The really interesting thing about Boeing's (NYSE:BA) fourth-quarter earnings report is how it underlines the fact that management is making its earnings less cyclical. That on its own is something that should encourage an upward re-rating of the stock by the investment community. But when you add in the point that commercial aviation is enjoying an era of never-seen-before profitability, Boeing really begins to look like a highly attractive company to invest in. Let's consider those points in the context of the Q4 report.
End markets are less cyclical
One of the biggest concerns investors traditionally have had with Boeing relates to the cyclical nature of its earnings. Passenger growth tends to correlate with global economic growth; when passenger growth slows, airlines make less money, and stop or cancel their aircraft orders -- which is bad for Boeing.
That said, there's a strong case to be made that structural changes in the aviation industry -- deregulation, technological advances in aircraft efficiency, governments reducing support for national carriers, the rise of low-cost airlines, etc. -- have led to a steep improvement in airline profitability.
As the chart below illustrates, airline profitability has risen dramatically in the last decade, as load factors -- which measure capacity utilization -- have increased. Put simply, global airlines are running more efficiently, and making money as they never have before.
Moreover, the following chart shows that's it not just about economic growth. For example, compare the last five years with the 2004-2007 period, when economic growth and passenger growth was actually higher, but airline profitability and load factors were far lower.
This is an important point for Boeing, because it suggests that even when economic growth slows, airlines are likely to remain profitable, so demand for new aircraft will hold up much better than it did during previous economic downturns.
Margins are expanding
Boeing raked in about $12 billion in operating earnings in 2018, and about two-thirds of that came from its Boeing Commercial Airplanes (BCA) unit. CEO Denis Muilenburg's guidance for 2019 forecasts a 14% to 15% operating margin at BCA, compared to 13% in 2018 and 9.4% in 2017. Hitting that would target would achieve a long-held aim of the company.
However, the key question -- asked by Credit Suisse analyst Rob Springarn on the earnings call -- is how much of the margin improvement can be attributed to volume improvement (more aircraft deliveries driving down costs thanks to economies of scale) versus mix (delivering relatively more higher-margin aircraft) and improved productivity.
The gains from productivity improvements -- such as Boeing's attempts to cut supply-chain costs via its Partnering for Success (PFS) initiatives -- may prove more sticky even if volume growth slows due to an economic downturn. This would make Boeing's earnings less cyclical, as it would be able to keep its margins strong in poorer market conditions.
Check out the latest Boeing earnings call transcript.
In response to Springarn's question, Muilenburg said that increased volume was "a big driver" of the margin improvement, as was its increased delivery rate for the 787 -- Boeing plans to increase production of those aircraft to 14 a month in 2019 from 2018's 12 a month, to address its backlog of 604 ordered 787s. Muilenburg also talked of the productivity gains generated by PFS, and it's well known that Boeing is muscling in on its suppliers' margins by expanding its own manufacturing footprint and moving into the aftermarket.
If these productivity improvements are structural, then Boeing's margin will be supported even in a downturn.
Boeing Global Services is growing
The company is also reducing its earnings cyclicality by growing revenue at Boeing Global Services (BGS); services and aftermarket revenues tend to hold up better in down markets. Muilenburg also reiterated his aim for BGS to grow "faster than the average services market growth rate of 3.5% as we further expand our broad portfolio of services offerings and continue to gain market share."
In fact, BGS revenue growth in 2018 was 17%, and the segment contributed 21% of total earnings -- more than the 13% contribution of the Boeing Defense, Space & Security (DS) segment. Moreover, as the chart below shows, new orders have outpaced revenue in recent quarters -- indicating strong growth ahead.
Muilenburg expects BGS revenue to grow by 8.9% to 11.7% in 2019, slightly higher than the overall company's projected growth rate. In addition, BGS is expected to have an operating margin of more than 15%, compared to around 11% for BDS, and 14.5% to 15% for BCA. In other words, Boeing's least cyclical business is growing in earnings importance even as BCA is in the middle of a boom in orders.
Boeing deserves a re-rating
Putting these points together, it appears that Boeing's earnings are becoming less cyclical. This should reduce its downside when end demand eventually slips -- and that should make the stock more attractive for long-term investors.