Shares of the aerospace giant Boeing (BA) popped 2.5% today after a favorable feature story in Barron’s over the weekend said the stock could rise as much as 20%. Also a report of a large order of 737s from European discount airline Ryanair probably contributed to the jump today. The Barron’s story confirmed our outlook from a few weeks ago (“Boeing’s Airplane Business is Skyrocketing“). The stock is a core industrial holding for O’Brien Greene.
Barron’s writes that Boeing benefits from its strong position in the large airplane business duopoly that it shares with its European counterpart Airbus. After rising 80% last year, shares of Boeing’s stock have fallen 8% this year, while the S&P 500 is up about 9%. Both the long-term and short-term picture look good according to Barron’s, and the recent pullback is a good buying opportunity:
Sellers may see surging plane deliveries as a signal that Boeing, whose earnings per share have quadrupled since the end of the last recession, is nearing a classic cycle peak. But growing demand for flights, especially in emerging markets, combined with fuel-efficiency gains and cheap financing, should keep earnings moving steadily higher—and free cash flow soaring. A massive order backlog reduces risk. Look for the shares (ticker: BA), recently around $125, to climb 20% over the next year to $150. And dividends provide a 2.3% yield.
We agree with Barron’s optimistic take on Boeing. One question that the article failed to address though is the weakness in Boeing’s defense division. The U.S. Department of Defense has cut spending drastically in the last year. The Pentagon expects to slash spending by $31 billion in 2014 and then $45 billion in 2015, shrinking the army to pre-World War II levels. Boeing is the second largest defense contractor in the world, with about 25% of revenue or $22 billion coming from the Department of Defense in 2013.
While U.S. spending cuts may be a serious headwind for Boeing in coming years, there are several reasons why they won’t be devastating. First of all, with so much turmoil around the world, there might be increased appetite for defense spending once again in the near future. Even if that doesn’t happen, though, military spending from foreign governments could pick up some of the slack. The company recently secured a $2.5 billion dollar deal with India for military helicopters in addition to another deal with Saudi Arabia for $247 million of helicopters. Also, Boeing has already prepared for large-scale spending cuts with cost cuts of its own. The company has already cut $2 billion with plans for another $4 billion.
One of the most encouraging things about Boeing right now is the valuation. Barron’s writes: “Boeing shares look plenty affordable at 14.8 times projected earnings for the next four quarters, a 8% discount to where they have traded over the past 15 years, and a 6% discount to the S&P 500, versus a 4% premium, historically.” Despite the trouble in the defense division, Boeing’s booming airplane business and reasonable valuation make it highly attractive. In addition to its appreciation potential, moreover, the stock sports a solid 2.3% dividend yield.