Shares of Boeing (BA -0.76%) reacted negatively to the news that it would take charges on its troubled KC-46 tanker program due to a quality issue. Frankly, the knee-jerk reaction is understandable; the last thing the market wants to hear about are more charges on its fixed-price-development defense programs. It highlights the risk in buying the stock, but is it significant enough to change the investment thesis around it? Here's the lowdown.
What happened
Chief financial officer Brian West, in a presentation at the Bank of America Global Industrials Conference this week, told investors about the charges. Although a figure wasn't disclosed, he did say Boeing's defense, space, and security segment (BDS) would be negative in the first quarter.
On a brighter note, he outlined that the event wouldn't impact Boeing's guidance for $3 billion to $5 billion in free cash flow (FCF) in 2023. That's fair enough, but then again, management's FCF guidance for 2023 is so wide that it would take a lot to move it.
Moreover, the charge comes after a year when Boeing took significant charges on fixed-price defense programs in an attempt to de-risk them. And the charges drain cash flow: BDS is forecast to have an operating cash outflow of $500 million to $1 billion in 2023.
All of this goes a long way to explain the adverse market reaction to the news, particularly as the investment case for the stock is based on management giving cautious guidance and quietly executing its plan to reach $10 billion in FCF at some point between 2025 and 2026.
Avoiding any more costly charges and operational mishaps on its fixed-price defense programs is a key part of the plan, alongside ramping up commercial airplane production. As such, investor patience is wearing thin over operational mishaps.
It's also slightly embarrassing for management since it comes a month after West told investors at another conference that the company made "a pretty big step" to de-risk those fixed-price development programs, "and while you could never eliminate risk, we did our very best on the very big assumptions to retire as much risk as we could. And we feel very good about where we are in terms of those products."
Does it matter?
According to an earlier article on the website Air Current, a Boeing supplier told the company that cleaning and adhesion testing hadn't occurred before on fuel tanks for the KC-46 tanker and the Boeing 767 freighter. The issue is now causing delivery delays on both programs, but West expects them to recover by the end of the year.
While the incident highlights the pressure on Boeing's supply chain, it's more an embarrassment than a game-changing event. And it's worth noting that it wasn't an issue of component availability; instead, it came down to a supplier not following the required procedure. As such, it's important not to extrapolate that this is an event linked with the inability of Boeing to ramp-up production based on the unavailability of components.
Boeing is a risky buy
As noted earlier, management's guidance has been set with some pretty wide parameters, and a margin of safety is built into them. Unfortunately, recent events have tested that margin somewhat.
The market's reaction demonstrates the level of tolerance investors have for mishaps at the company, and that's a risk in itself. The stock lost about $5 billion in market cap following the latest news, a reaction that doesn't appear justified by the magnitude of the issue. However, looking at it another way, it also illustrates the "wall of worry" that the stock can climb provided it delivers on its plans.
All told, Boeing is a risky stock, but if you are prepared for more potentially bad news along the way, it continues to look attractive for long-term investors.
