Boeing Co. (BA, Financial) has been one of the best dividend growth stocks in the Dow Jones Industrial Average in recent years. The stock, however, has dramatically underperformed the market since it peaked in early March, just nine days before one of its planes crashed. Since then, the stock has shed 15% while the S&P 500 has gained 6% and is now trading at an all-time high.
With that being said, Boeing has rallied 10% this month. Therefore, as it is very rare to find this exceptional stock at an opportune valuation, the big question is whether or not Boeing has bottomed.
Business overview
Boeing is the largest commercial jet manufacturer in the world and the second-largest producer of military weapons. It was founded in 1916 and operates in three segments: Commercial Airplanes, Defense, Space & Security and Global Services.
Boeing is an industrial stock. The vast majority of stocks in this sector are cyclical; they face intense competition and thus struggle to protect their margins. Boeing is a rare exception in this group. It essentially operates in a duopoly with Airbus (XPAR:AIR, Financial) as the two companies have a dominant position and strong pricing power. This competitive advantage is paramount for the stock.
Thanks to this advantage, Boeing has been able to grow its earnings per share every single year in the last decade, at an enviable 16% average annual growth rate. This growth record is certainly impressive for an industrial stock.
Headwinds
Boeing got into trouble after two major accidents that occurred within six months of each other. When a Boeing 737 MAX jet belonging to Lion Air crashed in October, the stock slumped 7%, but recovered within the next three trading sessions as there was no evidence the company was responsible for that accident. However, things took a turn for the worse on March 10, when a Boeing 737 MAX jet belonging to Ethiopian Airlines crashed in a similar manner, shortly after takeoff.
The 737 MAX has a new safety feature composed of two sensors that measure the angle of the plane. Whenever the plane is at a very steep angle, it runs the risk of losing the support from the air that passes under its wings and falling. The two sensors measure the angle of the plane and drive the nose of the aircraft down whenever the angle becomes too steep. The problem in the two accidents was the fact that one of the sensors malfunctioned. Consequently, the mechanism drove the nose of the aircraft down, causing it to crash. Even worse, the pilots were not familiar with this safety mechanism and did not know how to turn it off in order to operate the plane manually.
Boeing admitted it did not inform its customers that their pilots needed to go through additional training. Even worse, the company had to correct mistakes in the software of the flight simulator of this model because it could not replicate the actual flight conditions the pilots faced when the crashes occurred.
The consequences
Since the plane crash in March, all 737 MAX jets have remained grounded. Boeing is doing its best to correct the issue in order to receive approval from the Federal Aviation Administration to return the planes to the sky. However, the whole process is taking longer than initially expected.
The 737 MAX was initially expected to return to flight mode in late May or early June, but it is now expected to receive approval in December. As there is great uncertainty over this estimate, however, investors should not be surprised if the plane remains grounded for the remainder of the year and into next year.
Due to the grounding of this model, several airlines have been forced to cancel flights on a daily basis. Southwest (LUV, Financial), the largest global operator of the 737 MAX, has cancelled all the daily flights of this model until early September. American Airlines (AAL, Financial) has cancelled 115 daily flights until September, while United Airlines (UAL, Financial) has cancelled 40 to 45 daily flights until early August.
Many airlines, including the top three Chinese airlines, Qatar Airways and Turkish Airlines, have requested compensation from Boeing for the financial losses they have incurred from the grounding of the plan. Even some of Southwest's pilots have said they will seek compensation from Boeing to cover their legal costs as well as lost income due to the cancelled flights.
Moreover, the grounding of the 737 MAX model took its toll on Boeing's first-quarter results. The company delivered only 149 commercial aircraft in the first quarter, 19% lower than in the prior-year quarter. Earnings per share fell 13%, from $3.64 to $3.16. In addition, Boeing assumed a $1 billion charge from its reduced production volume, which resulted in higher production costs.Â
As a result, the grounding is expected to have a much more severe impact for the remainder of the year, particularly in the second quarter. To be sure, Boeing's jet deliveries in May plunged 56% on an annual basis, from 68 to 30, and the company posted negative net orders in the first five months of the year.
This performance is in sharp contrast to that of Airbus, which has greatly benefited from the issues facing its main competitor. The French company grew its deliveries by 40% in the first five months of the year. As long as the 737 MAX remains grounded, Boeing will remain under pressure.
Is this the bottom?
The impact of the pending safety issue was prominent on the first day of the Paris Air Show. Airbus received new orders for 123 planes, while Boeing did not announce a single new order.
The company surprised everyone on the second day of the event, however, announcing it received an order for 200 737 MAX jets from the owner of British Airways, International Airline Group (LSE:IAG). As British Airways used to purchase its planes from Airbus, it sent a strong endorsement message in favor of Boeing. This triggered a 5% rally in Boeing's shares.
Growth prospects
While the pending safety issue with the 737 MAX will weigh on Boeing's performance longer than initially expected, we believe it will prove to be a one-time issue. The company will eventually resolve the problem and return to its multiyear growth trajectory thanks to the secular trends that support its business.
Boeing and Airbus expect average annual passenger growth of 4.6% and 4.4% over the next 20 years. Moreover, Boeing recently revised its long-term forecast upward. It now expects the airline industry to require approximately 44,000 new aircraft (up from 42,730) worth $6.8 trillion over the next two decades. About half of the new airplanes will be needed to cover the increased demand in Asia, particularly in China and India, while the remaining half will be used to replace less efficient models.
The favorable, multiyear secular trends are clearly reflected in the impressive growth record of Boeing, which has grown its earnings per share at a 16% average annual rate over the last decade. This growth pace is impressive, particularly for an industrial stock.
Valuation and expected returns
As we view the current safety issue as a temporary setback, we expect Boeing to earn approximately $23.50 per share by 2024. The stock has traded at an average price-earnings ratio of 17 over the last decade. Thanks to its strong growth prospects, the stock can reasonably be expected to trade at an earnings multiple of 18 five years from now.
If our assumptions prove to be correct, Boeing will be trading around $423 by 2024 for a 2.4% average annual price appreciation. If we add the 2.2% dividend yield, we can expect it to offer an approximate 4.6% average annual return over the next five years. Such a return is not sufficient to justify purchasing the stock right now.
Final thoughts
Boeing benefits from the duopoly status of its business and, therefore, has an exceptional growth record, with ample room to keep growing for decades. However, the market is well aware of this, so it is hard to find this exceptional stock on sale.
The pending safety issue has exerted pressure on the stock, leading some investors to think they have been given a rare investing opportunity. Unfortunately, the correction is too shallow, indicating the market agrees that the safety issue as a one-time event. In the absence of a bear market, we do not expect Boeing to revisit its recent lows, so the bottom is probably in for the stock. On the other hand, the stock is not likely to offer attractive returns from its current price.
Disclosure: I am not long any of the stocks mentioned in this article.
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