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Boeing In Flux: How Its Navigating Industry Crosswinds

This article is more than 7 years old.

Correction: The article earlier incorrectly stated that Boeing had announced it would not increase production of the 787 Dreamliner. The error is regretted.

With airlines feeling the heat from a prolonged global economic weakness and rising geopolitical concerns, Boeing has also had a tough time filling its order books lately. The aerospace giant has only managed to get 335 commercial orders so for this year, down from 470 orders it had in the comparable period in 2015.

As of August 15, Boeing is among the most heavily shorted companies in the Dow Jones Industrial Average with just over 5% of its float being shorted, as investors show concerns over the company’s recent performance. In the past 12 months, the stock has lost nearly 9% in value, underperforming the Dow Jones US Aerospace & Defense Index, which grew 7.2% during the same period.

Low oil prices have helped airlines extend the use of ageing aircraft. This has eased the urgency to buy more fuel efficient planes, which is making it difficult for manufacturers to sell newer aircraft.

Additionally, demand for wide-body aircraft has been declining, as narrow-body jets become more attractive with added capacity and range. Smaller planes operating on routes also allow for higher frequency of flights. Boeing predicts that greater adoption of the low-cost carrier model­— especially in emerging markets—has driven this shift in demand. Although Boeing posted stronger-than-expected revenue of $24.75 billion in the second quarter, the aerospace giant recorded a net loss of $234 million.

An Evolving Boeing

However, Boeing has been evolving—aligning itself to current market trends and making efforts to better adjust to changing demand dynamics. The airplane maker has announced reduced production levels of its legacy 747 planes to just six a year, starting September. It may also stop production of the aircraft after fulfilling its current backlog of 21 airplanes.

Likewise, the company is currently in the process of reviewing production levels of the 787 Dreamliner. Boeing CFO Greg Smith, while speaking at the Jefferies Industrial Conference, said that the aircraft manufacturer would consider supply and demand factors before taking the decision to increase monthly 787 production to 14 aircraft, from the current 12. The company is also considering a drop in the production rate for the long-range 777 aircraft, only if the gap to the 777X transition is not bridged.

Mr. Smith said: “If the market’s not going to demand it, we’re not going to go.” However, news of the company’s evolution hasn’t been received well by investors.

At the recent Farnborough International Airshow, Boeing Commercial Airplanes President Raymond Conner said: “I think people are in a wait-and-see type of mode, and with fuel prices being down a little bit, they can fly the older aircraft a little bit longer, and they don’t have to make these longer term decisions just yet. We haven’t seen a slowdown with respect to the single-aisles, but the wide-bodies have slowed down a little in terms of sales. We’ll adjust ourselves accordingly. Our view is to always get ourselves balanced with demand.”

Boeing’s recent net-loss on its second-quarter earnings was primarily due to a one-time write-down from the KC-46 tanker and 747-8 programs. The bottom line was also hit when Boeing reclassified expenses related to a couple of 787 Dreamliners. Based on the industry’s seasonality, the first two quarters of the year are generally slower for the aerospace giant in terms of orders and deliveries in comparison to the last two quarters where both metrics tend to pick up pace.

More importantly, Boeing has a mammoth backlog of nearly 5,700 planes with commercial airplane orders worth $417 billion. Roughly 4,400 of those are for the narrow-body 737 and 737 MAX planes, where future demand is expected to come from. Currently, the company is on track to increase production of its 737 planes from 42 to roughly 47 per month by 2017. It also plans to increase production to 52 per month by 2018 and 57 per month by 2019.

According to Boeing’s 20-year forecast, it sees the need for 39,600 airplanes, out of which 28,100 are expected to be narrow-body planes. With such a backlog, even if Boeing doesn’t receive any new orders, it can still sustain itself. However, that doesn’t mean orders are not important, since they tend to cushion the company’s liquidity in the future.

Although Boeing’s deliveries are still low in comparison to the same period in 2015, it has managed to deliver 432 planes so far this year, signifying continuing cash inflows for the company. During the second quarter, the company reported operating cash flow of $3.2 billion primarily due to its deliveries. The majority of the cash inflow for Boeing comes at the time of delivery.

Hence, while orders are showing a downward trend, the company’s relatively strong deliveries have been supporting growth. Boeing is in the process of aligning its production goals to the needs of the market, as some airline carriers have been deferring deliveries—a fact that investors should keep in mind when looking at Boeing stock.

Furthermore, in an attempt to reduce inventory levels, Boeing has recently started to offer the 787 to customers who had placed an order for the 777 aircraft. The company has offered Pakistan International Airlines the option of taking on the 787 Dreamliner in lieu of its outstanding order for five 777-300ERs.

Defense Segment to the Rescue

Recently, Boeing managed to secure a $2.8 billion contract with the US Air Force for the first two production lots of KC-46 Pegasus aerial-refueling tankers. This is part of a $52 billion program for building 179 tankers by 2017 and marks the beginning of efforts to replace roughly 450 Cold War era tankers. Additionally, the defense segment aims to shift its focus on aftermarket services rather than developing newer fighter jets.

According to the head of Boeing’s Defense segment Leanne Caret, it makes more sense to focus on serving the company’s military planes already in the market rather than manufacturing newer ones. According to a recent Canaccord report, Boeing’s Commercial Aviation Services division has the potential to become a $10 billion business unit by 2020. Additionally, the Defense, Space & Security backlog stands at $55 billion, out of which 37% is from international customers.

It’s not hard to understand why Boeing is going through a difficult period during a tectonic shift in airline industry dynamics. According to estimates compiled by Bloomberg, the company’s adjusted EPS is expected to decline 19% in fiscal 2016. From then on analysts project an ascent mode. In 2017—when Boeing starts delivering its 737 MAX aircraft—earnings are projected to rise 54%.

Boeing shares currently trade at an attractive 13.7 times FY17 earnings. With an expected surge in profit next year and successful efforts toward execution of its production realignment, I see a favorable risk-reward case for any investment in the airplane maker’s stock.

By: Shayan Shamim