Anyone considering investing in aerospace giant Boeing (BA -1.90%) should watch closely as the production ramps on its narrowbody 737 and widebody 787 aircraft. However, while that remains the key swing factor in the company's plan to reach $10 billion in free cash flow (FCF) in the 2025/2026 timeframe, the investment case also rests on the defense, space, and security segment's ability to deliver profitable growth. Here's why.

Boeing's medium-term plans 

Investors were left in doubt about the company's focus during the investor day event in early November. As you can see in the chart below, Boeing's debt has ballooned in recent years as its FCF has turned negative. Consequently, management must deliver a credible plan to increase FCF and pay down debt. 

BA Net Financial Debt (Quarterly) Chart

Data by YCharts

To do so, management laid a plan to increase operating cash flow (OCF) from $4.5 billion to $6.5 billion in 2023 to around $12 billion in 2025/2026. As a reminder, FCF is simply OCF after capital expenditures have been taken out. Regarding FCF, Boeing's management expects FCF to increase from $3 billion to $5 billion to $10 billion in FCF in 2025/2026. 

How Boeing will increase cash flow

The breakout of OCF by segment shows expectations for:

  • $9 billion in OCF from Boeing Commercial Airplanes (BCA)
  • $3 billion from Boeing Global Services (BGS)
  • $2 billion from Boeing Defense, Space, and Security (BDS)

Improvement at BCA -- coming largely from increasing BCA FCF by $6 billion from 2023 to 2025/2026 -- is critical to the plan. That's something that will come from ramping the monthly production rate on the 737 to 50 a month from the current rate of 31 a month, and the 787 from 5 a month in 2023 to 10 a month.

Ramping aircraft production is critical to earnings growth because margins tend to expand as Boeing's production volume increases. 

BGS is also a valuable cash generator, but management isn't expecting a significant marginal increase in BGS FCF -- just $0.3 billion from 2023 to 2025/2026.

Boeing defense, security, and space 

All of which leads us to BDS. Management plans to increase FCF at BDS by $2.7 billion from 2023 to 2025/2026. This plan is hugely important for two reasons:

  • It implies a significant turnaround at BDS, which is necessary for Boeing to meet its medium-term debt reduction plans.
  • It's also highly significant for Boeing -- its defense-focused business needs to contribute earnings and cash flow over the long term, because its BCA earnings can be cyclical.

The second point was highlighted during the worst of the pandemic when Raytheon Technologies' substantive defense spending exposure gave it much more stability than Boeing's. It's an important issue given that both companies sell high-ticket items that require massive investments over multi-year time frames to develop products (aircraft engines and aircraft), generating earnings over decades. 

In short, Boeing needs FCF to develop new planes and improve existing aircraft. 

BA Free Cash Flow Chart

Data by YCharts

Unfortunately, the recent history of BDS isn't covered in glory. While the loss in 2022 is partly attributable to factors beyond Boeing's controls -- including higher-than-expected supply chain, logistics, and raw material costs -- BDS has had high-profile and multi-billion dollar cost overruns on fixed-price programs like the KC-6 tanker (aerial refueling), T-7 (pilot training aircraft), and VC-25B (Air Force One) programs. 

BDS

2018

2019

2020

2021

First 9 Months of 2022

Revenue

$26.4 billion

$26.23 billion

$26.26 billion

$26.54 billion

$16.98 billion

Earnings

$1.66 billion

$2.61 billion

$1.54 billion

$1.54 billion

($3.66 billion)

Operating Margin

6.3%

9.9%

5.9%

5.8%

(21.5%)

Data source: Boeing presentations. BDS = Boeing Defense, Space & Security.

The subject naturally arose in the recent investor conference, with management seeking to soothe investor fears by pointing out that the KC-46 and VC-25B programs would be substantially derisked by 2025. However, that's a few years away, and Boeing's track record on these problematic fixed-price contracts doesn't give a lot of confidence. 

What it means to investors 

All told, while it's right to focus on the commercial aerospace recovery at Boeing (BCA is a much larger earnings and cash flow generator than BDS or BGS), the company still needs to demonstrate it can return BDS to consistent profitability. Not least to potentially support the overall company should commercial aerospace be negatively impacted in the coming years. Boeing's cash flow, debt management, and investment ability will desperately need BDS' contribution if the latter occurs. As such, investors need to keep a close eye on BDS.