This Metric Could Fuel 30% Upside For An Industry Giant

David Sterman's picture

Friday, October 10, 2014 - 1:30pm

by David Sterman

While investors gauge the pulse of the market on a daily or weekly basis, and most companies weigh in on a quarterly basis, the executives at The Boeing Co. (NYSE: BA) think in terms of decades.

Decisions they made a long time ago impact results now, and their current moves will impact shareholders well into the next decade. For these executives, the goal is quite simple: Invest massive sums in new designs and reap the rewards down the road.

Back in October 2012, when I suggested Boeing as a top rebound candidate for coming years, I took note of a looming surge in free cash flow that could be sustained for many years to come.

Since my last look at the company, Boeing became a free cash flow machine. For the three-year period that ends in December, Boeing is on track to rack up a cumulative $18 billion in free cash flow. That has helped set the stage for 10% annual dividend increases over the past few years and, by the looks of things, there’s plenty more where that came from. Because Boeing is making planes as fast it can (and at full list prices), and thanks to a series of recent upgrades to popular models, its factories will be running at full bore for the foreseeable future.

The one number that you need to know about: Consensus forecasts project that Boeing will generate nearly $10 billion in free cash flow by 2016, and stay near that level until the end of the decade.

As fans of our Total Yield newsletter know, that kind of financial strength can lead a growing stream of shareholder perks. The rising dividend is being paired with a $10 billion share buyback program, which was initiated at the end of 2013. Boeing is also delivering Total Yield via the balance sheet. Long-term debt is on track to fall to $4 billion by 2016 from $9 billion in 2012, according to analysts at Merrill Lynch. That level of debt is likely optimal, setting the stage for much larger dividend hikes -- and even more share buybacks in subsequent years.

A bit of turbulence
The rosy long-term outlook hasn’t helped Boeing in the near-term, as shares have drifted roughly $20 from its 52-week high. Analysts expressed concerns that Boeing and its rival Airbus may see a slowdown in orders as the global economy cools.

Here’s the problem with such concerns. The two aircraft makers actually can’t build planes fast enough. “With a total combined backlog of roughly 8,700 units, both Boeing and Airbus appear to be feeling the heat from customers to increase production beyond the projected build rates,” note analysts at D.A. Davidson.

In recent years, Boeing has been building an average of 42 planes a month, though capacity expansions will boost that figure to 47 by next year. Davidson’s analysts think that Boeing will need to boost capacity to around 52 per month by the end of the decade. Boeing’s current commercial plane backlog stands at $400 billion, up from $319 billion at the end of 2012.

Executives at Boeing must be wondering why Wall Street is even thinking about a looming slowdown. Back in July, they boosted their long-term industry outlook thanks in large part to an expected surge in Asian passenger fleet expansions.

Boeing also predicts that global air cargo will double over the next 20 years, which will help keep the factories running at full bore for quite a while. Boeing’s current commercial backlog of orders would keep its factories working non-stop until 2019. Unless you assume that Boeing stops receiving new orders, then it’s reasonable to expect the order book for 2020 and 2021 to start filling up soon.

Flattening defense
To be sure, Boeing’s military sales appear to have peaked. They slumped 5% in the second quarter, from a year ago, key legacy programs such as the C-17, F-15 and F-18 are approaching the end of their life cycle, and it’s unclear how this division will fare in coming years. “There are currently many active international fighter jet competitions,” note analysts at Merrill Lynch. “However, we recognize that international fighter jet contract awards are notorious for their unpredictability.” Notably, a retrenchment in this niche should have no impact on free cash flow, as the development costs for those planes have already been expensed.

By the time the current cycle ends, Boeing will likely have generated more than $10 billion in annual free cash for several years. Equally important, such a level of free cash flow stands in contrast to the company’s $90 billion market value, which will be steadily reduced as the $10 billion buyback program shrinks the share count in coming quarters. The company’s Steady Eddie business model suggests a price-to-free cash flow multiple of around 8.0 (which using inverse math creates a free cash flow target yield of 12.5%. That means that shares have more than 30% upside from current levels.

Risks to Consider: Terrorism, along with a potential spike in oil prices, have historically been the key factors behind a slump in air travel and aircraft demand.  It’s hard to forecast such events, but if they occur, shares of Boeing could be priced for an industry slump.

Action to Take --> Investors crave predictability in a company’s financial results, and with a backlog that extends more than five years, Boeing surely delivers. Shares drifted out of favor on concerns about the global economy, which may indeed have an impact on a number of U.S. blue chips in 2015. But Boeing’s business model should sideswipe such near-term concerns, making this the true buy-and-hold stock. A compelling Total Yield score and solid potential upside are the key traits that you need to know about Boeing.

Like I mentioned earlier, Boeing’s phenomenal free cash flow makes it a perfect candidate for StreetAuthority’s Total Yield newsletter. Using the Total Yield strategy, we found companies that have returned 15% a year on average since 1982. Last year, this elite group of stocks more than doubled the S&P 500. For more information on the Total Yield strategy, click here.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.