There's a powerful case for Boeing (BA 0.25%) stock. After all, despite its problems in recent years, it's still one of only two major players in commercial airplanes, it has a huge backlog, and it needs only to execute on its medium-term plans to leave the stock looking an excellent value at the current price. On the other hand, it hasn't been a good year for Boeing, and there's near-term risk around the stock. Does it all add up to make the stock a buy or a sell? Here's the lowdown.
Boeing in 2023
As the year began, the investment case was clear. The framework for how to think about the company was laid out in its investor conference in November 2022. Simply put, Boeing is aiming for $10 billion in free cash flow (FCF) between 2025 and 2026. To get there, Boeing needs three things to happen by 2026:
- In defense and commercial aerospace, Boeing's supply chain and labor problems must ease, leading to margin expansion and facilitating increases in airplane production
- Successfully ramp up its airplane production, mainly on the narrowbody 737 MAX and the widebody 787
- Work its way through problematic fixed-price defense programs (which have caused multibillion-dollar charges) and unprofitable legacy programs in defense
With a current market cap of around $120 billion, merely hitting the $10 billion FCF target would put Boeing at 12 times FCF in 2026 -- a highly attractive valuation that implies considerable upside for the stock.
Supply chain problems are ongoing
While the investment case for Boeing is still intact, at least according to management's ongoing guidance for 2023 and 2025/2026, the reality is that there's evidence that Boeing could disappoint on all three factors mentioned above.
First, significant supply chain problems continue to haunt the aerospace industry, and in Boeing's case, they are threatening to force it to miss its 737 production targets this year. These were highlighted recently by the CEO of Safran (a joint-venture partner of General Electric's in CFM International, a company producing the sole engine for the Boeing 737 MAX and one of two options on the Airbus A320neo), Olivier Andries, when he noted that supply chain trouble would last through 2024. Andries said CFM is "still discussing quantities of engine supplies for 2025."
Boeing's airplane production increase
However, engine supplies are far from the worst problem for the company right now. A manufacturing quality problem with fuselages supplied by Spirit AeroSystems is hurting Boeing's third-quarter 737 production, and management has already told investors to expect 737 MAX deliveries at the low end of its 400-450 guidance for 2023.
Image source: Getty Images.
It's critical to understand the importance of the production increase in commercial aerospace because profit margins on airplanes tend to expand as more airplanes are produced in a program. This is a point CFO Brian West recognized in his recent presentation at a Jefferies investor conference: He said Boeing commercial airplanes' "margins will be negative in the quarter, and they will be similar to the first-quarter margins of this year, impacted by this lower volume of deliveries in BCA, as well as some higher period costs" in the third quarter.
Boeing's defense problems
Third, the narrative on Boeing's defense business is not improving. In fact, West also said Boeing's defense, space & security (BDS) operating margin will also be negative in the third quarter and similar to the negative 8.5% reported in the second quarter.
Going back to the investor day in November, management outlined an aim of largely derisking its problematic fixed-price programs (around 15% of its defense revenue) through 2024. These programs include high-profile programs like the VC-25 (Air Force One) and the long-troubled KC-46 tanker. In addition, Boeing aims to improve some legacy programs' profitability (around 25% of its defense revenue).
Unfortunately, West's update at the recent Jefferies event talked of "persistent supply chain and labor stability issues" in the "25%," and getting them back on track was "proving to take longer." He also talked of "new pressure" in the "15%" and the "need to address it."
Is Boeing stock a buy?
The stock is still attractive in the long term. Still, given the recent commentary and 737 MAX production trajectory, the near-term risk around its full-year outlook is significant, and cautious investors will want to wait to see what management says on its upcoming third-quarter earnings presentation in October before buying in or adding more to a position. The reality is that it hasn't been a great year for the company so far.
