Since reaching a new all-time high of $158.83 in February, shares of Boeing (NYSE:BA) have fallen by 20%. Much of that drop has occurred just in the last week, amid a broader global stock sell-off.
Still, there have been other worries behind Boeing stock's poor performance over the last six months. Boeing recently took a big charge on its KC-46 aerial refueling tanker program, the pace of new orders has fallen short of deliveries in 2015, the 787 Dreamliner program continues to burn cash, and some industry observers think Boeing may be unable to ramp up production of the new 737 MAX on schedule.
These worries may be overstated, though. Boeing has specifically addressed some of these key issues. Most importantly, its huge order backlog virtually guarantees strong sales, earnings, and cash flow for the next several years, justifying a higher valuation for Boeing stock. Let's take a look at each of the four worries outlined above.
KC-46 slip-ups: Should investors worry?
Last month, Boeing announced an $835 million charge related to its KC-46 tanker program. For this project, the U.S. government insisted on a capped-price development contract where cost overruns (beyond a small margin) are Boeing's responsibility. In this case, Boeing had to make changes to the fuel system, incurring additional engineering and retrofit costs.
The KC-46 program suffered another setback this month as mechanics accidentally damaged parts of the fuel system on what was supposed to be the first fully functional prototype. This forced Boeing to delay the first test flight by about a month.
While these setbacks are unfortunate, Boeing has now completed most of the major development hurdles. Even if it has to take another special charge at some point, the program will still be a net positive, steadily producing billions of dollars of annual revenue for more than a decade.
The Boeing order shortage
Another concern weighing down Boeing stock is that the company will fall short of a 1:1 "book-to-bill" ratio in 2015. (This measures the ratio of new orders to deliveries.) Bears believe that Boeing won't receive enough orders to keep its backlog steady, due to a combination of the strong dollar, weak economic growth across much of the world, and uncertainty about the future of U.S. Export-Import Bank financing.
Boeing fell short of a 1:1 book-to-bill ratio in the first half of the year. However, as of last month, CEO Dennis Muilenberg remained confident that Boeing would close the gap in the second half of 2015.
Furthermore, Boeing has bagged plenty of orders for the 747, 767, and 777 programs, which have the lowest backlogs. By contrast, the main laggard has been the 787 program. This is hardly cause for concern, as the 787 backlog stretches more than five years. Boeing has also gotten new 787 order commitments from El Al and Qantas this month.
The 787 keeps burning cash
Another long-running worry is the low profitability of the 787 Dreamliner program. Boeing's "deferred production" balance reached a total of $27.7 billion last quarter. This represents costs it has incurred for early production planes in excess of the expected average cost per aircraft over the full accounting block of 1,300 units.
In simple terms, while Boeing has reported accounting profits on its 787 deliveries to date, on a cash basis it has actually lost money. These cash losses have been bigger than expected.
That said, Boeing expects the deferred production balance to start declining after it increases the production rate from 10/month to 12/month next year. Cash profits should increase further over time as production increases again to 14/month, the mix shifts toward the pricier 787-9 and 787-10 models, and Boeing ekes out more production efficiencies.
In fact, rather than seeing the big deferred production balance as a problem, investors should perhaps look at it as an opportunity. Between now and 2022, Boeing should convert that $27.7 billion deferred production balance into cash, creating a huge windfall for long-term Boeing stock owners. The 787 program will continue producing strong cash flow far beyond then, too.
Is the 737 MAX on schedule?
Boeing recently began final assembly of the first 737 MAX, the next-generation version of its extremely popular 737 jet. By the end of the decade, Boeing plans to ramp up production to 52/month, the fastest commercial jet production rate in history.
However, some observers are skeptical that Boeing and its suppliers can meet that ambitious schedule. Last week, The Wall Street Journal reported that a shortage related to part of the 737 MAX engine thrust reverser (used for braking) could delay the production ramp-up.
Yet a Boeing spokesperson said last Friday that the 737 MAX program remains on schedule. And even if a shortage developed, it would be unlikely to have a major impact on the program's long-term profitability.
Not much to worry about
All in all, the 20% drop in Boeing stock over the past six months seems like an overreaction. Most of the concerns raised by bears seem like nitpicking in the grand scheme of things. After all, Boeing has a firm order backlog of nearly $500 billion and is about to reach the cash breakeven point for its long-suffering 787 aircraft program.
The combination of those two factors positions Boeing to produce steadily rising earnings and cash flow in the next few years. Boeing has shown a disposition to return most of that cash to investors -- it has significantly increased its dividend in the past two years and is repurchasing a lot of Boeing stock. This should drive strong returns for long-term investors.