Dec. 13, 2016: Boeing yesterday announced another production rate cut for the 777 Classic, effective next August.
The rate goes to 5/mo. Because of the transition to the 777X, the actual delivery rate will be 3.5/mo.
Leeham Co. was the first in March 2014 to identify a major production gap and predict rates would have to come down significantly from the then-current 8.3/mo. Aerospace analysts on Wall Street began recognizing the gap shortly after.
Boeing stuck to its guns for nearly two years that it could maintain rates through the transition to the 777X. Officials finally acknowledged demand wasn’t going to match production. Officials announced a rate cut to 7/mo. Analysts didn’t believe this was enough. Yesterday, Boeing agreed.
Simultaneous with the announcement to lower the production rate at the cost of an unspecified number of jobs, Boeing increased its dividend well beyond Wall Street expectations. Accordingly, the stock rose in after-hours trading by $2.34 (1.49%).
Initial analyst reaction from three notes LNC received was generally positive, save for Goldman Sachs.
At what we assume are now the 777 delivery plans for 2017-2020, there are still approximately 70 open delivery positions for the 777. If Iran deliveries actually occur (political and financing risk remains), there will still be several open spots. Versus our model, which takes the 777 to 2/month in 2019, there are still 34 open positions in that time frame (including only 9 firm aircraft sold for 2019). We continue to see downside to consensus EPS and cash expectations from 777 rate, price and margin.
The $1.42 quarterly dividend creates a 3.6% yield. Taking the buyback authority back to $14bn implies a plan to sustain the current repurchase pace. However, BA is now slated to payout 180% of our 2017E net income estimate to dividend + buyback; which is not sustainable without increasing net leverage eventually. We remain concerned with new aircraft supply/demand; and while that can of course be debated, production is at an all time high (both absolute and % of fleet), in what has historically consistently been a cyclical industry. We therefore see risk in this planned use of capital, see downside to medium-term buyback expectations and note buyback historically has been pulled at cycle turns.
A large dividend hike was a possibility. Our expectation was for an increase of ~30%, above the market at 15-20%, with the potential range being anywhere from 20-50%. Our view was driven by a change in tone at the management level where the CEO recently noted there is “significant value” associated with the dividend and that the Board would take a “hard look” at its policy. Accordingly, we believed the 30% increase better demonstrates confidence in the cash flow story and to an extent addresses investor concerns over its growth, sustainability, and accounting, which is why shares are trading at a considerable discount on a FCF basis (where on 2018 consensus BA trades at ~10x while peers are at ~14x). The new quarterly dividend of $1.42/share now represents a yield of ~3.6% vs. prior of ~2.8% and a S&P 500 median of ~1.8%. We believe shares have the potential to re-rate higher and possibly trade at more comparable levels to peers on a FCF basis and in the $175-200 per share range (or ~25% above current levels). Thus, we raise our PT to $185 (from $155) premised upon a ~13x 2018E P/FCF.
Boeing announced: (1) it will cut 777 production to 5/mo from 7/mo in August 2017; (2) a 30% dividend increase; and (3) a new $14B share buyback authorization that replaces the prior program – i.e., $7B of authorization was added. Overall, we think the positive of the dividend increase will more than offset the negative of the 777 rate cut as the effective yield now approaches 3.6%. Based on lower 777 production, we reduced 2017E EPS to $9.30 from $9.45 and 2018E EPS to $10.00 from $10.65. Our valuation range is unchanged at $155-$160 based on 14x 2016E FCF/share.