Description

Boeing is the largest aerospace firm in the world, with 50% more revenue than its nearest competitor. It recent press has been particularly poor. It is guilty of disappointing analysts on earnings, of ethical violations in procuring pentagon contracts, of stealing competitors’ data, of building flawed satellites, and of losing its innovative, risk-taking and technological edges. Even their favorable press has been interpreted badly (such as, “the planes don’t start shipping till 2008,” and “they’re probably sliding shipments forward to improve revenues,”). But if you screen out the news, Boeing operates very profitably, even through this protracted aviation downturn, producing earnings and free cash flow. Further, if viewed by summing the value of its major segments, the stock appears extremely cheap. In fact, by using this analysis one can conclude that the current stock price of $48 per share assigns a very low value for the commercial aerospace business.

The conundrum in valuing Boeing is how to value the commercial business in light of Airbus’ ascension to equal status. BA once possessed the dual competitive advantages of selling a family of planes that covered a wide range of distance/passenger combinations, and a customer base familiar with its jets’ operations and maintenance. Airbus now equals BA on both fronts. Worse, Airbus has stolen BA’s thunder by producing the A380, the largest commercial plane in the world. Boeing’s two direct responses, a stretch 747 and a nearly-supersonic jet, both failed, leaving BA to go after the middle market with its incumbent 737 and not-yet-produced 7E7.

But the 737 and 7E7 is where we believe BA will prevail in commercial aviation. The 737 is the most popular passenger jet in history, with derivatives that can fly short-haul and coast-to-coast efficiently. And with airlines trimming hub-and-spoke operations in favor of point-to-point, super-efficient long-haul planes are needed, and the 7E7 fills that gap. The 7E7 also fills the hole that will be left by the 757 and 767 jet families as they are retired or shifted to cargo duties. Boeing thinks the 7E7 market could be $400bb over 20 years. Further, we don’t believe the world’s airlines want to see a return to a monopoly environment (Airbus, this time), so we think the market will force the duopoly model to hold. Finally, while comps are definitionally singular (just EADS), domestic builders and assemblers of commercial aviation products also have EBITDA multiples above 10.

Putting meat on this bone, Boeing recently projected that this year’s defense operations will produce $30bb in revenue and $3.0bb in EBITDA. That could be worth at least $33bb, or $39 per share. Then add 1.5x the book value of Boeing Capital Corp, or another $3.50 per share, for a total of $42.50 per share, or $5.50 below the trading price today. That figure also represents 4x book (6x tangible book). Finally assume the commercial aviation business can produce $2.0bb in EBITDA (it exceeded $3bb in ’02) – it is worth an additional $20bb, or $23.50 per share (dilution is not significant). That’s a total of $66 per share. The $10bb after-tax pension and benefit liability can be, and is being, mitigated by annual cash contributions, rising interest rates, and rising markets, as well as the new Medicare bill. But even taken in its entirety, the $12 per diluted share that it represents still leaves a valuation of $54 per share.
The stock is cheap here.

Catalyst

New large orders on 7E7 jet; Pentagon favorable decision on 767 tanker program; equity analysts beginning to see the value opportunity.