In its third quarter earnings, Boeing (BA) reported a year over year increase of 11% in its revenue to $22.1 billion, owing to the growth in the deliveries of its commercial airplanes segment. This segment accounted for around 63.2% of the total revenue of the company. Boeing secured commitments from China for around 200 of its 737 MAX commercial airplanes, amounting to approximately $20.7 billion. The multibillion orders from China are expected to boost this highest revenue contributing segment. These orders came from the country's state owned airline, China Aviation Supplies Holding Company, and leasing firms that are associated with China's banks. The 737 MAX includes new engines and various other enhancements, making them more fuel efficient than the existing models. Also, the company has improved the fuel efficiency of the 737 MAX by 14%, making it the most fuel efficient plane in the single aisle airplane market. China is the world's fastest growing airline market, and I expect Boeing will secure additional commitments for these airplanes in the future from this country. Boeing had 1,567 confirmed orders for its 737 MAX as of September, and it expects China will order around 3,900 single aisle aircrafts over next 20 years.
In another billion dollar deal, Korean Air Lines placed an order to purchase Boeing commercial airplanes for approximately $3.7 billion. Korean Air Lines is South Korea's largest airline. As per this deal, this airline will buy five Boeing 747-8s, five 777-300ERs, and one 787 Dreamliner. With this deal, Korean Air Lines will replace its older fleet of 15 747-400 jumbos with the new version of 747s. The Korean market registered the maximum number of international visitors globally. During the period of January - August 2013, around 822, 128 international visitors arrived in Korea, which is a growth of 21.06% over the same period last year. I feel this will lead Korean Air Lines to place additional orders in the future, which in turn will boost Boeing's commercial airplanes segment.
Recently, Boeing advised airline companies to avoid flying its commercial airplane 787, which employ engines made by General Electric (GE), near high level thunderstorms. The problem regarding these engines is that at high altitudes ice crystals form, causing the engines to loose thrust temporarily, which could lead to a forced landing of the airplane. From April 2013 to November 2013, six such incidents have taken place.
Following Boeing's advice, Japan Air is expected to replace Boeing's 787 airplanes with Boeing's 777s. However, I don't consider these factors a major cause of concern for either company, as GE is expected to find a solution to this problem soon. GE's engines used in these Boeing airplanes have a number of orders lined up from airline companies including United Continental (UAL), China's Xiamen and Hainan Airlines, UAE's Etihad Airways, Aeromexico, and Kenya Airways. GE is working on software to fix this engine 'icing' problem, and this solution is expected to be available in the first quarter of next year. The above mentioned Boeing 787 has huge demand, so 'icing problem' isn't a major cause of concern for Boeing.
In its third quarter of fiscal year 2013, Boeing reported that after the successful launch of its commercial airplane 787-10, it had strong demand for its 787 airplanes. Therefore, the company intends to increase its production rate from ten planes per month currently to 12 per month by 2016.
Commercial airplane | Cost (in million $) |
787-8 | 211.8 |
787-9 | 249.5 |
787-10 | 288.7 |
As per the above table, on average, the cost price of a Boeing 787 airplane is $250 million. At the production rate of ten planes per month, these airplanes generate revenue of around $30 billion annually. At the production rate of 12 per month, this revenue generation is expected to increase to $36 billion.
(click to enlarge)
Orders through November 19, 2013 (Commercial airplanes) | 737 | 747 | 777 | 787 | Total |
Net Orders | 780 | 5 | 88 | 164 | 1037 |
As per the above chart, the 787 accounts for 15.8%, the second most delivered airplane of the commercial airplanes segment. Since it is increasing production of a prominent airplane of this segment, it will be significant boost for Boeing's commercial airplanes segment in the long term, in addition to the above discussed contracts.
Growth in commercial airplanes is expected to be a key factor for future growth of the company's revenue. In the third quarter of fiscal year 2013, revenue from the commercial airplanes segment increased 15% year over year to $13.98 billion. With the above discussed major contracts, the growth rate of this most revenue generating segment will increase further next year.
This growth in the production rate is equally beneficial for GE. Boeing's 787 employ GE's engine, which costs around $20 million. At the current production level of ten planes per month, these engines generate around $2.4 billion of revenue for GE. After the growth in the production rate, I expect this revenue generation will increase to $2.88 billion, which is a growth of 20%. As this production rate is expected to increase in 2016, it is a long term growth opportunity for GE.
GE is also betting on the contracts with a Saudi Arabia based company, Saudi Electricity. On November 24, 2013, GE signed two contracts with Saudi Electricity, worth around $453 million. This deal is for the maintenance of Saudi Electricity's gas turbines at new power plants 'PP13' and 'PP14' in Riyadh. This new deal follows a previous deal, signed on November 20, 2013, under which GE will supply around 12 gas units and four steam turbines for the power plant. In addition to growing fundamentally, GE's stock valuation also supports its growth prospects. The company's trailing twelve months price to earnings ratio is 19.16, higher than its forward price to earnings ratio of 15.26. The price to book, or PB, ratio of the company is 2.22, lower than the industry s PB ratio of 36.7. The trailing twelve months price to free cash flow, or P/FCF, ratio of GE is 14.34, lower than the industry's P/FCF of 17.96. The growth fundamentals and stock valuation prompt me to have a bullish outlook on the company.
Benefits to another supplier
United Technologies (UTX) supplies various components to Boeing's commercial planes. This supplier is also expected to benefit from Lockheed Martin's (LMT) F-35 fighter jets. Recently, the Pentagon finalized a contract worth $1.1 billion with United Technologies for its business unit, Pratt & Whitney, to manufacture around 38 engines for Lockheed's F - 35 fighter jets. The delivery of these engines is expected to commence from the fourth quarter of this year.
Considering that 38 engines are worth $1.1 billion, then the cost of each engine will be $28.94 million. Currently, Lockheed produces around 29 F-35 jets, from which Pratt & Whitney is expected to generate revenue of around $839.26 million annually. According to the Pentagon, the F-35 is poised for more production from 29 per annum to 42 next year. Consequently, at a price of $28.94 million, Pratt & Whitney is expected to generate revenue of $1.21 billion annually next year by supplying engines to the F-35. In the third quarter of fiscal year 2013, Pratt & Whitney's net revenue declined 5.26% year over year to $3.38 billion. The contract for F - 35 fighter jets and growth in the production of these fighter jets, are expected to partially offset this decline next year. Considering these growth prospects, I feel United Technologies is an attractive investment opportunity.
Conclusion
The price to free cash flow of Boeing is 11.46, lower than the industry's ratio of 15.43. For the third quarter, the trailing twelve months price to sales, or P/S, ratio of the company is 1.23x, which is also lower than the industry's P/S ratio of 1.24x. Going forward, the company's P/S ratio is expected to be 1.24x, lower than industry's P/S of 1.28x. All these valuation parameters indicate that Boeing's stock is currently undervalued. I advise investors to rely on this stock for comfortable returns.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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