The case for buying Boeing (BA 2.27%) stock is based on the idea that it's a good way to play a recovery in the global economy from the COVID-19 pandemic. That's a good case in itself, provided you are confident that air travel will recover to its former glories. However, to be fully confident in buying a stock, you have to believe that there aren't better options exposed to the same investment assumptions (a recovery in air travel), and you have to be comfortable with the company's outlook. Let's take a look at Boeing in light of these considerations.
Boeing is hoping commercial air travel starts to recover. Image source: Getty Images.
The key to a Boeing revival
There are two key factors that will drive Boeing's stock in the medium term. The first is conditions in commercial air travel, and the second is Boeing's production rate.
Fleshing out these points in turn, you can see below how important Boeing Commercial Airplanes (BCA) is to the company by looking at the 2018 figures -- relevant because this is before the 737 MAX grounding. In addition, Boeing Global Services (BGS) needs commercial airplanes to be flying in order to generate demand for them to be serviced by BGS.
Investors may be hoping that Boeing Defense, Space & Security (BDS) could pick up some of the slack. However, CEO Dave Calhoun said that he expected growth "at the lower end of the single digits" partly due to "pressure that will ultimately come down as a result of all the COVID spending here in the United States."
All told, everything points to Boeing's prospects being intrinsically tied to commercial aviation, and in particular the market for new airplane orders. As such, given a scenario where air traffic comes back but airplane orders lag because airplanes continue to use legacy aircraft, Boeing could underperform.
|
Boeing Operating Earnings |
2020 |
2019 |
2018 |
|---|---|---|---|
|
Commercial Airplanes |
($13,487 million) |
($6,657 million) |
$7,830 million |
|
Defense, Space & Security |
$1,539 million |
$2,615 million |
$1,692 million |
|
Global Services |
$450 million |
$2697 million |
$2,536 million |
|
Boeing Capital |
$63 million |
$28 million |
$79 million |
|
Total |
($11,795 million) |
($1,317 million) |
$12,137 million |
Data source: Boeing presentations.
Why production rate matters
Turning to the second factor, aircraft orders lead to production increases, and production increases lead to margin expansion at Boeing. This is because as production increases it tends to lead to a drop in the unit cost of production. As such, when the outlook for production gets better, analysts usually rush to upgrade Boeing's earnings assumptions and the opposite holds when production rate assumptions are cut.
As you can see below, the ongoing impact of the pandemic on aircraft demand has led Boeing to cut its production rates on the 787 and 777 wide-body programs, while it's far from clear where 737 MAX orders will go in the future.
| Boeing Airplane |
Production Rates in 2021 |
Notes |
|---|---|---|
|
Boeing 737 family |
"Gradual increase to 31 per month in early 2022 with further gradual increases to correspond to market demand" |
Only 43 airplanes delivered in the 737 family in 2020 |
|
Boeing 747 |
0.5 per month |
N/A |
|
Boeing 767 |
3 per month |
N/A |
|
Boeing 777 and 777X |
2 per month |
Reduced rate from 5 per month at end of 2020 |
|
Boeing 787 |
5 per month |
Reduced rate from 10 per month at end of 2020 |
Data source: Boeing presentations. Author's notes.
However, the biggest problem Boeing has right now is that it's ill-positioned for the type of recovery that most commentators are expecting. The consensus is that it will be led by domestic travel, which implies narrow-body demand will recover before wide-body demand. That's unfortunate for Boeing because the 737 MAX debacle has given airlines a reason to order Airbus A320 NEO aircraft instead.
Moreover, Boeing previously had high hopes for a cycle of wide-body airplane demand to begin in this decade, with the new 777X being the key beneficiary. Unfortunately, that's not going to happen now, and in any case Boeing recently pushed back the expected date of first delivery for the 777X to late 2023. Meanwhile, the slump in the wide-body market does not bode well for orders/production for the Boeing 787 Dreamliner.
Is Boeing stock a buy?
Boeing will see better days, and aviation bulls may want a piece of it in their portfolio. However, a lot of things need to go right for Boeing to flourish in the coming years. Not only does the recovery need to encompass orders growth, but Boeing also needs to win out on orders, particularly in the narrow-body market with the 737 MAX.
Image source: Getty Images.
On top of that, Boeing needs to demonstrate it's over its production issues that have led to defects on the 787, and "design modifications necessary to meet the various global regulators' expectations" on the 777X, according to Calhoun.
Meanwhile, the debt taken on board to deal with the cash outflows in recent years means Boeing's net income will be constrained by higher interest payments.
Data by YCharts
As such, Boeing isn't just a play on a recovery in commercial aviation. And with all of these moving parts needing to come together, it's difficult to argue that Boeing is a buy over many other options in the industry on risk/reward basis. As such, it's probably one worth avoiding for now.
