Analysts are wrong – this debt-ridden stock is a classic value trap

Ever since a plugged door blew off a Boeing 737 Max 9 Alaska Airlines plane in mid-flight in January, the regulator has taken “unprecedented steps to increase oversight on Boeing”. This has meant everything from having more safety inspectors on site to halting production expansion.

The timing couldn’t have been worse, coming so soon after the 737 Max was grounded worldwide for more than a year as a result of two crashes that killed 346 people. It has led to an overhaul of Boeing's management team, with chief executive Dave Calhoun, chair Larry Kellner and the head of the commercial airplanes division, Stan Deal, all stepping down.

It has also reopened the threat of criminal prosecution relating to the earlier crashes. The company paid $2.5bn (£1.6bn) to the US Department of Justice in 2021 as part of a deferred prosecution agreement (DPA). However, the Department of Justice recently wrote to a judge arguing that “Boeing breached its obligations under the DPA” by failing to enforce a proper compliance and ethics programme.

Boeing argues that it honoured the terms of the agreement, and said that it had "redoubled its efforts" to encourage employees to raise concerns about safety.

Financial engineering

Boeing's problems are largely of its own making, and it has been accused of focusing too heavily on financial engineering and not enough on the aeronautical variety.

In Flying Blind: The 737 MAX Tragedy and the Fall of Boeing, journalist Peter Robison argued that the plane maker had been more interested in earnings targets than innovation. The 737 Max was allegedly a rushed response to rival Airbus’s (FR:AIR) A320neo family, which was taking a greater share of the key single-aisle passenger airline market. Rather than creating its own new model from scratch, it sought to tweak the 737 model that had first been developed in 1967.

At the same time, the company allocated $41.5bn to share buybacks between 2013 and 2018, which was “enough capital to develop several new aircraft, had they chosen to”, Robison wrote.

The company has paid a heavy price for this. It has racked up an accumulated net loss of almost $24bn over the past five years, while heavily bleeding cash. Its net debt has risen from $5.3bn at the end of 2018 to over $40bn in the first quarter of this year.

The increased oversight it faces is also slowing production, making its financial position worse. Delivery rates of new planes slowed to just 24 in April, from 44 per month last year and 67 per month in 2018 – the last year prior to the initial Max groundings.

The company reported a free cash outflow of almost $4bn in the first quarter, and chief finance officer Brian West later had to roll back on the company’s initial assessment that it would be cash flow generative this year.

West told investors at an aerospace conference last month that Boeing's cash outflow for the second quarter would be the same or “possibly a little worse” than the first, adding that it would likely use, rather than generate, free cash flow this year. This “inadequate performance” prompted Moody’s to downgrade Boeing’s debt rating to the bottom rung of its investment-grade ladder, with a negative outlook.

Orders flying in

Despite all of this, however, there are plenty on Wall Street who, after a 30 per cent slide in Boeing’s share price this year, believe the aerospace group is undervalued. 60 per cent of analysts tracked by FactSet have the shares on a ‘buy’ or ‘overweight’ recommendation.

There are good reasons for this. For a start, Boeing is too big and too important to fail. Around a third of last year’s revenue, some $24.9bn in total, came from its defence, space and security arm. It makes F/A-18 Super Hornet and F-15 Eagle fighter planes, as well as Chinook and Apache helicopters, mainly for the US military but around 30 per cent of its backlog is for non-US customers. With spending rising on both sides of the Atlantic as Nato members seek to boost security, this is a good market to be in.

Demand is even more robust in the commercial aerospace market, where Boeing enjoys an effective duopoly with France’s Airbus. So strong, in fact, that they’re struggling to keep pace with supply. As of the end of April, Airbus has a backlog of 8,617 planes which, at last year’s delivery rates, would take almost 12 years to clear. Boeing’s backlog is smaller, at 6,209, but would take the same amount of time to shift given its lower production rates.

Both companies are trying to remove bottlenecks in the supply chain and ramp up production of their narrowbody jets. Airbus is trying to boost production of its A320 family by around 50 per cent to 75 by mid-2026. Boeing’s 737 ramp-up rate is more modest at 50 planes a month by 2026, but it is starting from a much weaker position.

If Boeing manages to hit its target, its valuation could soar. FactSet consensus forecasts are for Boeing to transform an operating loss of $773mn last year into a profit of $2.9bn this year, before a big step-up to $6.9bn in 2025 and $9.3bn in 2026. If that works out, it will help to cut its net debt pile from around $36bn this year to just $23.1bn by 2026, with analysts suggesting it could be debt-free within five years.

There are plenty of reasons to think that it might not, though. Following West’s recent admission that it would miss free cash flow targets, Stifel analysts remarked that this “continues a recent track record of putting out guidance commentary and later revising that commentary lower”.

Boeing is also contending with a regulator that has faced stinging criticism from politicians and safety advocates alike for its previous lack of oversight. Any further safety mishaps could prove reputationally ruinous, so caution would be understandable.

Production is another hurdle. Wells Fargo analyst Matthew Akers points out that for Boeing to reach its 2026 target, it would have to increase its production rate by more than 10 per month over the course of next year, which is “roughly double” the ramp-up rate it has managed in the past. “We think [Boeing] will ultimately walk away from these production targets,” he said.

Tim Clark, president of one of Boeing’s biggest customers, Emirates, this week told Bloomberg that the plane maker faces a “five-year hiatus” before it emerges from its current crisis.

Time is money

It can’t afford to wait that long, given the need to improve its cash position. It finished the first quarter with $7.5bn of cash and "marketable securities”. This has been bolstered after the company tapped debt capital markets for $10bn last month, but there is the sizeable second-quarter outflow to contend with, plus the need to spend billions more bringing Spirit AeroSystems (US:SPR) back in-house.

Spirit makes all of Boeing’s 737 plane bodies and used to be part of the group until it was spun off as a separate entity in 2005. Boeing is looking to buy it back to regain control over production and, although terms have yet to be agreed, it’s fair to assume Spirit’s shareholders will expect a premium over the company’s current market capitalisation of $3.6bn.

With West telling investors last month that the “number one priority” for financing the Spirit deal is holding onto Boeing's investment-grade rating, a dilutive equity raise could well be on the cards.

The scale of Boeing’s debts makes some common valuation metrics meaningless – it has a negative book value and its enterprise value (the sum of its market capitalisation and its debt, minus cash) is more than 270 times its forecast cash profit for 2024.

Even when you take a leap of faith and value the shares off future broker earnings targets, they look expensive at 33 times consensus forecasts for 2025 and 21 times for 2026. This is especially true when compared with Airbus shares, which trade on 19 times 2025 numbers and 15 times 2026 numbers despite its superior market position and more secure financial situation.

Boeing may well go on to address safety concerns and ramp-up production. However, the regulatory, management and financial challenges it faces mean that, at their current price, the shares are not worth taking a flier on.