- Boeing was downgraded to underperform due to a $15 billion discrepancy in its FCF projections.
- The discrepancy can also emanate from underestimating the disruptive power of new competitors.
- Besides valuations and competition, Boeing still has an impending SEC probe which might prove detrimental to the stock's upside momentum.
Boeing: The $15 billion Discrepancy
The bearish sentiments for Boeing, last week, came from Ronald Epstein and Kristine Liwag of Bank of America (NYSE:BAC) over concerns that Boeing's (NYSE:BA) new 787 Dreamliner was not profitable enough for the company. As a result, Bank of America/Merrill Lynch downgraded Boeing to an equivalent of a sell rating when they downgraded Boeing from neutral to underperform. Although the analysts raised the price target on Boeing by $10 to $125, the new price target is still below Boeing's current stock price.
"The bull thesis on the stock is predicated on strong free-cash-flow generation in the out years, largely driven by the 787 Dreamliner, in our view. Boeing's current outlook assumes that the 787 will generate $29 billion of cash by 1Q22, while our analysis shows that Boeing will only generate $14 billion of cash," wrote analysts Ronald Epstein and Kristine Liwag in a note to clients on Wednesday. "Boeing will likely take a charge on the 787 program and/or extend the block size...Boeing will likely offset its working capital requirements by squeezing its suppliers and increasing its accounts payable on the balance sheet....We expect the stock to be pressured in the medium term, as Boeing grapples with industry concerns regarding overproduction as well as development and production risks on programs like the 787, 777X and 737MAX." Bank of America/Merrill Lynch.
This is concerning because Boeing's current valuations hinge on the company generating "$29 billion in cash by 1Q22." Because Boeing's "strong free-cash-flow generation in the out years," according to Bank of America/Merrill Lynch, is "largely driven by the 787 Dreamliner," the potential shortfall in profits generated from the 787 Dreamliner would suggest lower than projected valuations.
For instance, if Boeing's current projections are based on the $29 billion in FCF generation, Epstein and Liwag's $14 billion projections suggest that Boeing's current valuations are way off, by $15 billion. A $15 billion discrepancy is 20% higher than Boeing's total cash of $12.01 billion in the most recent quarter (MRQ) and ~16% of Boeing's trailing twelve month (TTM) revenue of $96.11 billion. Any discrepancy of this magnitude (the $15 billion discrepancy) would be wealth-diminishing for Boeing's current shareholders.
More Reasons To Support The Bearish Case
Although the COMAC C919 is a direct competitor to Boeing's 737 and not Boeing's 787, the emergence of a new competitor will undercut Boeing's China growth story and can pave the way for other airline models that could compete with a variety of Boeing's aircraft's.
In early December of 2015, I wrote a piece entitled,"Why Boeing Investors Should Worry Over The COMAC C919?" The piece basically outlined why Boeing's current projection of 6,000 aircraft's in China over the next 20-years was in need of a revision. The rationale for the needed revisions was because of the introduction of the COMAC's C919. This is so because the COMAC C919 is intended to be in direct competition with Boeing's 737
"a great nation must have its own large commercial aircraft...China's air transport industry cannot completely rely on imports." - China's civil aviation chief Li Jiaxiang.
China is a huge market. According to the Indian Express, China is the world's largest civil aviation market. China is planning to add 6,330 new aircraft's worth ~$950 billion to its commercial fleet in the next 20-years. A net addition that will represent ~17% of the world's total aircraft demand.
It is because of this lucrative nature of China's civil aviation market that Boeing has been optimistic in projecting that its current Chinese "expansion is expected to continue, and in fact accelerate."
"Despite the current volatility in China's financial market, we see strong growth in the country's aviation sector over the long term," said Randy Tinseth, vice president of Marketing, Boeing Commercial Airplanes. "Over the next 20 years, China's commercial airplane fleet will nearly triple: from 2,570 airplanes in 2014 to 7,210 airplanes in 2034, with more than 70 percent of these deliveries accommodating growth...Enabled by China's growing middle-class population, new visa policies and the underlying strength of its economic growth, this expansion is expected to continue, and in fact accelerate," Tinseth said. "The 777, 787 and 747-8 are perfectly positioned to support Chinese airlines' continued globalization." - Boeing's news releases/statements titled, "Boeing Sees Demand in China for 6,330 Airplanes Valued at Nearly $1 Trillion."
This is where the impact of the COMAC C919 comes in. It will undercut Boeing's anticipated "strong growth" in China. COMAC is a state-owned manufacturer. This is an essential piece of information considering the fact that China's major airlines are state-owned. Meaning that the Chinese government is more likely to award future contracts to itself via COMAC than to award those contracts to Boeing or Airbus. This gives COMAC a great competitive advantage over competitors like Boeing.
In addition, it is easier for COMAC to replicate Boeing's aircraft's because "China has a component role on every current Boeing commercial airplane model."
"Today, Boeing jets are the mainstay of China's air travel and cargo system. More than 50 percent of all the commercial jetliners operating in China are Boeing airplanes. Over 8,000 Boeing airplanes fly throughout the world with integrated China-built parts and assemblies. China has a component role on every current Boeing commercial airplane model – the Next-Generation 737, 747, 767, 777, as well as the world's newest and most innovative airplane, the 787 Dreamliner." Boeing's mediaroom.
This presents huge potential headwinds for competitors like Boeing for two main reasons: it undercuts potential sales growth rates of Boeing's 737 and there is a chance that other Chinese manufacturers might develop a range of new models that are in direct competition to Boeing's other commercial airplane models.
Conclusion - The Pending SEC Probe
Overvaluation and competition are not the only challenges Boeing is facing regarding its 787 Dreamliner. About two months ago, The U.S. Securities and Exchange Commission launched a probe, which involves a whistle-blower's complaint that centers on projections Boeing made about the long-term profitability of the Boeing 787 Dreamliner and its 747 jumbo aircraft.
The outcome of this investigation is critical because it will answer questions that have already been raised concerning Boeing's ability to recoup its costs for both the 787 and the latest 747. It will also give more insight into whether or not Boeing's sales forecasts were too optimistic. Lastly, the SEC probe outcome will serve to prove or disapprove Boeing's FCF generation projections and its current valuation.