Analyst Peter Arment of Sterne Agee made waves last week by raising his price target for Boeing (BA 0.26%) to $196 based on the company's rising free cash flow. Boeing stock has already gained about 30% since December, and Arment's target implies that there is still upside of about 25% in the next year.
Boeing Stock 3 Month Chart, data by YCharts
Boeing stock already trades for more than 18 times projected 2015 EPS: roughly in-line with other major industrial companies. Investors may be unwilling to pay a significantly higher multiple, limiting the stock's upside in the coming year. However, longer-term, rising earnings and free cash flow could drive significant stock price appreciation for Boeing shareholders.
The Dreamliner is key
Boeing's revolutionary 787 Dreamliner aircraft program represents the key to its profit and free cash flow growth over the next 5-10 years. Boeing has burned through $26 billion over the last decade or so in order to get Dreamliner production up and running.
Boeing uses program accounting to offset these early costs against the expected profit from sales later in the production run. It then reports a profit margin equivalent to the long-term expected profit margin from the Dreamliner program.
But even with the benefit of program accounting, 787 margins are still in the low single-digits due to high production costs for early models. As the Dreamliner turns cash positive (expected to occur later this year) and becomes more profitable, it could have a tremendous impact on profit and cash flow, lifting Boeing stock.
Boosting Dreamliner profitability
Increases in the Dreamliner production rate will be critical for improving cash flow. Boeing plans to raise the production rate at its plant in Charleston, South Carolina from 3/month today to 5/month next year and 7/month by the end of the decade. The increase in production volume should improve efficiency, reducing unit costs.
Boeing is working to boost the profitability of the Dreamliner program. Photo: The Boeing Company
Cost reductions from suppliers will also contribute to lower unit costs. Lastly, a shift in the sales mix from the smallest model (the 787-8) to the larger 787-9 and 787-10 versions should improve cash profitability over time.
On the accounting profit side, increases in the Dreamliner accounting block could boost Boeing's earnings. In late 2013, Boeing increased the 787 accounting block from 1,100 planes to 1,300 planes. This maneuver improved the Dreamliner's profit margin by spreading the start-up costs over more units.
At some point in the next few years, Boeing may increase the accounting block again. Boeing's "Current Market Outlook" projects demand for 4,520 small widebodies between 2014 and 2033, and Boeing expects to get at least half of this market.
This suggests that Boeing will ultimately sell far more than the 1,300 Dreamliners included in its current accounting block. Once Boeing has more certainty about its long-term cost and average selling price trends, it will raise the accounting block again. By incorporating more profitable sales from later in the production run, this will improve the program profit margin.
Other profit growth sources
Boeing's other main aircraft programs -- the 737 and the 777 -- could also drive profit growth over the next 5-10 years. Boeing plans to ramp up 737 production from 42/month today to 52/month by the end of the decade. It will also transition to building the redesigned (and higher-priced) 737 MAX version in the next few years.
Meanwhile, Boeing CEO Jim McNerney has stated that Boeing will be able to maintain its current 777 production rate of roughly 100/year through the transition to the new 777X in 2020. The 777 will thus continue to be a reliable source of earnings and cash flow.
Finally, sales in Boeing's defense business could rebound thanks to stronger demand from international customers, primarily in the Middle East.
Thus, earnings from the Dreamliner family should soar in the next 5 years (both on a cash basis and in accounting profit terms). Profit from other parts of Boeing's business may rise at the same time. Both trends will be good for Boeing stock. Additionally, rising free cash flow will allow Boeing to increase its already-generous dividend and share repurchase programs.
By 2020, Boeing stock is likely to have far surpassed $200. In fact, barring any mishaps, it could even break through the $300 level by then. Even if Boeing's gains don't all come immediately, there are plenty of reasons for shareholders to stick around.
