Image Source: Robert Sullivan
Commercial aerospace giant Boeing continues to ride a wave of strong demand as its massive backlog continues to grow, but a write down related to the troubled KC-46 tanker appears to have investors thinking twice about its near-term margin performance.
By Kris Rosemann
Shares of former simulated Dividend Growth Newsletter portfolio idea Boeing (BA) faced a bit of selling pressure in the July 25 trading session following its second quarter earnings release as a write down related to additional costs in the troubled KC-46 tanker program helped caused a margin guidance reduction in its ‘Defense, Space & Security’ segment. Delivery of the first aircraft in the program is expected in October 2018, more than two years behind schedule.
Strong performance in Boeing’s ‘Commercial Airplanes’ segment, ongoing growth in its increasingly important ‘Global Services’ segment, and volume growth in its defense business gave management the confidence to raise its revenue guidance and ‘Commercial Airplanes’ segment margin, but a reduction in its ‘Defense, Space & Security’ segment margin guidance and that its earnings per share guidance remained unchanged may have investors taking a long look at its margin performance.
In the second quarter of 2018, Boeing’s top-line grew 5% on a year-over-year basis to $24.3 billion, and GAAP earnings from operations advanced 7% from the year-ago period thanks to 20 basis points of margin expansion as strength in its ‘Commercial Airplanes’ segment (~60% of second quarter revenue) more than offset weakness in its other two segments. Core earnings per share leapt to $3.33 in the period from $2.49 in the comparable quarter of 2017. The company’s backlog sat at $488 billion at the end of the quarter, up from $474 billion at the beginning of 2018.
Free cash flow took a step back to $4.3 billion in the quarter from $4.5 billion a year earlier as operating cash flow fell 5% to $4.7 billion. First half 2018 numbers still reveal growth in both metrics over the same period in 2017, and the quarterly free cash flow figure easily covered cash dividends paid of $1 billion in the period, which reflects a 20% dividend hike compared to the second quarter 2017 dividend payment. Boeing’s balance sheet remains healthy as it held $12.1 billion in total debt at the quarter’s end ($2.5 billion of which is attributable to Boeing Capital) and $9.8 billion in cash and marketable securities. The company’s Dividend Cushion ratio is a strong 2.5, and shares yield ~2% as of this writing.
Following the quarter, Boeing raised its full-year 2018 revenue guidance range by $1 billion to $97-$99 billion, but earnings per share and operating cash flow guidance remained unchanged. 2018 core earnings per share guidance sits in a range of $14.30-$14.50, while operating cash flow is expected to be $15-$15.5 billion in the year. The company raised its 2018 operating margin guidance in its ‘Commercial Airplane’ segment from ~11.5% to 11.5%+, but many investors appear to be hung up on the reduction in ‘Defense, Space & Security’ operating margin guidance to 10%-10.5% from ~11% despite revenue guidance for the segment being raised by $0.5 billion to $22-$23 billion. ‘Global Services’ segment guidance was unchanged.
Commercial aerospace remains a long-term growth industry, in the eyes of management, and investors can expect Boeing to continue participating in this growth. The company’s huge backlog is more than ten times the midpoint of its 2018 revenue guidance, and additional growth potential exists in the massive aerospace services space. However, margin performance may be worth keeping an eye on, especially as trade tensions escalate. Protectionist trade policies are likely to impact large multinational industrial companies the most, and Boeing’s apparently self-inflicted missteps related to the KC-46 tanker program have done little to inspire investor confidence at a time when showcasing strong margin performance may be of the utmost importance in the face of geopolitical uncertainty.
We’re not changing our position on Boeing at this time and have no plans to add the firm back to our ideas highlighted in the simulated Dividend Growth Newsletter portfolio. Despite near-term margin concerns and potentially increasing restrictive trade policies on the horizon, the long-term story at Boeing remains intact. The company continues to pay a healthy dividend, as evidenced by its solid Dividend Cushion ratio, but shares are currently trading well above our fair value estimate of $303 per share.
Aerospace & Defense – Prime: BA, FLIR, GD, LLL, LMT, NOC, RTN
Aerospace Suppliers: AIR, AL, ATRO, COL, HEI, HXL, SPR, TDY, TXT
Related: ITA, XAR, PPA, DFEN, EADSY, ERJ
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Kris Rosemann does not own shares in any of the securities mentioned above. Some of the companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.