Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
The "upgrade" we're going to discuss today isn't really an upgrade per se. But after watching Boeing's (NYSE: BA) stock tumble 12% in 10 days, today's note out of investment banker Berenberg reiterating its buy rating sure feels like an upgrade.
Here's what you need to know.
Boeing's MAX 8 isn't flying now, but eventually, it has to return to the sky. Image source: Getty Images.
What's happening with Boeing right now
Rather, Boeing's troubles began with the crash of a different 737 MAX 8 airliner, Lion Air Flight 610, on Oct. 29, 2018. It's the fact that two different 737 MAX 8 airplanes, operated by two different airlines on different sides of the globe, crashed in a manner that looks similar, that has investors looking askance at Boeing stock. It's also the reason air traffic regulators around the world have grounded this upgraded version of Boeing's best-selling airplane until someone figures out what went wrong.
Speculation is centering on a software program called the Maneuvering Characteristics Augmentation System (MCAS) that Boeing built into the upgraded 737 MAX 8. Among other functions, MCAS automatically tilts the plane's nose down when it senses the plane is about to stall (to ensure the plane doesn't stall). This is a useful function, in theory. Still, the consensus seems to be that the Lion Air Flight 610 crash was caused by some combination of defective sensors (which mistakenly told the MCAS the flight was stalling), deficient pilot training and/or airplane maintenance, and the difficulty of overriding MCAS when it makes a mistake. And this could be what happened in the Ethiopian Airlines Flight 302 crash as well.
Whatever the cause, the effect of two seemingly similar crashes occurring in the space of less than six months has been global plane groundings, an FAA-mandated change to the MCAS software, and an investigation by the U.S. Department of Transportation into how Boeing got the 737 MAX 8 certified in the first place.
After the loss of 346 souls aboard Boeing airplanes in less than six months, this all seems prudent.
No alternative to Boeing
But is it a reason to sell Boeing stock? In today's note, reported on CNBC, investment banker Berenberg argues investors should not in fact sell Boeing, because global airlines have "no meaningful alternative" to continuing to buy Boeing's 737 MAX.
The 737 MAX "is Boeing's most important programme," explains Berenberg. The 737 MAX generates 33% of revenue in the company's commercial airplanes segment, which in turn accounts for 60% of its annual sales, according to data from S&P Global Market Intelligence. And the plane accounts for 50% of Boeing's profits in this flagship division.
But the 737 MAX is important not just to Boeing, but to the airlines that fly it as well. For one thing, airlines have already sunk billions into buying hundreds of 737 MAX airplanes -- billions that are currently generating no return on investment as the planes sit grounded. And long term, these airlines need to spend billions of dollars more buying more single-aisle planes like the 737 in order to replace their aging and fuel-inefficient fleets.
Unless Boeing builds 737 MAXes to fill this need, there won't be enough capacity to satisfy demand for new planes.
A problem with production
Consider: Even after ramping production and producing 737 MAXes full tilt, Boeing still has unfilled orders of 4,600 737 MAXes in backlog. Rival Airbus' competing A320neo family of single-aisle aircraft has a backlog of 5,800 planes -- and it will take Airbus eight years to fill its own orders alone. Combined, that's more than 10,000 planes' worth of demand to be filled worldwide, and Airbus can't be expected to fill that demand on its own.
Berenberg says it's "unrealistic" for buyers to reject Boeing's plane "outright" and switch their orders to Airbus. Demand for this size and type of aircraft is so big that it makes Boeing "too big to fail."
The upshot for investors
So what is the solution, if not simply to stop building and flying (and buying) 737 MAX 8 aircraft? Not to put too fine a point on it, but the solution is to figure out -- definitively -- what is causing the crashes, and fix the problem.
Fortunately, Boeing has its software patch ready to go into effect early next week. It's at least possible that this patch will solve the problem, but if it doesn't, you have to imagine that the company will eventually figure out another fix, even if it's forced to go back to square one and excise the MCAS software entirely. The intractability of the production problem, and the inevitability of a fix, are therefore why Berenberg -- in contrast to the three analysts who have downgraded Boeing stock since the disaster in Ethiopia -- is sticking with its buy rating on the stock, and why I still like Boeing as well.
At 15.5 times trailing free cash flow, with modest debt, a 2.2% dividend yield, and a 12% projected growth rate, Boeing stock is still a long-term buy.
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