar screen. Boeing (NYSE: BA), a Dow Jones component, is a case in point.

With the notable exception of the shareholders of the company, you'd probably be hard pressed to find someone who even noticed the upward trajectory in Boeing's share price. Boeing has served almost as the perfect hedge against the Nasdaq Composite, having hit a low of $32 3/8 on March 10, the same exact day that the Nasdaq hit its all-time high water mark. Since that time, Boeing has marched steadily higher, gaining 100% in the intervening nine months. That's a big move, particularly when you realize that Boeing is not some small cap company just achieving critical mass.

So what is it about Boeing that has helped push its share price higher so fast? It seems as if I blinked and there it was, having transformed itself from one of the Dow dogs into one of its fastest growers. How could Boeing have added $30 billion in market capitalization without someone noticing?

Part of it has to do with the company's performance just prior to March. Boeing had seemingly endless streams of bad news, layoffs, earnings warnings, and so on. Corporate death watchers had Boeing CEO Phil Condit high on their list of impending executive firings. And from a long term perspective, even after the huge run up, Boeing has underperformed the S&P 500 over both three- and five-year periods.

But what we have in Boeing is a valuable lesson: One way to achieve significant gains in the stock market is to buy something when everyone else hates it. Of the Dow Component stocks, there were few that were more hated than Boeing through 1999. Well, maybe Philip Morris (NYSE: MO), which has also reversed its wretched share performance as of late, legal liabilities be damned. What is really interesting about Boeing is that its top-line revenues have declined significantly since last year. So the company is selling less than it was before, but its share price has skyrocketed.

Must be an increase in earnings, right? Nope. In fact, through the end of the second quarter, Boeing's net earnings were down from last year on an aggregate AND a per share basis: $1.03 billion versus $1.17 billion, and $1.20 versus $1.25, respectively. Finally, in the third quarter, which Boeing just reported, per share earnings surpass last year's level, still on lower revenues. But seeing as these earnings were just released, there is no way that they were the reason for a rise that began nine months back.

I'm going through this exercise to show one thing: The investor who hopes to have any long-term success in investing must be able to get past the income statement in his or her analysis of a company. Unfortunately, we're having to play Monday morning quarterback here, because Boeing was not a company that I had any interest in analyzing previously. But there are certain lessons that Boeing's performance give us that drive home the notion that a company's performance will inform its share price. Maybe not with perfect efficiency, but those people who did dispassionately analyze Boeing a year ago may well have seen something that gave them a good clue of what was to come. How'd they see it?

1. Rapidly Improving Cash Flows
A company is valued on the present value of its future cash flows. Boeing, for all of its revenues, had miserable cash flows. It stunk at creating wealth from its activity. But even in the first and second quarter of this year, Boeing showed a dramatic improvement, with its free cash flows increasing by more than 100% over the comparable quarter in 1999. Third quarter saw the same thing, an increase of 85% over the year previous. Businesses are built, in theory at least, to create free cash flow. Boeing has done several things to turn itself from a company that essentially spun its wheels, creating minimal value at the end of all of its activities, to one that is spinning off cash.

2. Improved Gross Margins
Boeing is not in a high margin business, particularly in regard to its consumer aircraft divisions. This is primarily due to heated competition from Airbus Industrie, the European aircraft consortium. Although Boeing is in the high visibility portion of the aircraft business, it's position as the "tube assembler" does not put it in the sweet spot of the process of building aircraft. For example, airline engine manufacturer General Electric (NYSE: GE) routinely garnered higher margins and longer revenue streams through its replacement parts, not to mention the huge benefit added by GE Capital financing. But Boeing has trimmed significant fat off of its production operations, and it has added higher-margin services and financial products to its product lists.

3. Debt and Share Control
Boeing in the past year has repurchased $1 billion of its own shares on the open market, retiring more than 5.5% of its total float. It repurchased with cash, rather than the completely shortsighted approach taken by some companies, who have issued debt to repurchase shares. Boeing still has a significant level of long-term debt, some $5.6 billion. But with $4.7 billion in cash in the bank, Boeing has the option of reducing its debt level if it is strategically beneficial to do so.

Boeing has some real challenges in front of it. In particular its military aircraft division remains at the whim of the prevailing political view toward defense spending. It is awaiting word on whether the Defense Department will buy its Joint Strike Fighter (JSF), a contract which would give it an additional revenue base. But Boeing nearly has as much business in commercial aircraft as it can handle, with a current backlog of some 1600 aircraft.

Boeing's performance as a company and as a stock then is not so much related to its ability to deliver top line growth. Rather, Boeing must continue to find ways to keep its costs in line and end the day with a healthy amount of cash on its balance sheet. I just wish I had noticed the transformation of this former ugly duckling a bit earlier.