- Our bearish sentiment on Boeing is already playing out with ~27% decline in the stock price.
- But we think things might get worse before they get better because of the new SEC investigation on the company.
- The SEC probe could result in increased uncertainty over Boeing's projections.
We believe that the recent Boeing (NYSE:BA) SEC investigation into its Dreamliner and 747 accounting practices is just the beginning of Boeing's problems.
We raised this issue last year in an article here on Amigobulls,"Why Boeing Investors Should Worry Over The COMAC C919?" Our arguments then were solely focused on Boeing's inability to deliver on its 20-year projections in China. The article outlined why the state-owned aerospace manufacturer's,, The Commercial Aircraft Corporation of China, Ltd. (COMAC), C919 aircraft intended to compete against Airbus Group's (OTC:EADSY) A320 and Boeing's 737 presented a huge threat from a revenue growth perspective. COMAC is well-capitalized -backed by the Chinese government - and well-positioned for the Chinese market and arguably the Indian market.
Since our last bearish thesis, Boeing's stock price has declined by ~27% in less than 70 days.
But the decline in stock price was not the only negative news surrounding Boeing stock.
"Revenue for 2016 is forecast to be between $93 billion and $95 billion reflecting the planned transition to the 737 MAX, lower F/A-18 and C-17 volume, and reduced 747 production and timing of deliveries. We continue to see revenue growth over the remainder of the decade with seven more commercial production rate increases planned as we deliver on our robust backlog. Core earnings per share guidance for 2016 is set to be between $8.15 and $8.35 per share. Our 2016 Commercial Airplane revenue guidance is set to be between $64 billion and $65 billion." - The Boeing Co. (BA) CEO Dennis Muilenburg on Q4 2015 Results - Earnings Call Transcript.
Boeing stock price slumped because the company forecasted lower-than-expected earnings and fewer plane deliveries because of production changes needed to boost output later in the decade. Changes vital to Boeing's ability to "deliver on our (their) robust backlog."
Currently, the possibility that Boeing might need to revise its 20-year projections amidst the COMAC competition and the SEC investigation is not just another hypothetical potential risk, it is a real and an imminent risk.
SEC Investigation At Boeing
What is this investigation all about?
"The U.S. Securities and Exchange Commission is investigating whether Boeing Co. properly accounted for the costs and expected sales of two of its best known jetliners, according to people with knowledge of the matter.
The probe, which involves a whistleblower’s complaint, centers on projections Boeing made about the long-term profitability for the 787 Dreamliner and the 747 jumbo aircraft, said one of the people, who asked not to be named because the investigation isn’t public. Both planes are among Boeing’s most iconic, renowned for the technological advancements they introduced, as well as the development headaches they brought the company." - By Robert Schmidt , Julie Johnsson and Matt Robinson in a Bloomberg article,"Boeing to Face SEC Probe of Dreamliner and 747 Accounting."
It is possible because of the type of accounting used in the industry called program accounting. According to the aforementioned article, the SEC authorized program accounting decades ago to deal with the fact that the aerospace industry faces its biggest expenses upfront: designing and devising manufacturing processes.
But the cost after the first products becomes increasingly low once the initial set-up is complete. This prompted SEC to allow companies to average the costs and anticipated profits over the duration of the "program" for a specific jet.
The problem with program accounting is its reliance on projections. Even very smart and very honest managers cannot accurately project or account for everything 20 years from now - which is normal and understandable. But this does not take into account the emergence of huge competitors like COMAC or the sudden emergence of the SEC headline risk.
But the most detrimental effect of program accounting is the potential to wipe out a huge chunk of your investment if the projections are proved to be wrong. This is a potential outcome of the SEC probe on Boeing. A decision that could cause enormous volatility, investor panic and increased uncertainty.
The most optimal outcome is for Boeing to emerge victorious. This can happen because proving that projections were fabricated can be extremely difficult. The discrepancy between actual and forecasted numbers can be explained with a myriad of reasons from historical events. Nonetheless, to avoid all headline risks that can accompany an SEC investigation, Boeing's management might settle with the SEC for any solid allegations raised. A decision that can also drain the company of cash and investor trust.
Needless to day, we envision a build-up of fear and uncertainty regarding the SEC inquiry on Boeing stock price. These headwinds will likely cause Boeing stock price to decline further. It is optimal to watch Boeing stock from the sidelines.
But our bearish sentiments on Boeing are not without risk. For instance, we expect their $14 billion buyback program to add some momentum to the stock. In December, Boeing's Board of Directors increased the company's share repurchase authorization to $14 billion and authorized a dividend hike of another 20%.
We believe this level of cash deployment can aid Boeing to bolster investor confidence as it shows management confidence in the success of its large and diverse backlog. Besides, the stock price has declined a lot in the last two months, meaning that a lot of these negative sentiments might already be priced in.
Moreover, Boeing will see a lot of de-risking emanating from the five-year extension of the US Export-ImportBank. But anything after five years is anyone's guess. Also, we are still seeing a lot of headline risk from the SEC investigation and this might jeopardize any bullish sentiments surrounding the Boeing stock.