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Boeing's Dreamliner Woes an Opportunity

January 20, 2013 | About:
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Gordon Pape

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Contributing editor Glenn Rogers joins us this week from Southern California where, as a frequent flyer, he has been keeping a close eye on the woes of the Dreamliner. Here he is to tell you about the investment opportunity Boeing's problems may present. Glenn Rogers writes:

Sometimes bad news can be good news. This is particularly true if the bad news is short term in nature and drives down the stock price, thereby giving investors an opportunity to buy a good company at a discount.

We've seen it happen many times in the past to companies as diverse as pharmaceutical giant Merck (MRK) (the Vioxx debacle) and Wells Fargo (WFC), a solid bank which saw its stock plunge to below $9 in the credit crunch of 2008 to 2009 (it's back around $35 now).

You might even put Research In Motion (RIMM) into that category. Its shares were trading in the $6 range last September and analysts were writing the company's obituaries. Since then they have more than doubled and they could go a lot higher if the new BlackBerry 10 is a hit.

I think there is a good chance that Boeing Corporation (BA) will join that list. The company has suffered one setback after another with its revolutionary new 787 Dreamliner being grounded pending safety checks in the U.S., Europe and Japan. The share price dropped $2.60 after the U.S. announcement, although it subsequently rallied somewhat to finish the week at US$75.04.

There have been a number of performance issues with the Dreamliner. None is at a level of seriousness that would call into question the viability of the program. But the concerns over batteries and the electrical system are bad enough to force regulators to step in and that put downward pressure on the share price.

It is not uncommon for new planes to have teething problems, especially technologically advanced aircraft with innovative designs and unorthodox materials. Just ask Airbus which recently reported difficulties with its upcoming jumbo jet. That being said, when a whole fleet is grounded after a couple of emergency landings, there is obviously an issue that has to be addressed. Nervous investors responded by dumping their shares and some analysts cut their Boeing projections (Goldman Sachs dropped their price target from US$98 to US$90). Clearly, there is risk attached to this company while it sorts out the problems with the new plane.

But Boeing is much more than just the Dreamliner, and nearly all of us have flown in their workhorse plane, the 737, or the massive 747. The company enjoys significant backorders on those products, which been in production for a long time with the bugs worked many years ago.

Boeing is the world's largest aerospace company and has a huge defense, space, and security business along with a satellite communication systems business. The company is a major supplier to the international space station and one of the leading exporters of finished products in the United States.

Most people associate Boeing with commercial travel, but the company also builds a number of combat aircraft, such as the Super Hornet and the Apache helicopter. It also manufactures many other staples of the U.S. military machine, including the Patriot missile system that got a lot of publicity in the recent Israel-Gaza conflict.

On a less sinister note, Boeing is a major provider of commercial satellites including many of the GPS satellites we all rely on to get from our house to the mall and back. The company employs more than 170,000 people around the world and has activities in more than 70 countries. Boeing is headquartered in Chicago and its revenues exceed $32 billion (figures in U.S. currency).

Financially, the company is very strong and has more than $11 billion in cash, which represents nearly 19% of its stock market value. Boeing will generate free cash flow over the next couple of years of more than $19 billion, so the prospects for future dividend increases and stock buybacks look promising.

The company reported third-quarter earnings of $1.35 a share, which was down 8% from 2011. However, for the first nine months of the 2012 fiscal year, EPS were $3.84, an improvement of 10% over the year before. Final 2012 results will be released on Jan. 30 and are expected to come in around $5. That would price the company around 15 times earnings. That's a little ahead of the broad market, which is likely why the stock had been trading sideways until the headlines of the last couple of weeks. However, going forward earnings should increase as Boeing moves up deliveries on 787 along with their other products.

The Dreamliner is not the only problem Boeing faces. The company could encounter headwinds with cutbacks to the defense budget looming as a possibility in the months ahead, although it is uncertain whether the Obama administration will have much success in this goal. In any case, the company is bullish on the outlook for its commercial aviation business, noting that the outlook for air travel continues to grow at 5% annually despite a recent mild contraction. Air cargo should grow at a similar rate going forward.

Boeing is forecasting global long-term demand for 34,000 airplanes with a projected value of $4.5 trillion. The largest percentage of this demand will be for the workhorse models like the 737 which the industry refers to as single aisle airplanes. Currently there are more than 900 airlines in operation and Boeing produces 50% of the in-service jet fleet with the rest going to Airbus, Brazil's Embraer and Canada's Bombardier.

There are high barriers to entry in this segment. There is a huge requirement for capital, regulatory approvals are onerous, and having the research development, engineering and manufacturing skills needed to produce these complex aircraft keeps the pool of competitors quite small. That is largely true of the defense segment as well.

I had hoped that the bad news about the Dreamliner would hit Boeing's share price harder than it has so far. So for the moment, my recommendation is to closely watch the stock over the next two or three weeks. If it closes in the mid-to-high $60s, I would be a buyer.

Action now: Monitor. Buy if the shares drop below $70. They closed on Friday at $75.04

About the author:

Gordon Pape
GuruFocus - Stock Picks and Market Insight of Gurus

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