May 12, 2016: Analysts were largely underwhelmed in their take-aways from the Boeing investors day. Their reactions:

Bernstein Research (Outperform)

Buckingham Research (Neutral)

Credit Suisse (Neutral)

Leadership sets strong tone, with clear qualitative objectives, and some metrics: Today’s investor event in Seattle represented Dennis Muilenburg’s first as CEO. Muilenburg used his presentation to outline a “sharpen & accelerate” strategy for Boeing’s future, centered on innovation and growth, performance and productivity, and driven by the best team and talent. In this context, Muilenburg emphasized an opportunity for Boeing to deliver sustained top and bottom line growth over the next decade, and to be an industry leader in cash generation. Similarly, CFO Smith expressed dissatisfaction with current segment margins, and also reminded investors to focus on cash flow. In that vein, cash flow growth should outpace earnings growth as 787 deferred burns down and productivity improvements come through. Cash flow is seen growing Y/Y in 2017 despite the headwind from lower 777 deliveries and flat Y/Y 787 deliveries owing to the introduction of the 787-10. Also today, Boeing said it plans to return 100% of future FCF to shareholders, with buybacks seen continuing at a consistent run-rate. While we see all of the above as positive and sensible, and we are not currently overly worried about a down-cycle (given strong traffic trends and some reversion in oil prices and FX), we think the margin targets (program and cash) are quite challenging, especially with numerous bridge 777s and 737-NGs delivering in the next couple of years, and so we reiterate Neutral and increase our TP to $148 (7.5% FCF yield applied to our 2016 FCF/share estimate) to reflect a slightly higher 2016 FCF/share forecast. We think evidence that the latest initiatives are bearing fruit would afford investors the needed confidence to value the shares on the higher FCF targets toward the end of the 5-year period ending 2020.

Rates: Five future production rates increases, one each on 767 and 787, and three more on 737, drive unit production from ~700 today to around ~900 in 2020. This, along with improved mix and more mature pricing on 787, drive the revenue growth in the five year timeframe.  A greater push into services, at both BCA and BDS, are also part of the growth plan. (Continues inside)

Price: 787 is a big part of the cash flow story, and based on figures introduced today, price and model mix account for ~70% of the planned recovery of $29B in estimated peak deferred for the program. There are two elements. First, model mix continues to swing toward the higher priced 787-9 and 787-10. Second, with 400 of 1,300 units delivered, BA is largely past the lower pricing for launch aircraft, and the penalties resulting from delivery delays that pressured pricing before. We estimate true (discounted) pricing for -9 is ~$125M and -10 is ~$145M, significantly higher than the $80-$110M that early -8s and 9s likely sold for. We are fairly comfortable with upside here, though we note that BA still needs to sell ~245 additional 787s to complete the block, and those prices are therefore assumptions in the curve at this stage. Regarding the rest of the BCA portfolio, management sees neutral pricing in the backlog, though we suspect there is some price pressure on the slow selling 777 classics and 747s. The real wildcard is the 737, where one might expect aggressive pricing was needed to fill the bridge, though Boeing notes upward pressure on rates and solid pricing on MAX has supported overall program price assumptions. .

Cost: With this year’s investor event centered around tours at both Everett (widebody) and Renton (narrowbody), we expected BCA’s focus on greater factory productivity to dominate the narrative. Management did not disappoint. From the first tour, through the evening reception, formal presentations and closing tour, Boeing stressed that it is looking at every inch of both BCA and BDS for efficiencies. CEO Muilenburg characterized the exercise as playing offense, meaning that this is margin-enhancing rather than margin-defending.  Management is specifically looking for double digit margins (company-wide) by next year, with “mid-teens” within five years. To put this into perspective, a mid-teen margin in 2020 would translate to a 74% increase in core EPS versus our current expectation, which assumes core margins remain ~9%. In Boeing’s factories, the efficiencies come from a variety of initiatives, but the key ones are improved flow (to reduce travel time, man-hours and WIP), and automation, which also improves labor time and WIP. And of course, both benefit capacity. Further, Boeing is making no secret about adjusting its make/buy strategy in certain areas, primarily critical path technologies. As a result, it is just completing its new Composite Wing Center on the Everett campus, which will house construction of 777X wings. This is a significant departure from 787, where the composite wings were outsourced (Japan). Boeing views capabilities such as composite structure fabrication and assembly as critical path items and centers of excellence that it wants to control. For all of the issues that plagued 787 during its 3+ year delay, we think Boeing has made a very concerted effort to learn from past missteps and act accordingly and decisively. This brings us to the supply chain, where Boeing has become more aggressive about reopening contracts to improve both terms (pricing) and efficiencies, often in exchange for greater share on future programs. When there is no meeting of the minds, unexpected changes can occur (e.g. Heroux-Devtek winning 777X landing gear). These are the actions behind Partnering for Success, and they are migrating into a newly energized initiative by Boeing to capture more of the lifecycle revenues from its programs by tapping into the aftermarket. Boeing notes that while it has roughly 50% of the installed fleet, it only sees 6% of the aftermarket revenues. It wants to increase its market share in two areas.

• First, it believes it can supply more “high-value” aftermarket parts, especially where it controls more IP. Boeing again characterized some of these opportunities as a “win-win” for itself and its suppliers, though we’re not sure the latter would agree. Still, we think Boeing likely has the upper hand here, as long as it does not overplay it.
• Second, it wants to provide data analytics, especially through subscriptions sold to its airline customers to help manage maintenance activity and save fuel. In order to do this, BA has reconfigured Gold-care, which is no longer simply a “nose-to-tail” maintenance offering, but now allows for customization. Gold-care today covers 60 airlines and 2,200 aircraft.  Boeing has 3,200 aircraft subscribing to some form of its data analytics package. Lastly, one other incremental data point from today is that supply chain step/downs (price agreements) will drive another 25% of the 787 deferred burn-down.

Unexpectedly, internal cost efficiencies are only expected to account for 5% of the 787 deferred recovery, which jibes with the fact that much of the innovation we saw in Seattle was on the 777 and 737 lines where we suspect there is greater opportunity at this point, given all of the past attention to 787.

First MAX delivery moves left; No decision yet on MoM airplane: First delivery of the 737MAX is now targeted for H1 2017 (from Q3). Regarding a middle of the market airplane, Boeing is in the process of gathering data and speaking to customers about what the optimum size, capability and price of the airplane needs to be, but management did note that it is clear this is not a market that can be addressed by an existing aircraft. No commentary regarding an expected timeframe was forthcoming.

Conaccord (Hold)

Goldman Sachs (Sell)

 JP Morgan (Neutral)

Boeing management laid out an ambitious program of cash flow growth based on higher volume, improved efficiency, and higher 787 cash flow at its investor meeting in Seattle yesterday with a commitment to return that cash to shareholders. There were no numerical targets but management envisions FCF moving significantly higher off 2016’s $7.2 bn forecast with annual increases through 2020. Clearly, not all of this is priced into the stock but there is also plenty of risk around the outcome. Some of these risks revolve around execution and what Boeing controls, even though CEO Dennis Muilenburg has clearly stepped up the energy level on efficiency and cost management. Other risks, such as aircraft demand and the competitive landscape, lie outside management’s control and will affect sales, margins, and, importantly, valuation. It will take some time to evaluate whether management’s plans are panning out and we see some of the broader risks holding sway in the near term and so we maintain our Neutral rating.

Wells Fargo (Market Perform)