Markets Defy Reality of Boeing Super Cycles
- kevinhalloran
- Jan 10, 2017
- 4 min read
Compelling empirical order book data suggest Boeing (BA) should trade 15-30% lower than its current trading range
50-year correlation to S&P may further portend downturn in broader markets
Key Book-to-Bill ratio at potential inflection point
Boeing (NYSE:BA) has been in the news lately, as much for its positioning regarding potential sales to Iran and its twitter-to-twitter battle with Trump over Air Force One, China and the Ex-Im Bank. No doubt, some headwinds are lurking, not the least of which is explored through this deep-dive look at its historical trading behavior in relation to its order book, delivery schedule and the S&P index.
Our research suggests a trading range of $100-$115 for Boeing with significant downside risk attached. Historically, what has been good for the country has been good for Boeing, to paraphrase Charles “Engine Charlie” Wilson’s comments about GM. The chart below shows the remarkably correlated relationship between the S&P Index (SPX) and Boeing’ share price over the past fifty plus years.
Defense sales at Boeing used to account for a good chunk of its revenues. That’s no longer the case, as commercial aircraft sales now account for over 70% of its revenues, and have grown at a nearly 10% CAGR over the last 10 years. Defense sales have declined slightly during the same period. To be sure, operating margins are better in the defense space, but only negligibly (about 100 basis points).
In short, Boeing has become a proxy for the airline industry, global growth, and US industrial strength. So, do we expect to see the same correlation between Boeing’s share price to the S&P moving forward, which would make an investment in Boeing essentially a macro play? Not at all — in fact we see significant divergence from Boeing’s recent highs and what is expected based on its performance in the commercial aircraft arena. To understand this divergence better, it is necessary to look at Boeing’s historical order book. We tracked orders since 1962, as shown below. Not surprisingly, some major cycles are evidenced, we call these industrial super cycles. Interestingly, there was commonality in these cycles up through the Great Recession — 6 years from order cycle top to trough. Recovery periods, that is peak to peak, varied more from 7 years to 14. The Great Recession created a hiatus in the super cycles.
You will note the steep decline in Boeing’s order book over the past two years, from 1432 aircraft in 2014 to our estimate of 500 this year. This decline does not reflect a slowdown in the demand for commercial aircraft per se, but rather a drop off after the very robust order book in 2012-2014. Boeing pre-sold much of the global demand. This active period swelled Boeing’s backlog and despite very good improvement in its production line (an increase of nearly 60% in annual deliveries from 2011 to 2015), the number of “production years” (backlog divided by a moving average of prior year deliveries) has remained between 7 and 8 years. Boeing will be delivering aircraft for a long time coming.
Finally, we look at Boeing’s book-to-bill ratio since 1990, as shown below, in relation to its share price. While not quite as highly correlated, the graphic provides illustration to the cyclicality in Boeing’s production practice versus its order book and how the market values this. We are currently entering a nadir, with Boeing’s book (sales) to bill (delivery) ratio estimated at .67 for YE 2016. You will note that past troughs showed significant rebound in subsequent years, however, given the sales activity from 2012-14, we don’t believe Boeing will replicate this feat moving forward. Instead, we believe Boeing will enter a period of sales “malaise.” Additionally, you will note the buoyancy in the share price despite the drop off in this key ratio, another divergent sign.
We then ran a multiple regression analysis using the order, delivery and S&P trading data for a period of 54 years, with estimates for YE 2016 inclusive. The chart below shows this relationship, and the exceptionally high correlation (88.9 Adjusted R-Square factor). We also show what the model predicted for the YE closing price of Boeing for each year. You will note that the model was a very accurate predictor up through 2013.
Since 2014, however, there has been an unprecedented divergence between the expected outcome and Boeing’s share price. Our model generates an expected YE share price of approximately $92, or 40% below today’s current price. We also ran the model without the delivery data (buy on the rumor, sell on the news) and found the same high degree of correlation. Using that model, we generate an expected share price of $100.
So what is at work? Animal spirits. Boeing now trades at nearly 24 times earnings, a full throated 33% higher than its trailing 5-year average and about the same premium to industrial peers. Price to book valuations are even more incongruous.
We believe that Boeing, as a proxy for industrial America and global growth aspirations, is simply trading beyond its ability to deliver. Cash flow will be plentiful based on the current backlog, but does not come without downside risk (U.S. inflationary pressures leading to a recession, trade wars and a slowdown in passenger demand to name a few). The recent bump in the dividend and the announced share repurchase program echoes our belief that management knows what lies ahead and are using these as proactive measures to try to keep the share price at its lofty valuations. We are not convinced they will be successful.
Finally, we have not made the call on whether this is the canary in the coalmine for a broader market correction, but we are watching for the first gasp for air.