Vol. 4, No. 2 — Winging it
Vol. 4, No. 2 — Winging it
Boeing’s stock price is in a nosedive, but isn't cheap; Here's why the British economy is stuck in the mud; A spike in shipping costs won’t cause inflation to surge again; Value in cocoa and chocolate
Read time | 44 minutes
In this issue
Quote | Walter Bagehot
Cartoon | First-hand research
Finance | Winging it
Economics | Britain’s productivity problem
Economics | Inflation overboard
Markets | A gap is opening
Investment idea | Value in chocolate
Quote | Walter Bagehot
“Life is a school of probability”
Cartoon
First-hand research
Finance | Boeing shares aren’t cheap
Winging it
Boeing’s stock price is in a nosedive. Should you pick some shares up, or will they crash land?
Boeing has run into some turbulence. Earlier this year, on January 5th, the door plug of one of Boeing's 737 Max 9 planes came off shortly after the Alaska Airlines flight took off. One of the cabin panels blew out and took the door with it. Following this, the Federal Aviation Administration (FAA), America's aeroplane watchdog, ordered the grounding of 171 Boeing aeroplanes. The regulator mandated an inspection of these aircraft, forcing Alaska and United Airlines to ground their planes and cancel flights.
Boeing, the company that makes those planes, responded by saying they're enhancing quality inspections and will increase their focus on production processes. It's too little too late. Investors have punished Boeing's stock. The shares fell 9% at the opening bell after social media sites reported news of the blowout. And the shares have fallen a further 11% since. So, is Boeing stock a good buy at this level? No. There is too much uncertainty, and the shares are not cheap.
The shares aren't a good buy because there's too much uncertainty about whether the company will pass the new federal safety audit. Wells Fargo, a prominent American bank, published a report that raised doubts about whether Boeing would pass. The report, "FAA audit opens up a whole new can of worms," highlights Boeing's ongoing quality control and engineering problems. In response, the firm announced an independent advisor to review quality controls.
The FAA audit will focus on whether the aeroplane maker ensured its products conformed to approved design standards and were safe for operation. Boeing will face stricter regulatory scrutiny and operational restrictions if it fails the audit. This failure would lead to penalties and damage their reputation. Airlines and passengers would no longer trust Boeing planes, hammering sales and profitability.
Investors who buy the shares now are taking a massive risk. If the firm passes the audit, the shares should bounce a bit. But if it fails, traders will hammer the stock. Massive fines, replacement costs, and a long trust-building period would decimate the firm's value.
While the shares appear fairly valued according to analysts' consensus estimates, these forecasts are too bullish. A discounted cash flow model using analysts' consensus estimates for growth and margins suggests the shares are worth about $172, 15% below the $203 stock price when Valuabl went to press. The ten analysts covering the company forecast sales to grow at a 12.5% compound annual rate for the next few years and for operating profit margins to recover and stabilise around their all-time highs.
These assumptions are too generous. Even if the firm passes the audit, customers and airlines will continue to be put off by the unsettling prospect that their plane doors might rip off while in the air. That will dent sales at both the airlines and at Boeing. Furthermore, even though Boeing supplies aeroplanes on large contracts with long lead times, purchasing managers will tear those contracts up if there are suspected problems with the aircraft.
Additional scrutiny and competition will also weigh on profit margins. Given the extra compliance costs, checks, and price cuts Boeing will offer to get their planes back out there, analysts are too upbeat about profitability. The firm's margins seem unlikely to return to and stabilise around their all-time highs. The rose-coloured outlook analysts have forecast is unlikely to come to pass. Consequently, analysts' expectations are probably not indicative of the stock's actual value.
As a result, Boeing stock has much more downside than upside. In the bull case, in which the aeroplane maker's sales soar while costs decline, Valuabl expects a 34% upside from the current price. But, on the other hand, if growth continues at the current rate and margins only recover to the industry's 7.3% average, there is a 61% downside from the current price.
A Monte-Carlo simulation—a fancy technique for studying the sensitivity of outputs to inputs—on the valuation model suggests the fair value of the stock is closer to $142-155. That's below the estimate using consensus figures because of the distribution of capital costs. While the median unlevered business beta for the global aerospace and defence industry is 0.7, the distribution is positively skewed. The 25th percentile of betas is 0.4, while the 75th percentile is 1.2. That means if the firm's US dollar cost of capital is higher than the 7% modelled, it's likely to be a fair bit higher, pulling value down.
The stock also has much more downside than upside because of the firm’s debt pile, stacking the deck against us. The worst-case scenario is calamitous. Should sales growth continue at the current rate, but margins only recover to the firm's long-term average of 5%, there's an 85% downside from the current price. Buying Boeing shares could rip a hole in the side of your portfolio unless you have a parachute. ■
Economics | Deleveraging and underinvestment
Britain’s productivity problem
Output and earnings growth have ground to a soggy halt. The British economy is stuck in the mud. Here’s why.
Forget the Falklands. British productivity is in the doldrums. For the last 15 years, the country's inflation-adjusted output per person has gone sideways when measured in US dollars. In fact, the country's gross domestic product (GDP) per person is still below its previous 2017 peak. On average, Brits produce $48,900 of stuff yearly, while in 2007 they produced $50,500 worth.
That trend is a concern. But more of a worry is how poorly the country has done compared to its peers in the G7, a group of big, rich countries. In 2007, real British GDP per person was $6,400 higher than the country's G7 peers. Now it's $10,700 lower. Britain's productivity problem comes from ongoing credit contraction since the global financial crisis (GFC), a lack of capital investment, and the gravitational pull of rising house prices.