Last year belonged to the defense stocks. As a sector, the various defense contractors and aerospace firms surged on the wave of optimism surrounding President Trump’s election. But none rose as much as Boeing Co (NYSE:BA).
Flying through the air like one of its jet fighters, BA stock more than doubled the return of the S&P 500 over the trailing twelve months. And when you factor in the Boeing’s hefty dividend, its total return was closer to 60%.
So far, 2017 has been another sonic boom for BA stock.
But with Boeing stock already soaring so high, the real question is whether not, future gains are warranted. Especially, when you consider that Boeing wasn’t exactly firing on all cylinders before. The market may be already pricing in a lot from BA.
Plenty of Positives for BA Stock
It’s easy to see why BA has been riding high over the last year. Despite Trump’s tweets about the rising cost of Air Force One, we all know that he is pro-military and has already made plans to boost America’s defense forces budget by a substantial sum. As one of the largest defense contractors on the planet, that spending will make its way to Boeing’s bottom line.
Perhaps sooner than later as Trump has directly reversed course on BA and he has hinted at having the military order more of its F/A-18 Super Hornet fighter jets over Lockheed Martin Corporation’s (NYSE:LMT) F-35’s. A slew of new international orders for fighter jets hasn’t hurt either. If you remember, Boeing’s fighter jet business was in danger of closing within ten years.
As if that wasn’t enough, BA has scored some major wins regarding its Dreamliner program. The firm recently delivered its 500th plane. That’s a critical mark as the project has been incredibly costly for Boeing, but it should now be able to begin seeing profit from the wide-body aircraft.
These reasons, as well as a supportive buyback program, have helped BA stock become the defense stock of the moment and led to its strong returns over the last year.
Turbulence Ahead for Boeing Stock
But investors may want to reach for their airsick bags when it comes to BA stock. Boeing stock isn’t exactly flying in clear skies, and there could be some serious turbulence ahead.
While the potential for high sales is there, the truth is, Boeing has continued to see its yearly sales decline over the last few years. Between 2012 and 2014, BA received more than 1,000 orders per year for its commercial planes. Orders fell to just around 760 in 2015 and decreased by another 100 orders last year. Lower oil prices have only clipped demand for many airlines to upgrade their fleets to newer, more fuel-efficient airplanes.
So, overall sales have been dropping at BA. But Boeing does have an enviable backlog of orders already in the queue, right?
Well, not exactly. The problem is those 5,700 or so orders aren’t exactly what they seem. The vast bulk of those is for its standard 737 jets. These smaller/thinner aircraft aren’t exactly profit-making machines as margins are much thinner than its widebody planes.
Moreover, analysts have now begun to question, BA’s rate of production, given the lower sales figures. To keep things profitable, Boeing may need to cut production to match sales. That will reduce just how effective that backlog is and “kick the can” down the road in terms when those 5,700 plus plans actually get turned into profits.
But there’s Trump, right? Higher military spending is going to be sweet for BA stock. The answer is yes … to a point.
Last year, only about 23% of Boeing’s revenues came from U.S. government contracts. That number also includes foreign military sales that are done via the U.S. government. The vast bulk of its sales are still commercial airlines sales. Even potentially worse is that most of these are from foreign/international companies. With Trump playing fast and loose with trade, BA actually could see itself on the nasty end of a trade war. That would hurt a lot more than the gains from additional fighter jet orders.
On the back of all this potential turbulence is the fact that Boeing stock is no longer cheap.
The 50%+ surge in shares have pushed BA stock’s price-to-earnings ratio up to nearly 24. That in of itself is pretty high for the overall market and is above historical norms for Boeing. Also pretty high is Boeing’s current price-to-sales. From 2000 to 2016, BA stock traded for a P/S ratio of 0.85%. Today that number is north of 1.1 and reflects the general expensiveness of the entire defense sector.
In the end, a lot of the optimism for Boeing stock has already been baked into shares, and some of that sanguinity may have been overstated by traders.
Time to Catch Another Flight Away From BA
Truly, there’s nothing wrong with Boeing stock. This isn’t a case of a firm about to implode. BA Stock isn’t going anywhere.
The problem for Boeing is that it may have run-up too fast, too quickly. It’s going to take a lot to significantly move shares over the next year. We’re simply not going to see the same kind of gains like we did in 2016. The Trump Bump has already run its course in BA stock. Even worse is that we may see some share price declines if things don’t run 100% smoothly as expected. A lot of future faith has been placed in Boeing’s hands. And given the headwinds, we may not see that happen.
For investors looking for real growth, they may want to catch another flight elsewhere.
As of this writing, Aaron Levitt did not hold a position in any of the aforementioned securities.
