Boeing’s Shrinking PE and The Fiscal Cliff

Steve is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The day Boeing (NYSE: BA) announced its third quarter earnings, the share price essentially went nowhere.  The next 9 trading days through November 8 saw Boeing shares shed almost 2.4% of their value, in line with the 2.2% decline in the S&P 500. This price action appears to be driven by fears about the looming fiscal cliff and tighter defense budgets in the wake of the election results.   However, since late January, when the company provided its initial earnings and revenue guidance for 2012, the share price has declined by more than 5%, significantly trailing the S&P which has posted an increase of almost 5% over the same time frame.  This performance divergence is counterintuitive considering that Boeing’s EPS guidance has been raised each quarter since then.

Back in January, the company guided EPS of between $4.05 and $4.25, which is a decline of more than 20% from 2011.  However, median revenue guidance was for growth of about 15%.  Obviously, declining earnings are unfavorable, but the share price did not immediately falter.  Instead, shares remained range bound between about $67 and $77 per share even as the company raised guidance from the initial $4.05-$4.25 range to $4.15-$4.35 after Q1, then to $4.40-$4.60 after Q2, and finally to the current guidance of $4.80-$4.95.  As a result of the rising forward EPS and flat share price, the median forward PE has shrunk from about 18.2x in January to the current 14.6x.

Because I assume one of the drags on Boeing’s shares is potential cuts in military spending, a comparison of the forward PE’s of other suppliers will help to determine if Boeing’s share price weakness is out of line for its industry.  Before delving into Boeing’s competitors in the defense business, note that the defense segment comprises only about 50% of Boeing’s revenue (commercial aviation is the other major segment) so the comparisons are not perfect.  Also note that I have included only two major defense contractors from a larger pool of competitors that could include General Dynamics and Honeywell, among others.  First, Northrop Grumman (NYSE: NOC) has seen its forward PE, based on median guidance, stay flat at about 8.8x to 9.0x even as the share price has increased by about 10%.  Similarly, Lockheed Martin’s (NYSE: LMT) forward PE has incrementally increased to 10.8x from about 10.5x as median EPS guidance has increased by more than 6%.

The significant disparity between the PE of Boeing in the mid to high teens and those of Lockheed Martin and Northrop Grumman in the single digits to low teens highlights the fact that a comparison between the more pure play defense contractors and the mixed business Boeing is not strictly apples to apples. This makes it difficult to identify a definitive reason for Boeing’s PE contraction relative to the other two companies.  However, Boeing’s relative share price weakness and PE contraction in the face of increasing EPS guidance could be a result of either analyst skepticism about Boeing’s guidance (possibly because of the impending defense spending cuts) or other unrelated factors.

As to the first possibility, the current median analyst consensus EPS estimate for 2012 is $5.00 which is above the high end of the company guidance of $4.95. Likewise, consensus estimated median revenue of $81.51 billion is slightly more than the median $81.25 billion guidance but below the high end guidance of $82 billion.  These analysts’ estimates are not indicative of material skepticism of company guidance.  From this I conclude that factors beyond the potential cuts in defense spending may be the source of Boeing’s shrinking PE.

An analysis of recent dividends suggests one possible cause of Boeing’s relative underperformance.  Boeing, Lockheed Martin and Northrop Grumman have all raised their dividend payouts in the past year with Lockheed Martin leading the pack with a 15% raise to $1.15 per quarter for a dividend yield of about 5% and a payout ratio of about 55%.  Northrop Grumman has boosted its quarterly dividend by 10% to $0.55 for a dividend yield of more than 3%.  Its payout ratio is at a safer level of about 30%.  Finally, Boeing raised its dividend only 4.8% to $0.44 quarterly and has a dividend yield of less than 3.5% with its payout ratio between its competitors at about 36%.  A dividend raise of less than a third that of Lockheed Martin and less than half that of Northrop Grumman is possibly discouraging potential buyers and holding back the share price.

A search for other possible causes of Boeing’s shrinking PE would entail a close look at competitors in the commercial aviation business. This may be the topic for a future post but for now, Boeing is, for me, the more appealing of these three defense suppliers to gain exposure to the upside of a fiscal cliff resolution and to limit the downside if we do in fact go over it.

56Steve has no positions in the stocks mentioned above. The Motley Fool owns shares of Lockheed Martin. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.

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