Boeing: The Real Cash Flow Growth Surprise (NYSE:BA)

Boeing (NYSE:BA) stock has recently enjoyed some positive momentum and that did not come as a major surprise. In October, I maintained my buy rating on Boeing stock despite the underwhelming quarterly results and since then the stock has easily outperformed the broader markets gaining 36% compared to the 12.9% gain for the S&P 500. More recently, I also discussed the improving relations with China that did increase the stock price. But more importantly, I noted that while analysts were euphoric on the improving Sino-American relations and portrayed this as an event that was closely connected to a meeting between President Joe Biden and President Xi, I showed that the first foundation for positive developments were already established in September 2022. And if we look at the stock price development since then, the stock has gained 70%! It shows the value of timely and accurate coverage as well as context placement.

In a recent report by a fellow contributor, the case was made that Boeing would be meeting its free cash flow objective of $10 billion by FY25/FY26. The main component hinges on adding a cash flow component from the Boeing 737 program to Boeing’s cash flow projections presented during its Investor Day in 2022. Having followed the industry for over a decade and with a degree in Aerospace Engineering, I could see that some top level input variables such as the sales price were far from the actual values. As I believe investors should have access to accurate information, I will be using this piece to provide better reflective numbers as well as a more complete assessment on the moving items which are not limited to just one program. As I show in this report, the Boeing 787 program is as important, if not even more important, than the Boeing cash flow growth story.

Boeing 737 Program Rates Will Significantly Add To Cash Flow Generation

The Boeing 737 program without doubt will be a major driver of cash flow, in my view. The underlying calculations, however, can be quite complex as we have to process the 2023 deliveries and determine the delivery rate and mix in 2025.

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Using a combination of delivery schedules and assumptions as well as preliminary flight and delivery data, we expect that the delivery numbers for 2023 for the Boeing 737 MAX will be around 390 while the targeted rate in 2025-2026 will be 600 airplanes. Although I do believe Boeing will aim to be higher in terms of production rate by 2025-2026 using the more conservative targets provides some padding.

The graph above shows a typical pre-delivery payment profile for Boeing standard contracts. The way things work, Boeing receives a small down payment when an order is signed and then over the course of two years prior to delivery, a percentage of the list price. Upon delivery, the discount is applied and the customer makes a final delivery payment calculated as the difference between the sales price and the sales price after discounts. For the Boeing 737 MAX the deliveries are currently around 58%. For 2023 that indicates that around $6 billion in final delivery payments has been received. We do the same for the 2025/2026 numbers arriving at a figure of approximately $9 billion. The difference of roughly $3 billion between these two figures represents the increase in delivery payments between 2023 and 2026. This also needs to be corrected for a cash outflow to suppliers that still need to be paid bringing the tailwind from higher deliveries to $1.95 billion.

For the Boeing 737 MAX program, there are two pressures witnessed in 2023 that will dissipate in the years ahead and those are the reduced delivery payments. The inventory of pre-built jets will largely liquidate in 2023 and 2024 and Boeing expects around $700 million in lower delivery payments. I have assigned around $350 million in pressure to 2023 with another $345 million in pressure on payments made by Boeing to customers calculated using the $304 million paid in the first nine months of 2023 and paced with total deliveries Boeing 737 MAX deliveries in 2023. This brings the total tailwind to approximately $2.65 billion.

The Boeing 787 Is Also A Major Source Of Cash Flow Growth

While the Boeing 737 MAX program has a huge cash flow upside, the Boeing 787 most definitely should not be left out of the equation. Boeing has aimed for 70 to 80 deliveries for the program in 2023 and preliminary figures suggest that Boeing indeed did achieve that goal delivering 73 airplanes which would render around $4 billion in delivery payments. By 2025-2026, Boeing aims to produce at a rate of 10 airplanes per month, which would render $6.9 billion in delivery payments indicating $2.9 billion of upside driven by mix, volume and efficiency. After supplier payments, this would bring the tailwind to $2.4 billion. Furthermore, abnormal production for the Boeing 787 will evaporate. In the first nine months of 2023, Boeing incurred $937 million in abnormal production costs which annualized would be in the range of $1.25 billion, bringing the total cash flow upside to $3.6 billion making it a bigger driver to cash flow than the Boeing 737 MAX program.

Boeing 777X Will Be A Drag On Cash Flow

While Boeing will be restarting production of the Boeing 777X this year, the program will continue to be a drag on cash flow and has been a cash flow drag through 2023. As Boeing will restart production, the abnormal costs will be largely dissipate leaving the break-even nature of production in play. Boeing recently booked a big order from Emirates, but the art will be to build a diverse and sustainable backlog that allows Boeing to increase production rate and better amortize costs.

Rebuilding The Free Cash Flow Bridge For Boeing

During the Boeing Investor Day, the chart above was presented. Back then, Boeing still assumed deliveries to be significantly higher for the Boeing 737 MAX program in 2023. As that did not materialize, the free cash flow estimate for 2023 has shifted more toward the lower end and more upside for BCA has shifted towards future years.

I have put the previously discussed programs and components of each program together and we get a positive cash flow driver at BCA of $6.7 billion. There’s some uncertainty regarding the production profits of the Boeing 777X. That’s currently modeled as a net positive as the abnormal cost dissipate and the production losses will not be offsetting the positive removal of abnormal costs. Boeing has marked the Boeing 777X as a near-break even program, which I have processed as a program with production loss margins of around 5%. As a reference, the Boeing 787 program initially had production loss margins of 30%. So, I might be too positive assuming only 5% but that is driven by Boeing having highlighted the near breakeven nature.

Having processed the cash flow drivers, we get to a 2026 free cash flow estimate of around $10 billion which is in line with what Boeing has aimed for. However, it needs to be kept in mind that the drivers barely add up meaning Boeing needs to execute extremely well on ramping its production for the Boeing 737 MAX and Boeing 787 programs and managing cost on the Boeing 777X. It requires strong execution on all program and not just on one program. Furthermore, strong order inflow also is required as these orders while sitting in the backlog for years still enable a downpayment at the time of signing.

At the same time, I do believe that Boeing will be looking to push production rates significantly beyond what currently is announced by the jet maker, which would see production rates for the Boeing 737 MAX close to previous rates achieves on the Boeing 737 program and also the Boeing 787 could see higher rates as the company has the capacity to go up to 12 assemblies per month and even further, which is 20 and 40 percent higher than what Boeing has currently targeted.

Is Boeing Stock A Buy?

I believe that Boeing stock remains a buy. Implementing the 2024 and 2025 free cash flow projections from analysts at a 7.6% discount rate and a median price-to-free cash flow of 15.6x gives us a $302.50 price target providing roughly 25% upside. What investors should keep in mind is that solely based on free cash flows for 2023 or 2024, Boeing is significantly overpriced so the net present value of the 2025 free cash flows is of importance to Boeing’s valuation. It’s up to investors to decide whether they feel comfortable making investments with that timeframe in mind.

Conclusion: Boeing Stock Remains A Buy

It’s important to understand that Boeing’s cash flow is not driven by one program. Portraying it as such ignores the fact that both the Boeing 737 MAX and Boeing 787 program can pull the cart for Boeing. Our assessment shows this rather clearly as well as the need to execute strongly on all fronts. Failure to do so, does put the free cash flow target Boeing is aiming for directly at risk.