Boeing Stock Holds Plenty Of Risk

  • 4,500 jobs to be cut by June which will consist of managers and officers. 18 KC-46 tankers will struggle to be delivered by next August.
  • Dividend investors should be wary of the attractive dividend as it had been frozen before, due to lower cash-flow.
  • Boeing is under pressure to decrease the 787 deferred production and reduce its costs. Some analysts view Boeing's expectations too lofty.

Some US multinationals have been holding up very well in the present strong dollar environment but Boeing Co (NYSE:BA) has been having its own problems especially when trying to compete against the likes of Airbus, which currently is benefiting from the weak euro. That's why it came as no surprise when Boeing announced that it would be culling 4,500 jobs by June in an effort to stop the bleeding.

Although the job cuts were needed, they are happening at the worst possible time as the company presently has close to 5,800 unfilled orders for planes (backlog). One would think that reducing the headcount would ultimately slow down production which Boeing can't afford, right now, despite the jobs being of executives and managers. These job cuts come on the back of reports that Boeing will struggle to deliver its scheduled amount of KC-46 tankers to the US air force next year which again shows that more delays and subsequent cost overruns are on the horizon.

This is the risk (or reward depending on how you view an investment in Boeing stock) you take when investing in a stock like Boeing and the tanker contract exemplifies this. Boeing needs to deliver 18 of them by August of next year to ensure the remaining 161 tankers are also built by the manufacturer which would be a contract worth $43 billion. A feast or a famine. But next year's deadline isn't the only risk facing Boeing Co in the near term.

Dividend investors will be attracted to the generous yield on offer (3.39%) which is much higher than the average in this sector. However, when we look at the fundamentals, we see that the company actually froze its dividend from 2009 to 2011 because of cash flow problems. This is the problem with cyclical stocks. We see in the auto industry and the aviation industry that, because of the cyclical nature of the respective sectors (huge upfront costs), recessions can be bruising and sometimes loss making.

Furthermore, operating margins and gross margins have not risen over the last 10 years illustrating that cost control is still an issue. Moreover, dividends per share ($3.64 in 2015), since the great recession, have vastly outpaced free cash flow levels ($6.91 billion printed in 2015) which again illustrates that this cycle could be nearing a top. It's all going to be about gaining market share in the ultra-competitive commercial market because I see no growth in the defense business in the near term. Why? Well, governments are still heavily in debt and the general fiscal environment is not as it was in the past. This is demonstrated by the US defense budget which has fallen by around 16% since 2010 meaning Boeing has to generate the growth in commercial. The risk will be in not being able to meet its demand backlog which would mean significant market share loss to its competitors.

Also, as the company has firmly committed to buybacks ($6.35 billion of stock bought last year) and dividends ($2.49 billion paid out in 2015), it must keep margins elevated to ensure these shareholder initiatives can continue to be implemented. Why? Because Boeing is currently undergoing many new initiatives which are wide open to risk and must be managed carefully to ensure profits don't dwindle. For example, and apart from the KC-46 program, Boeing is working on the 777x which is a span new aircraft and very complex.

The problem with a company like Boeing is that it is always working with deadlines which means if it encounters any problem during testing, it must be rectified immediately which usually means more cost. While the 737 MAX program seems to be running nicely, the 787 model still carries plenty of risks. Boeing has already stated that significant cost reductions will come through on this model from 2016 which would keep margins and cash flows elevated. However, the jury is still out on this assertion as Boeing has made these promises before and has come to regret them when the reality struck.

The 787 increasing the margins is not certain, which would adversely affect cash flow. In fact, Credit Suisse Group reported recently that Boeing is at risk of reporting a $7.5 billion shortfall on the model which again elevated my fears.

Regarding technicals, Boeing stock has been unable to break out to higher highs nor break through the trend line I have drawn which would indicate a new bullish pattern. As a matter of fact, the stock on a short-term basis is currently dropping and these latest set of lay-offs plus the the damage that was done to the share price recently (due to an SEC probe into accounting practices) may mean this stock will see lower prices in the near term. I just don't like the technical damage that was done to the stock in February.

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To sum up, the cyclical nature of Boeing's business is a risk that dividend investors especially should be aware of. With almost 5,800 of its orders unfulfilled, 787 worries and 4,000 job cuts just announced, I find it hard to see how it will regain its former highs. A weaker dollar will undoubtedly help and I feel it may need more that this to compete against its arch-rival - Airbus.

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  • I do not have any business relationship with the companies mentioned in this post.
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