Author, contributor: Jaime Rodriguez, Analyst Prep Program, 2022 Alum
The Boeing Company (BA) has been one of the hardest-hit companies in the Aerospace and Defense industry from the coronavirus pandemic and production failures. How can using strategic consideration, typically carried out by investment bankers, help Boeing recover and prosper into the future?
Key Points
- The process of strategic consideration and what investment bankers do.
- Boeing is currently operating with negative earnings and needs to restructure to turn profitable.
- The company is on the lowest ends of operational margins and equity capitalization relative to the
industry. - Issuing $19.9 Billion in equity can help Boeing reinvest back into the company to create more
operational efficiencies, pay back additional debt, and improve cash flow.
Strategic Consideration and the Role of Investment Bankers
Firstly, what is strategic consideration? This is the process of analyzing a company’s financial profile and determining appropriate solutions to address problems the business may be facing or to spark increased growth of the company. Some of the most significant strategies include restructuring of capital, mergers, and acquisitions, stock splits, share buyback programs, asset sales, and initial public offerings (IPOs). These are just some options a company could decide between in strategic consideration; there are many more. With so many options and some of these techniques requiring complex analysis and modeling, investment bankers help companies throughout this process.
An investment banker uses analysis of the company’s business model and financial statements, the company’s stock performance, economic outlook, and industry competition to develop, pitch, and carry out strategic consideration. They work directly with executives of companies to provide a different perspective and alternative solutions to growing the business in a competitive environment and provide answers to questions that may require a deep understanding of finance and technical skills. Additionally, a banker would provide techniques for carrying each solution out and the company’s outlook on a pro-forma basis (after it is carried out). These include whether to issue debt or equity, what company should the business acquire or merge with and if the deal would be accretive(higher pro-forma earnings per share) or dilutive (lower pro-forma earnings per share), how many shares a company should repurchase, or how much capital is required for each strategy. It is also the responsibility to look out for the client’s best interest. This not only builds trusting relationships between the firms but also means presenting the information in an appealing, professional format, carrying out negotiations, and making the best decisions with the company’s resources. Of course, this is a lot to consider with huge consequences, which is why there are teams of investment bankers that contribute to each part of the process. This ranges from analysts who typically use technical and soft skills to build the necessary models and pitch books to the managing director who works directly with clients and top executives as well as guides the investment banking team on what direction each deal will be heading towards.
Situation Overview
Now that we understand a little more what goes into strategic consideration and the advisory process, let’s discuss The Boeing Company’s situation. Boeing is one of the largest international aerospace and defense product manufacturers and designer companies. The company sells aircraft, military weaponry and technology, space shuttle and launch components, and global services. They operate in four main business segments: Boeing Commercial Airplanes (BCA), Boeing Defense, Space & Security(BDS), Boeing Global Services (BGS), and Boeing Capital (BCC). As of March 11, 2022, the company’s stock is down 14% YTD, granted the equities market has been suffering from macroeconomic conditions and international relations. However, the stock price has fallen 29% YoY, and 60% from its high in February 2019. Boeing also generated its third continuous fiscal year of negative earnings with its 2021 fourth quarter and full fiscal year report. Net revenues came in at $62.3 billion, but net income came in at ($4.3 billion) with earnings per share of ($7.15). While margins have improved from 2020, Boeing’s worst financial year, the gross profit margin was 4.8%, the operating income (EBIT) margin was -4.7%, and the adjusted EBITDA margin was 2.6% in 2021. This decline in performance isn’t without explanation. In 2018 and 2019, two Boeing 737 MAX aircrafts crashed in a tragic technical malfunction claiming the lives of hundreds of people. This resulted in the grounding of the 737 MAX model, causing increased operational expenses and a damaged consumer reputation. To top this, the coronavirus pandemic began in March of 2020, effectively halting the entirety of air passenger travel, damaging two of Boeing’s most critical segments are BCA and BGS. The aerospace and defense industry was arguably one of the hardest-hit industries from the pandemic, and Boeing was one of the most affected companies because of the increased effects from its previously mentioned situation. A lot of companies recovered in 2021 and the industry is set to recover sometime in the next 1-2 years. In fact, commercial air travel is expected to reach 80-90% of its pre-pandemic levels in 2022, and the global commercial aircraft market is expected to grow at a CAGR of 5% into 2027. Boeing has not recovered like the rest of the industry but is expected to return to profitability in 2022.
Let’s look at the valuation of Boeing. Using comparable company analysis and discounted cash flow analysis, we have valued Boeing at an enterprise value range of $138.2 billion to $195.7 billion. The range limits were determined using the midpoints of the mean and median enterprise values from all valuation methods. With this range, Boeing is fairly valued at an enterprise value of $163.7 billion and an implied enterprise value of $166.9 billion. From a price per share perspective, Boeing’s valuation range is $135 to $233. At a stock price of $176.23, Boeing is trading at multiples of 2.3x Enterprise Value(EV)/Sales, 17.7x EV/EBITDA, and a forward P/E ratio of 18.9x. This is fairly in line with industry averages, but there is a lot of upside potential if Boeing can improve its margins and perform more closely to the rest of the industry. Here is my pitch to CEO, Mr. David L. Calhoun, on how the company can capture this.
The Boeing Company Strategic Consideration
It is important to recognize a couple of things to make the best decisions for Boeing: Boeing is currently in a restructuring phase, margins are significantly lower than its peer group, and the company’s debt to equity ratio is below the industry average. It was pointed out earlier that Boeing has reported three continuous years of negative earnings, which is why Boeing needs to restructure. The peer group median for Gross margins, EBIT margins, EBITDA margins, and Equity/Capitalization is 18.0%, 10.5%, 13.4%, and 81.4%, respectively. Whereas Boeing’s margins are 8.6%, -0.8%, 2.6%, and 63.3%. As a result of operational difficulties, the company’s cash flow has suffered, and they expect cash provided from operations to continue to be negative.
With proper strategic consideration, Boeing can address and resolve each situation. Currently holding $59.6 billion in net debt and $104.1 billion in equity, raising $19.9 billion in equity can raise its equity/capitalization ratio to 68.6%, initially. This would mean the issuance of about 111 million shares at an average price of $178.56, which would dilute shareholder value, but if Boeing can implement my next recommendation, earnings per share can recover tremendously. With this extra capital, Boeing should reinvest this back into the company. Increase the spending on research and development(R&D), increase spending on capital expenditures, and pay back additional debt.
It is critically important to improve the business from a fundamental and operational level before engaging in any complex measures such as acquiring another company, buying back shares to support the stock price, or even issuing dividends (this is not as complex, but still takes capital away from the business). These are all strategies that I would highly suggest Boeing reimplement, but only after reinvesting in itself to build back to a level where they can fully take advantage of these other options. Through focusing on recovery, The Boeing company can grow significantly higher than rushing into things, similar to a sports injury. If a basketball player tears their ACL, they do not just shrug it off and play the rest of the season. Instead, they risk surgery, take time to recover, and learn the fundamentals over again so that when they make their return, they can improve from where they left off and are less likely to reinjure themself. Boeing needs to risk diluting shareholder value, take the time to invest more in its own business, and build back their earnings per share. However, from my analysis, this recovery may not be as long and grueling as expected.
If Boeing increases R&D by 1% (for example, instead of 2.5% of net revenue, spend 3.5% of net revenue) each year from the standalone basis, increase capital expenditures to 60 basis points more than the standalone basis in 2022, then 50 basis points in 2023, and 40 basis points the following years; I predict that revenue will grow two percentage points higher than current expectations each year and COGS will begin to improve 2% each year starting 2023 from the standalone case. Additionally, the inventories days turnover rate will improve by 30 days due to the company’s improved ability to properly develop, deliver, and sell their products. On the debt side, I recommend that Boeing spends an additional $2.0 billion each year on paying down debt which will improve Boeing’s recently damaged credit rating, and gradually improve its equity/capitalization ratio to more resemble its peer group over time. As a result, Boeing’s cash flow from operations will turn positive; free cash flow will increase, earnings per share will be significantly higher than the standalone basis (see the presentation for specific numbers each year), and possible share price of $396.72 in 2026 taken from a P/E ratio range of 15.0x to 21.0x and EPS range of $14.85 to $28.94. This also makes room for the reinstatement of share buyback and dividend programs (discontinued in 2020) as well as starting the process to grow through acquisitions.
Summary Recommendation
Raise $19.9 billion in equity to align capitalization with its industry and use the proceeds to improve margins and operations in business as well as increase debt paydown. Reinvesting proceeds into the business will increase profit margins, improve working capital, provide better cash flow, and cause higher EPS for the foreseeable future.
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