After Earnings, Is Boeing Stock a Buy, a Sell, or Fairly Valued?

Boeing BA reported earnings on Oct. 25. Here is Morningstar’s take on Boeing’s results and the outlook for its stock.

Key Morningstar Metrics for Boeing

• Fair Value Estimate: $223.00
• Star Rating: 4 Stars
• Economic Moat Rating: Wide
• Uncertainty Rating: High

What We Thought of Boeing’s Earnings

• Boeing’s third-quarter revenue came in slightly higher than Wall Street’s expectations, but a slew of charges brought earnings in below consensus estimates. Boeing took similar charges in the third quarter of last year; they weren’t as huge this time, but it’s disappointing nonetheless. The charges came mostly from the Defense & Space unit, where Boeing has more fixed-price development contracts than other defense contractors, and probably more than was prudent. These were signed under previous management, and include a $4 billion contract for two new 747 conversions to serve as Air Force One. The $2.5 billion in cost overages on the project thus far hit Boeing’s bottom line. The company also had yet another delay in reviving its 737 assembly lines to normal pace because it discovered another incorrect procedure used by Spirit Aero, a big supplier of 737 fuselages.
• Even though these results were disappointing, and we can’t rule out the possibility of more hiccups, our thesis for Boeing is that it has an incredible runway of revenue, profit, and cash flow growth ahead of it, especially once the 737 and 787 assembly lines get back to full speed. The basic thesis is that in the next 20 years, the number of big jet airplanes in service will almost double as global economic growth drives increased demand for travel, particularly in Asia and Africa.
• We still have a High Uncertainty Rating for Boeing’s stock, so it would need to trade at a 40% discount ($133.80) to earn 5 stars. The uncertainty is linked to how volatile the firm’s stock has been, especially with its recurring 737 troubles. That rating may notch down to Medium sometime in 2024 as the 2025-26 timeframe (when management expects its manufacturing operation to return to stability) comes closer into view.

Fair Value Estimate for Boeing Stock

With its 4-star rating, we believe Boeing’s stock is undervalued compared with our long-term fair value estimate.

We value Boeing at $223 per share, which represents 24 times our 2024 free cash flow and 2 times our 2024 sales estimates. We think the enormous special charges and fleet groundings are mostly behind Boeing, and we forecast a couple of years of hard slogging as it clears up supply chain issues that hamper production pacing. Our valuation includes healthy long-term global demand for Boeing’s products, as well as the successful scaling up of deliveries (and eventually margins) on its bread-and-butter 737 and 787 models in the 2026 timeframe.

The COVID-19 crisis shocked the aviation industry and essentially halved global revenue passenger kilometers in 2020. Beyond the pandemic and lingering manufacturing headaches, we expect GDP growth will drive above-GDP RPK growth, especially in emerging markets. We assume a replacement cycle among most airlines will take place, and that the vast majority of fleet growth will be from narrow-body aircraft as an emerging-market middle class demands more short-haul and point-to-point medium-haul travel.

We expect that the mix shift toward the high-margin 737 MAX and eventual returns to learning-curve-based cost efficiencies should help the company improve margins. We expect Boeing to return to 2018 levels of 737 MAX production by 2025. We’re anticipating the firm to produce around 68 737 MAX a month in 2031 versus about 48 per month in 2018.

We expect that volume increases in the high-margin 737 MAX will bring Boeing commercial’s operating margin to the mid-teens. Overall, we expect the operating margin to improve to about 13% at midcycle versus 12% in 2018. These forecasts include aggressive research and development spending on the development of a brand-new airframe design within our forecast period, though it won’t fly until the 2030s.

Read more about Boeing’s fair value estimate.

Economic Moat Rating

We think Boeing merits a wide moat rating because it benefits from durable intangible assets and switching costs. Although we think the firm has taken some competitive hits in the commercial aerospace duopoly with Airbus, the commercial airplane market is large enough and so difficult to break into that it supports two wide-moat aircraft manufacturers.

We believe Boeing’s defense business is more exposed to operational risk than its peers due to its higher exposure to fixed-price contracts. Still, we think the firm is turning a corner operationally and benefits from intangible assets stemming from the technical complexity of its products. There are also switching costs from the time and effort the military faces to switch suppliers, as well as a lack of viable alternative suppliers.

In our view, Boeing Global Services has intangible assets from proprietary access to aftermarket part designs, as the Federal Aviation Administration and other regulators require that spare parts be identical to the original design. It also benefits from switching costs stemming from a lack of alternative suppliers for such parts.

In the commercial aircraft manufacturing segment, we believe the technical complexity of aircraft manufacturing and the extensive regulatory barriers to entering the market constitute wide-moat-caliber intangible assets. Both Boeing and Airbus benefit from these barriers to entry, and it means they operate in a duopoly in the global large-frame jet aircraft market. We expect virtually all global revenue associated with air travel growth will continue to flow through the two incumbent manufacturers’ top lines. What’s more, we believe that airline demand for their products will remain high enough for long enough for both firms to generate economic profits for decades.

Further, we see the lack of alternative aircraft suppliers, the criticality of their products to customers, and very long product cycles as powerful switching costs. These three factors usually reinforce each other to allow long-term economic profits to persist at both Boeing and Airbus. At present, Boeing has a superior product in the wide-body or long-haul category, while Airbus is enjoying the advantage at the long-range end of the narrow-body.

Read more about Boeing’s moat rating.

Risk and Uncertainty

We think Boeing’s biggest risks are macro risks that limit demand and operational risks that constrain supply, both of which the company has weathered over the last three years. We think Boeing deserves a High Uncertainty Rating, but note it is still working through much higher supply risks than Airbus as it revives production and deliveries for 737 MAX and 787.

On the demand side, the pandemic dramatically reduced air travel and aircraft deliveries. Trade group IATA reported that passenger demand declined by nearly two-thirds in 2020. While we anticipate travel to return to previous levels eventually, its recovery is likely to be patchy and may face renewed disruption. The future of business travel is also somewhat more uncertain than that of leisure travel. Because high-yielding business travelers are some of the most profitable customers for airlines, any lack of a resurgence in business travel may dampen new aircraft demand.

China is a major aviation market, and notwithstanding the recertification of the 737 MAX in the country and resumed deliveries of new planes in due course, we suspect it may be easier (if not simply more expedient) for local airlines to substitute future marginal orders of 737s for Comac C919s while maintaining or growing their share of orders for Airbus narrow-bodies.

Read more about Boeing’s risk and uncertainty.

BA Bulls Say

• Boeing has a large backlog that covers several years of production for the most popular aircraft, which gives us confidence in aggregate demand for aerospace products.
• Boeing is well-positioned to benefit from growth in emerging markets in KPM and a robust replacement cycle in developed markets over the next two decades.
• We expect commercial airframe manufacturing will remain a duopoly for most of the world for the foreseeable future. We think customers will not have any meaningful options other than continuing to rely on incumbent aircraft suppliers.

BA Bears Say

• We see substantial operational risk in Boeing’s plans to simultaneously ramp production of the 737 MAX and sell those aircraft in storage as the aviation crisis and supply chain issues unwind.
• In the long term, changed consumer behavior (especially among business travelers) could be unfavorable for aviation.
• As recent history has proved, aircraft development is notoriously susceptible to development delays, hiccups, and cost overruns.