The medium-term outlook is critical for Boeing (BA 1.10%) investors because nobody is buying the stock for what it is now, but rather what it could become. Management has long-established medium-term guidance, and investors are inevitably penciling it into valuations and monitoring the key milestones to hit it. Here's a look at what it is and some thoughts about what it means to the investment proposition.
Boeing's medium-term outlook
Management laid out its 2025/2026 targets at its investor day presentation in November 2022. The key parts of the plan involve a multiyear increase in airplane production, notably the 737 narrowbody, and a significant increase in Boeing defense, space, and security (BDS) profit margins, leading to $12 billion in segment operating cash flow. After $2 billion in capital spending is taken out, Boeing expects $10 billion in free cash flow (FCF) in the 2025/2026 timeframe.
Three things stand out to me related to these goals and where it stands today:
- Boeing is falling behind on its milestones.
- When, and not just if, matters in terms of meeting guidance.
- The target is highly relevant for Boeing's long-term future, too.
NYSE: BA
Key Data Points
Boeing's milestones
Unfortunately, Boeing's progress toward its target isn't progressing as smoothly as hoped. Having outlined expectations for 400-450 Boeing 737 deliveries in 2023, leading to a production rate of 50 a month in 2025/2026, Boeing promptly missed its Boeing 737 delivery target for 2023 by only delivering 396 planes. Rather frustratingly, the key issues haven't been so much about supply chain difficulties and the unavailability of components. Instead, manufacturing quality issues have continued to hit Boeing, with the recent high-profile panel blowout on an Alaska Airlines flight the latest mishap.
As such, management decided to postpone its 2024 guidance on its recent earnings call -- not a good sign when investors are looking for a bridge to Boeing's medium-term guidance.
The other less-often discussed issue is that BDS continues to report losses. Boeing is not alone in suffering margin pressure in its defense business; RTX and Lockheed Martin are also feeling it. There appears to be particular pressure on defense contractors' fixed-price development programs, which were won in less inflationary times. Back in October, Boeing CFO Brian West held out the prospect that BDS would contribute to Boeing getting to the $10 billion FCF target, but with a contribution "maybe not quite as much" as originally expected.
Speaking on the recent earnings call, West still remains "confident" in the 2025/2026 goals, "although it may take longer in that window than originally anticipated, and we won't rush the system," he said.
Image source: Getty Images.
When, not just if, matters
While pushing the timeline for that $10 billion target further out might not seem to matter too much, it actually should make quite a difference to the way investors think about the stock. Looking at matters simplistically, it's reasonable to expect a mature industrial company to trade at 20 times its FCF. Slapping a 20 times FCF multiple onto Boeing and assuming it hits the $10 billion target gives you a target market cap of $200 billion, or $327 per share based on the current price.
That figure represents a 56% premium to the current price. For argument's sake, say the $10 billion is hit at the start of 2025, implying a stock return of about 56%. Now, say it's hit at the end of 2025; this implies a 25% annual return. Finally, assume the $10 billion target is hit at the end of 2026, implying a 16% annual return.
As you can see in this example, the timing makes a big difference to the investment proposition. For reference, Wall Street analysts expect Boeing to hit the $10 billion target sometime in 2026, as the consensus is for $8.8 billion in FCF in 2025, followed by $10.8 billion in 2026.
Image source: Getty Images.
Thinking longer term
The Boeing 737 first flew in 1967, and while it's been updated several times (the 737 MAX is the latest generation), Boeing hasn't completely redesigned its narrowbody workhorse for decades. It takes time and, above all, billions in cash to develop a new airplane. Boeing CEO David Calhoun has articulated that there won't be a new Boeing plane in place before 2035.
However, Boeing will need to invest beforehand, and Boeing is holding $52.3 billion of consolidated debt. Simply put, Boeing needs the $10 billion in FCF sooner rather than later, not least to pay off debt and prepare for future investments.
Boeing in a few years
The company will likely be in a better place in a few years than it is now. Still, the nuance of the timing of its FCF generation has a significant impact on the investment proposition and its longer-term future. The stock is attractive, but there are plenty of other aerospace stocks to buy that are executing better operationally. Right now, Boeing needs a few quarters of solid execution to dispel the doubters.
