Boeing is Ready to Take Off

By Ankit Agrawal - September 17, 2012 | Tickers: HXL, PCP, SPR, BA | 0 Comments

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The Boeing Company (NYSE: BA) announced its impressive 2Q results in july with revenue, EBIT margin, and EPS all ahead of the consensus estimates. Year to date sales were up 25% and operating profit was up 23%. Going forward, I believe Boeing's product lines are in demand because of the efficiencies built in. Airlines will want these aircraft more for replacement than the riskier growth strategy in the past because the world carriers are desperate to reduce operating costs, especially in the fuel consumption area. Thus, I expect strong growth in most of these product lines and am optimistic about earnings upside driven by both increases in production of existing and new highly profitable products. As perceived risk on development efforts abates, I think recent valuation improvements will not only be sustained but also expanded.

 Cancellation Impact Overblown

Recently, Qantas announced it was right-sizing its capacity by cancelling 35 of its 50 orders for the 787. Investors should recognize that at the end of July, Boeing had 505 787-8 firm orders and 339 787-9 firm orders for a total of 844 airplanes. And at a delivery rate of about 120 in 2014, it will take years to work through those firm orders. Although I know that any sizable order cancellation is negative for Boeing's stock and a concern for the strength of the commercial aerospace cycle, I believe this one cancellation would not substantially derail any earnings or cash flow estimates for Boeing or the suppliers. The another reason for my optimism is that I believe the issues are related to Qantas's financials and not a reflection of the 787 performance as initial 787 deliveries to carriers have met and exceeded performance metrics.

Though there will be a short-term impact on the stocks given Qantas is an important customer, I believe the impact of this cancellation will be nominal. I also anticipate some short term weakness with supplier stocks such as Hexcel (NYSE: HXL) Spirit AeroSystems (NYSE: SPR) and Precision Castparts (NYSE: PCP).

• Hexcel - In new wide bodied aircraft like the Boeing 787 and the Airbus A350 XWB composites account for over 50% of the airframe.
• Spirit Aero Systems- It supplies Boeing with 737 fuselages and nose-and-cockpit sections for all its widebody jets.
• Precision castparts- The company casting the engine parts, is catching an especially good ride on the Dreamliner.

However, Boeing's total backlog still stands at record levels and execution is still the key. I advise investors to buy Boeing and the stocks of its suppliers as the weakness appears overblown given considerable support of Boeing's record backlog.

Robust Growth Likely in Civil OE

Boeing derives 63% of their sales from civil OE. I believe that demand for its commercial product line is now less dependent on the economic cycle since the new aircrafts have significantly increased operating efficiencies, which the airlines want in order to reduce costs. As a result, backlogs are solid with 6-7 years of production booked and a balanced geographical exposure. I believe that new airplane demand will continue to be supportive with the price of oil in the sweet spot range. Also, the OE cycle is set for robust growth over the next few years as deliveries ramp up for both wide bodies and narrow bodies. Additionally, with the introduction of the 787 and the gradual ramp-up to 10/month, I believe OE will outpace aftermarket growth. Also, I don’t expect a significant pickup in the level of order cancellations or deferrals based on a low-single digit global economic growth assumption. Its peer EADS also derives 70% of its sales from civil OE but I prefer Boeing over EADS due to Boeing's superior profit returns and lesser exposure to Europe.

Boeing is changing the face of commercial aerospace with the 787. I firmly believe that the use of composites as the primary structure on the 787 marks a fundamental shift in the industry. I expect to see continued strength in aircraft deliveries as Boeing continues to increase production rates and 787 deliveries begin. Boeing is also improving its internal execution. Going forward, I believe strong civil production and higher emerging market exposure with improved internal execution will have significant impact on the overall results. Thus, I am bullish on this stock.

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