Bernstein Research (Outperform)
|Boeing held its investor conference this week, including tours of Everett and Renton facilities. Overall, we viewed the event as positive, with management emphasizing strong free cash flow growth through the decade, with potential for margin expansion.
Consistent with our analysis, the 737 and 787 are described as sold out through 2019, with a decline in 777 deliveries in 2018. The 787 should serve as the key driver of rising free cash flows, along with lower capex. Margins should be aided by flat R&D.
Cost reduction is key to Boeing’s margin goals, which should be helped by a large backlog with prices set. We are more positive on services at this stage, which is a key focus. Defense is now expected to see modest growth. We rate BA Outperform, TP $184.
Buckingham Research (Neutral)
|At its investor day, BA lowered widebody production due to the impact of introducing new models into current production lines. In 2017, introducing the 787-10 into the 787 production line drives flat 787 deliveries yoy (135 deliveries in 2016) versus expectations of ~144 (based on a 12/month production rate achieved in 2016). In 2018 and 2019, introducing the 777-X into the 777 production line reduces 777 Classic output to 5.5/mo from 7/mo in 2017 and 8.3/mo currently. Similar to previous production programs, the introduction of both the 787-10 and 777-X will incorporate two blank positions associated with each airplane under assembly in order to give the extra time needed to work on the initial low rate production aircraft. The blank positions also have the impact of reducing actual output, but not the production rate.
BA expects to recover the entire ~$29B in 787 deferred production. BA expects the 787 cash flow recovery to be driven by a better mix of 787-9s/10s (70%), supplier price step downs (25%) and internal productivity (5%). The current 787 mix is 2/3 787-9s and 1/3 787-8s and is expected to improve as BA winds down the remaining 135 787-8s in backlog. A key issue is how BA can achieve the gross margin of >35% implied by the $8.8B in deferred production expected to be recovered on future orders needed to fill out the 1,300 unit block (161 aircraft). In a highly competitive pricing environment, it’s difficult for us to see how BA can achieve a >35% gross margin.
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.
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.
|Boeing (BA) hosted its 2016 investor day in Seattle. The tone regarding the margin opportunity, cash flows, and BA’s competitive position were all generally bullish. Management provided some incremental details on the 787 and increased its commitment on capital return to shareholders. However, we do not believe management did enough to lower cycle fears and the potential impact from softening demand. We believe BA is executing about as well as it can and is pulling the appropriate levers, but concerns about the cycle, and the potential impact on cash flows, will limit upside on the stock, in our view. We are incrementally more impressed with the goals and focus, but remain concerned about the competitive environment, and potential risks to the demand for aircraft. As such, we are maintaining our HOLD rating and our $140 price target.
The company was confident on the near- and long-term margin upside across the business. Specifically, the company guided to double digit margins in 2016, and then set mid-teens as a ~2020 goal for each business segment. The margin improvement in BDS will come from continued cost cutting, and potentially some mix benefit as services see faster growth in what is likely a basically flat top-line environment for BDS. For BCA, the important levers are execution (backlog and new model transitions), automation, cost reductions, and supply chain cost reductions. We believe the impact on price is more than BA has acknowledged, but we could be surprised by BA’s margin success as it attacks its cost structure with increased focus. Services will also be a positive mix.
Management highlighted its increased confidence in the FCF outlook, and has now committed to returning 100% of FCF to investors through buybacks and dividends. BA has $10.5B remaining on its authorization, and we expect will remain aggressive with its buyback. Management expects FCF to grow faster than EPS. As a result of this commitment, we believe BA has limited its ability to address potential new opportunities, such as in the middle-of-the-market, as lower R&D and development spending is important for the FCF story.
Boeing also provided new details on its 787 deferred cost recovery. Management indicated that it sees the $29B deferred recovery driven by mix shift and pricing in the block (70%), supply chain pricing step downs (25%) and internal productivity (5%). This seems reasonable, as we believe BA has good visibility on pricing and mix, the key drivers. However, this all hinges on the cost and learning curve assumptions, which are difficult to get confident with considering we hear 787 lease rates are under pressure, and there are slots opening up, which can impact timing of future deliveries.
We are maintaining our HOLD rating and our $140 price target. While the tone from management was confident, and the company did provide incremental detail to support its bullish outlook, we continue to see risk to the commercial cycle, and believe concerns will for now limit upside in the stock.
Goldman Sachs (Sell)
|Stealth 777 rate cut: BA says in 2019 and part of 2018 it will produce at 7/month but deliver 5.5/month as it fires blanks ahead of the 777X. BA had previously said it would fire selective blanks but it would not be a high volume number. We read this as a change that potentially reflects an inability to fill the 777 bridge. We also continue to believe BA will cut the base production rate lower than 7/month, and deliver less than 5/month, in 2019.
Margin and cash flow targets: BA has committed to a 10% BCA margin and cash flow growth in 2017. Cost reduction is a large driver and was a focus at the event. But BA also stated there are risks to achieving these targets. We think these targets will be very difficult to achieve when we consider 777 volume and price, 737 price, R&D, advances and the pace of 787 deferred unwind. We think BA could miss the targets, and we continue to see downward pressure on margin and cash over the next several years.
Product strategy: BA said it continues to evaluate potential new products in narrowbody given the competitive position. We think Airbus is in a better position in the narrowbody market, and BA may need to act. This would likely impede the cash flow case given the development cost.
Cash deployment: BA is now committed to deploying 100% of free cash via buybacks and dividends. However, we think there will be less cash than expected to deploy, and BA historically has bought back primarily at peak.
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)
|Effective 777 Cut In 2018-19. The transition from the 777 to the 777X (service entry: 2020) will reduce the monthly delivery rate of revenue-generating 777s (i.e., excluding test articles and “blanks” needed to pace the transition) to 5.5 from 7.0. On an annualized basis this implies a temporary cut of 18 777s, or perhaps $2.5B of revenue, $0.50 of EPS and $400-$500M in free cash. Separately, Boeing still expects to fill the 777-to-777X production bridge, with customers interested from China and the Middle East. Used aircraft ability and existing lease extensions were cited as headwinds to new orders.
Margin “Aspirations”. Boeing reiterated its aspirational goal of a mid-teens consolidated segment margin in the “mid-teens” (2016E: mid-9%) driven by a variety of factors including: (1) an improving BCA mix (e.g., shift from 787-8 to 787-9/10); (2) supply chain, including “Partnering for Success” (i.e., better pricing); (3) factory automation; and (4) a focus on growing the (higher-margin) services business. Consensus Bloomberg estimates for 2020 imply something closer to an 11% operating margin, but reflect the expected double-digit in 2017.
All FCF to Shareholders. Boeing said its plan is to redeploy about 100% of its free cash flow on dividends and share buybacks. These percentages were 122% in 2014, 133% in 2015, and 126% in 2016E, so the plan is in line with recent actions.
787 Deferred Details. The company is confident in recovering the 787’s $29B deferred production balance, which falls into three categories: (1) 70% is from a favorable mix shift to more -9s/-10s and improved pricing on the 900 aircraft remaining in the accounting block; (2) 25% from (mostly) already contracted supplier step-downs as production volumes increase; and (3) 5% from internal productivity (i.e., learning curve). Still, we believe the effects of lower price escalation (i.e., inflation adjustments) on gross pricing remains a risk.