Boeing (NYSE: BA) CEO Dennis Muilenburg recently argued that the aerospace giant was becoming a less cyclical company. In other words, its revenue and earnings are likely to show less volatility in the future. This usually means the market will reward Boeing with a higher valuation than it has in the past. In turn, this could lead to a substantial rise in the share price.
I think Muilenburg is right, and the actions management is taking are likely to positively change the investment proposition for the stock in the long term. Here are five ways Boeing stock is becoming more attractive.
A Boeing 777 in flight. Image source: Getty Images.
Airline profitability has improved
As you can see below, there's been a dramatic improvement in worldwide airline profits in the years following the 2008–2009 recession, and this bodes well for airplane orders. The reason is subject to debate, but it's indisputable that airlines are doing a better job with managing passenger load factors (ratio of passenger-kilometers traveled to seats available).
Data source: International Air Transport Association.
Indeed, load factors and airline profits are significantly above the previous peak before the recession, and if this speaks to long-term trends, then airline profits are likely to hold up during the next slowdown -- good news for the aerospace industry.
Boeing's services growth
Muilenburg sees Boeing Global Services (BGS) as being its strongest growth opportunity in the coming years. That's good news for investors, because services revenue tends to be less cyclical than aircraft sales -- airlines cancel orders in a slowdown, but they can't avoid servicing aircraft.
Moreover, as you can see below, BGS is growing at a double-digit pace compared to an industry services market that Muilenburg sees as growing at a 3.5% annual rate in the long term.
Defense, space, and security
Data source: The Boeing Company presentations.
As Boeing grows its services revenue, you can expect its earnings to be less cyclical.
Wide-body replacement cycle
If a slowdown does indeed occur in the commercial aviation industry, it's likely to be felt in the narrow-body market. Boeing and Airbus have seen surging orders in the last few years and now have multiyear backlogs.
That said, Muilenburg believes there is likely to be a significant pickup in wide-body aircraft demand led by the need to replace aging fleets. As such, Boeing's new 777X aircraft and its existing 787 Dreamliner are well placed to benefit. If Muilenburg is right, then any slowdown in the commercial aviation industry for narrow-body craft will be supported by some underlying improvement in wide-body orders.
Muscling in on aircraft suppliers markets
It's no secret that Boeing is trying to increase its own manufacturing of components on aircraft. This is particularly interesting in a slowdown because it means Boeing can grow revenue by improving its own content per plane even if airplane sales aren't growing at all.
Muilenburg's address at the recent Morgan Stanley Laguna Conference discussed the possibility of moving into markets as diverse as avionics, mechanically actuated systems, interiors, and auxiliary power units (APU).
In fact, Boeing already has a deal in place with France's Safran to develop APUs and earlier this year bought aerospace parts company KLX for $3.2 billion. Moreover, given the potential for supply constraints as Boeing ramps up production on the 737, it wouldn't be surprising to see Boeing make aggressive moves toward making more equipment for its own aircraft.
Increasing earnings and cash flow margin
Muilenburg also believes that the company is on track to hit its target of 15% operating income margin by 2020. As you can see below, this would mark significant improvement, and if it's due to structural factors, investors can expect higher long-term margin in the future -- even in the event of a slowdown.
The good news is that Boeing has plenty of opportunities to carry on increasing margin. As noted above, increasing the amount of its own content on aircraft would help improve profitability. In addition, Boeing continues to pressure suppliers for price cuts through its Partnering for Success (PFS) initiatives, whereby suppliers benefit from a volume of work in the long-term in return for price cuts for Boeing.
Another big opportunity for cost-cutting comes from the increasing use of automation and digitization in Boeing's production. The manufacturing sector is seen as being a big winner from the Internet of Things (IoT) revolution, and just as aircraft engine manufacturers have a big opportunity to cut unit production costs by using IoT, so Boeing has a chance to increase productivity -- particularly important as it ramps up aircraft production.
In fact, Muilenburg described improving productivity through digitization as one of the key levers to generating margin expansion in the future during a recent investor presentation.
The takeaway for Boeing investors
All told, Boeing shouldn't be seen as a company merely enjoying a cyclical upswing in its end markets. It's doing that for sure, but management is positioning the company for long-term margin expansion while reducing the cyclicality of its earnings. There's a lot to like about Boeing in the coming years.
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