It has been a good few years for shareholders of Boeing Co. (BA, Financial). Since February 2017, the stock has soared 147%, a staggering result for a mature aerospace company with a (current) market capitalization of $232 billion. Moreover, since the pullback in late 2018, when shares sold off to lows of $304, the stock has appreciated almost 35% to its Wednesday price of $410.
Is this the result of organic growth, or is it something else? After all, the company is known for its extremely generous share buyback scheme, which is arguably what has been propelling the stock higher. But the commercial airline market has been steadily growing for many years now, and the stocks of both Boeing, and its European rival, Airbus (AIR, Financial), also reflect that. Let’s examine the debate more closely.
Recent financials look good
On Jan. 30, Boeing reported its full-year earnings for fiscal year 2018, during which the company logged record revenues, earnings, earnings per share and cash flow. Total revenues for the year came in at $101.1 billion, representing a 7.5% increase year-on-year. Earnings per share for the year were $16.01, an increase of almost 23% compared to 2017. Operating cash flow clocked in at $15.3 billion, an increase of 15%.
Overall, headline numbers were extremely positive for Boeing, which would help explain the meteoric rise in the stock price over the course of the last year. Digging a little deeper into the numbers, Boeing delivered 806 aircraft in 2018, compared with 763 in 2017. Furthermore, the company plans a production ramp for its 737 and 787 models, which bulls have eagerly priced into the stock.
Some strong prospects
There are a number of fundamental reasons why investors are bullish on Boeing.
Margin expansion. Operating margins increased from 11.6% in the fourth quarter of 2017 to 15.6% in 2018. This is because aerospace companies benefit from economies of scale that kick in when they build more planes. By increasing the number of unit made, they are able to bring down per-unit costs, which in turn leads to expanding margins. Given the promised 737 and 787 production ramps, as well as a possible 777 ramp, it is easy to see why investors expect this to continue.
History of share buybacks and dividend increases. Last year, Boeing repurchased $9 billion of shares and paid $3.9 billion in dividends. In last December, the company also raised its dividend 20% to $2.05 per share. Given that the company is sitting pretty on $8.6 billion in cash, and given that cash flow is so robust, there is reason to believe that the dividend will be safe for a long time going forward. Add to this the fact that Boeing has an order backlog that essentially secures future cash flows and you can understand why investors see this as a safe income play.
Incredibly strong market position. Boeing and Airbus operate an effective duopoly over the market for commercial aircraft, which affords investors a degree of safety when picking one or the other. It is not in the interest of buyers to strongly prefer one over the other, so the balance of power is maintained. These incredibly strong moats mean that neither company has to worry about being disrupted by an upstart competitor, and instead can focus on expanding margins and securing more contracts. Of course, this has been the case for a very long time, and it is likely not a major factor for the current valuation, but it nonetheless simplifies the industry for investors.
There are risks on the horizon
For all the euphoria around this stock, however, there are a number of risks that investors may want to consider before jumping in. First, it’s expensive.The stock is currently trading at a price-earnings ratio of 25, which represents all-time highs for the company. This should give value investors reason to pause.
Second, any worsening in the already shaky global economy would have serious knock-on effects on the market for commercial air travel. Yes, to a certain extent Boeing’s near-term contracts are already signed and agreed. But investors are pricing in the assumption that everything will continue to be at least as stable as it is now, with seemingly little concern for the potential downside impact of a slowdown in demand.
Third, the stock buyback scheme has come under some criticism of late, with some saying that is unsustainable, and that the reason the share price has skyrocketed over the course of the last few years is much more to do with this than any significant fundamental improvement in the market or the business.
Overall, while there is much to cheer about this darling of American industry, what is equally true is that this is currently a significantly overvalued company while large potential downside. Exercise caution with this stock.
Disclosure: The author owns no stocks mentioned
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