Boeing Co (BA) is a pretty shareholder friendly company. With Boeing stock yielding a generous 3.4% dividend, and the company having bought back a sizable chunk of its own shares over the last three years, it’s not hard to see why many investors love BA stock.
Over the last three years, Boeing has lowered its share count by an impressive 15% by spending $19 billion on share buybacks.
But Boeing recently pushed its buyback initiative into overdrive after repurchasing 26.8 million shares worth $3.5 billion during the first quarter alone. All of which works out to staggering $14 billion annualized.
Buybacks on such a large scale have a big effect on a Boeing stock, not only by substantially improving the dividend yield, but also by expanding the bottom line through earnings-per-share growth.
However, Boeing’s spending spree has caught the eye of Wall Street, with some analysts beginning to fret that the company could be borrowing from its future.
Notably, RBC Capital analyst Robert Stallard has expressed his worries that Boeing’s cash flow growth could be close to hitting a plateau due to the intended production cuts on its highly profitable 777s and the copious amounts of money that the company has been pumping into its 787 Dreamliner project. The analyst believes that it would be more prudent for Boeing to slam the brakes on its buyback spree and instead focus more on preserving cash.
Not everybody shares Stallard’s views though. Other analysts on the Street assert that without any new projects, such as development of a new airplane model or a big acquisition on the horizon, returning cash to shareholders serves Boeing better and helps the company to maintain an efficient balance sheet.
Boeing: Using Excess Cash Wisely
Any public company that has excess cash on its hands and needs to put it to good use is typically faced with three choices: pay down debt, invest in growth via either new company projects or mergers and acquisitions and/or buy back shares.
The question of which choice makes the best economic sense is largely a matter of what yields the best return on investment. Paying down debt is usually a good choice because it helps lower the long-term risk that a company might find itself burdened with a heavy interest expense if interest rates skyrocket.
The return on investment of paying down debt is thus closely tied with the prevailing interest rates. Interest rates are currently low and are unlikely to rise sharply in the near future. So, using much of its cash to pay down debt may not be the best use of its cash for Boeing right now.
However, the second option, investing in growth, is not as straightforward. Investing in growth typically has higher ROI than paying down debt or buying back shares. But such an investment is typically fraught with risk.
Companies can hire the services of investment bankers who will look at the expected ROI and weigh it against the weighted average cost of capital. But a growth investment typically has many unknowns and loose ends. A company can be completely blindsided by events and find itself with a bad investment, even after having done its fair share of due diligence and crunching the numbers.
BA’s 747-8 program, on which the company took multiple write-downs amounting to about $2 billion, is a good example. Some analysts fear that 787 Dreamliner could follow suit, though of course the write-downs on the Dreamliner could be much bigger than those for 747-8.
Now let’s have a peek at Boeing’s buybacks. Companies usually do a lot of buybacks when they believe their shares are undervalued and are confident price will go up. The ROI of buybacks is usually calculated by taking free cash flow per share and dividing it by the share price.
In the case of Boeing stock, this currently works out to around 8.8%, much higher than the prevailing interest rates. So we can say that buying back Boeing stock makes currently more sense than directing the company’s cash to pay down debt.
Buying back shares is usually risk-free and a good investment choice as long as management believes that its cash flow will continue growing. Buying back shares also helps send signals to the investment community that a company’s management is confident that the company’s in on the right trajectory and share price will keep improving.
Bottom Line on Boeing Stock
The big question now is whether BA can keep on growing its cash flow to continue rewarding investors. The company is confident it can do so by growing its margins through cost management and increased production efficiency.
Boeing’s goal is to boost profit margins from current mid-single digits to the mid-teens by the turn of the decade. The company expects to enter double-digit margin territory as early as next year. The company hopes to achieve this by re-engineering its operations to allow for more flexible and efficient designs, as well as using automation and 3D-printing manufacturing processes.
Regarding the risk of a huge 787 write-down, that does not seem very likely.
Boeing has already sold 1,154 Dreamliners. Although this doesn’t match the 1,300 number it has been using as the basis for deferring accounting charges and rising oil prices, which recently crossed the $50-per-barrel mark, it is likely to bring an inflow of fresh orders for the fuel-efficient jet and could do wonders for Boeing stock.
Boeing’s management has a pretty decent track record of creating shareholder value. As long as it continues on this path, BA stock is likely to make decent long-term gains.
As of this writing, Brian Wu did not hold a position in any of the aforementioned securities.
