Boeing Co (NYSE:BA) has had an amazing year, with BA stock currently up over 95%. That’s simply jaw-dropping from a staid industrial firm. Normally, you have to buy risky tech companies to get 95% yearly gains. In fact, looking at the Dow Jones Industrial Average, BA stock has far and away delivered the best performance of the year. Runner-up Caterpillar Inc. (NYSE:CAT) is up a more modest 75% on the year.
What’s gone right for Boeing? For one thing, international aviation is booming. Cheap oil prices have given the whole sector a big lift. And the airlines aren’t holding back — they’ve been firing off new plane orders left and right. As a result, share prices for the airline manufacturers are also on the rise. Boeing’s primary competitor, Airbus Grp/ADR (OTCMKTS:EADSY) is up a robust 55% for calendar-year 2017.
However, BA stock has outperformed both Airbus and its US-industrial firm rivals. Why? For one thing, its other big business, military defense, has been in favor since Trump won the election. So Boeing is attached to two hot trends at the moment. It also has grown earnings dramatically.
But here’s where things start unraveling for the BA stock bull case going forward.
Boeing has had a fantastic 2017 on an operational front. Operating earnings out of its core business have doubled on the year, which sounds amazing at first glance.
However, a more nuanced look shows that there’s less here than meets the eye. For one thing, Boeing recording gains on its pension program, presumably due to strong equity returns. As a result, its funding gap is smaller than before — and it can treat that as a profit. Don’t forget: What the stock market gives, the stock market can take away. There’s no guarantee that markets will remain strong in 2018. And if they go in the other direction, Boeing’s pension program may show a wider liability next year.
And another big chunk of Boeing’s increase in profits came from lower reach-forward losses. This comes from fixed-price contracts that Boeing was able to deliver under budget. It’s certainly good news that they aren’t getting hit with cost overruns. However, executing ably on preexisting contracts is a different thing than attracting new revenue streams going forward.
Bank analysts seem to have caught on to what’s happening here. The analyst consensus is just 2% earnings growth this year and 9% next year. Those are hardly the sort of numbers needed to justify BA stock’s 27 trailing and 27 forward price-to-earnings ratio. Again, we’re talking about a company that is supremely exposed to the economic cycle. It’s simply breathtaking that people are willing to pay 27x earnings for a company that is currently experiencing just about the best economic conditions possible for its business.
Boeing, like all too many companies nowadays, tends to time it share buybacks poorly. Between 2009 and 2012, when BA stock was in the dumps (as low as $30), Boeing’s shares outstanding steadily grew. Shareholders were diluted at rock bottom prices.
Between 2013 and 2016, with BA shares now around $120, Boeing turned on the buyback faucet, taking the overall BA share count down from almost 800 million to just over 600 million. Now, with the stock up in the stratosphere, Boeing plans to hit the buyback button even more aggressively, with $18 billion of fresh capital committed to the endeavor.
Boeing, it’s worth remembering, also bought back stock fairly aggressively during the prosperous period between 2004 and 2007. We all know what happened next. BA stock wasn’t immune. In fact it did way worse than the market, plunging from a pre-GFC (global financial crisis) high of $105 to just $30 in March 2009.
Given that Boeing remains a hyper-cyclical business, why are company executives so intent on buying back stock now at record high prices and valuation levels? For many of these executives, the thinking is clear: anything that juices the stock price in the short run leads to bigger payouts on stock options and fawning media attention.
Tragically, those stock gains tend to be short-lived. You see, Boeing isn’t paying for its rapidly rising dividend and gigantic share buyback out of mountains of new free cash flow. Instead, it has moved from a net cash position to a net debt position, while also drawing down reserves of working capital. These are the sorts of financial levers you get to pull in the short-term. But they’re no substitute for growing net income and free cash flow.
And yet, Boeing’s trailing-12-month free cash flow peaked at around $8 billion prior to the financial crisis, in 2013, and again in 2015. It’s poked up over $10 billion now — a 25% gain — however, the stock was previously quoted around $100 and now it is at almost $300. In other words, the market is light years ahead of Boeing’s actual fundamental economic progress.
Sure, Boeing can keep tempting you with share buybacks and dividends that it borrows to afford… For a while. BA does have a strong credit rating. But this is all financial maneuvering. The real business hasn’t grown anywhere near enough to justify the stock’s recent 150% run-up.
There’s a time and a place for everything. Caterpillar stock, for example, was at $60 and yielding 5% early last year. Investors hated it. I bought some. Now the stock is at $150, everyone loves it, it yields only 2%, and is trading near its highest valuation ever. Sure, it could go up more, but the odds now favor selling.
You don’t build fortunes chasing.
Instead, you make money being on the opposite side of an overextended herd. Boeing went from cheap last year to exceedingly expensive now, yet everyone seems to see only smooth skies ahead. When that’s the case, your potential returns are limited. Any sort of turbulence and BA stock will go into a steep and swift correction.
At the time of this writing, the author held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.