2012 Preview: Boeing

The calendar has turned, and the new year has begun. Now, what are you going to do with it? In our 2012 preview series, we're taking a look at some of our favorite stocks, and wondering: Will they do as well this year as last year? Or in Boeing's (NYSE: BA) case, could they do even better?

A few Foolish facts about Boeing

Source: Motley Fool CAPS.

What's ahead for Boeing?
A little over a year ago, I went public with a prediction that Boeing would be the best performing stock of 2011. Now, things didn't work out quite like I predicted. Still, with the Dow Jones Industrial Average (INDEX: ^DJI) climbing 5.5% for the year while Boeing stock turned in a 14% gain, I humbly submit that I was at least in the ballpark. As the year closed, Boeing found itself among the Dow's 10 best performers. Not a bad performance as other industrials stocks suffered through a rough 2011.

So far, so good. But what's next?

Last month, in our review of Boeing's performance for 2011, we outlined a few things Boeing got right last year. It won the KC-76 refueling tank competition, securing for itself a $30 billion revenue stream. Boeing also booked a win on its 787 Dreamliner project, earning FAA approval, and beginning delivery to its long-suffering customers. Plus, the company has made headline after headline with successful contract wins for its 737 and 777 airliners, ensuring Boeing's backlog will remain full for years to come. Long story short, it looks like everything's coming up roses for Boeing.

But that's just the problem. It looks like Boeing can do no wrong. Key to my buy thesis last year, though, was that the pessimism over Boeing was overdone, and with investors so skeptical, pretty much any good news the company could report in 2011 would have a positive effect on the stock. My worry today is just the opposite: So much optimism has been "baked in" to Boeing's share price that I now wonder if there's any room left to run.

Boeing -- not your typical defense stock
Now don't get me wrong. There are arguments in favor of buying Boeing today. At 15 times earnings, the shares don't look particularly expensive. Not with the dividend sitting at 2.6%, and analysts predicting 13.4% growth over the next five years. What's more, I've long argued that the "natural" price of aerospace and defense stocks (assuming 10% growth and 10% net profit margins) is one-times annual sales. Boeing sells for just 0.85 time sales. This suggests there could still be some upside left. But is the price really as attractive as it appears?

I'm not so sure. For one thing, Boeing doesn't quite fit my criteria for a one-times sales valuation; its 6% net profit margin is barely half what I'd like to see. (Albeit, the company's growth rate is more than 10%.) For another, Boeing's rivals in the military aircraft business, Lockheed Martin (NYSE: LMT) and Northrop Grumman (NYSE: NOC), are both much cheaper -- selling for less than 10 times earnings apiece, and for correspondingly low P/S ratios.

Boeing's quality of earnings is also problematic -- devilishly so. Free cash flow for the past 12 months comes to $666 million. That's a far cry from the $3.8 billion in "net income" Boeing claims under GAAP. Although historically, Boeing has been a good cash generator (averaging $3.6 billion annually over the past five years); right now its free cash flow backs up just 18% of reported net income.

Trouble's a-brewing
Now that Boeing's building and delivering 787s to its customers, I'd expect to see the company return to more historically normal levels of cash generation. Its yearslong backlog of 777s and 737s awaiting delivery, too, should help to replenish the company's coffers (currently in hock to the tune of $3.2 billion net debt). But these profits may not be as robust as we'd like to see. For one thing, in the race to secure sales (and deprive rival Airbus of same), Boeing sold a lot of planes at razor-thin profit margins. The vaunted 787, for example, is said to require 1,100 deliveries before it begins to turn profitable.

And even that may not be enough. Last year, we learned that Air India claims Boeing's delay in delivering the 787 cost it $1.3 billion in lost revenues. How much do you want to bet that customers like Delta (NYSE: DAL), operating on a 1.3% profit margin, or AMR (actually bankrupt) won't make similar claims? A billion here, a billion there -- could make a big difference to their bottom lines.

Foolish takeaway
All of which is to say, there's more to Boeing than meets the eye. While you can argue it's fairly priced, it's not obviously cheap. Personally, I think it's more likely to underperform the S&P this year than outperform. For this reason, I'm heading over to Motley Fool CAPS right now to rate Boeing an "underperform." (Feel free to follow along, and jeer if I'm wrong.)

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