The FCF 5: Does Boeing Pass these 5 Free Cash Flow Tests?

Industrials have increasingly caught my attention. Roper Technologies(NYSE:ROP) and a comparison between Honeywell (NYSE:HON) and United Technologies (NYSE:UTX) preceded a couple of “FCF 5” articles on Lockheed Martin (NYSE:LMT) and Dover Corp (NYSE:DOV). Here I turn again to another “FCF 5” review of an iconic industrial giant. Which one? Fellow aerospace and defence company Boeing (NYSE:BA).

Boeing to me (and I am sure many others) immediately conjures up images of commercial passenger planes. Iconic planes like the Boeing 747 Jumbo jet come to mind. Yet most recent 777 and 787 “Dreamliner” planes hardly fail to ring a bell for most people.

Yet this is not all they do. Indeed, this article was stimulated by a comment regarding my previous Lockheed Martin article by fellow SA contributor Travis Brown who highlighted Boeing’s activities in the area of space tech (he alsowrote an article on it). Certainly a quick look at the breakdown in revenue shows that, although commercial airplanes dominate, Boeing operates in a number of other segments:

Nonetheless, with secular growth in consumer air travel continuing at a rapid pace in recent years, it is little surprise to find that it is the commercial airplanes segment that continues to contribute most to growth. Since 2011, it is this largest segment that has outperformed:

Indeed, since 2011, $100 in revenue in the commercial airplanes segment has grown to over $182 in 2015. In contrast, only the Global Services & Support segment has managed to end 2015 with more revenue than 2011.

Since late-March, negative news flow has seen its share price drop back from about $136 (near where it started the year):

BA data by YCharts

How attractive, however, is Boeing as an investment? And does this share price drop offer a buying opportunity? Here I plan to take a quick look by focusing on its FCF (free cash flow) profile.

Boeing is going to pass through my five FCF tests. These tests form the first steps in my analysis of a company. Although far from exhaustive, it gives me a good indication of its competitive advantages, its FCF health and efficiency as well as the debt and dividend position. Fair value based on FCF alone is also calculated.

These tests merely mark the first step in what may develop into a more thorough analysis of the business in the future. So let’s get started.

1: Positive FCF

First things first. A straightforward one. All I look for to begin with is that the company has produced positive FCF for the last five years. Here Boeing does well:

Since 2011 Boeing has generated positive FCF consistently. 2011 itself is a bit of an anomaly. Boeing’s FCF was much lower that year due to changes in working capital. Since 2011 changes in working capital have been positive which have accentuated the effect. Yet in 2011 (and indeed 2010) it was deeply negative:

When discussing Lockheed Martin before I noted that this is quite common for such companies. The big-contract-heavy nature of their business often causes this to occur with a significant degree of variability. If we adjust for changes in working capital we get FCF figures like this:

As you can see, this smooths out the growth over the last five years. In this article, I plan to include both “ordinary” FCF and “adjusted” FCF figures for you.

No matter which “FCF” figure you prefer, Boeing gets a comfortable PASSfrom both at this stage.

2: CROIC: Cash Return on Invested Capital

Next we turn to its cash generating efficiency. Here I use the CROIC — or cash return on invested capital — to give me some pointers. CROIC takes FCF and divides it by the sum of the company’s debt and shareholders’ equity.

A CROIC of 10% or more is what I am looking for here to pass this test. This would mean that for every $100 of capital invested in the company, it would return at least $10 in FCF.

So, how well does Boeing do? Well, very strongly indeed:

Taking ordinary FCF Boeing averages a CROIC of about 31% over the last five years. Excluding working capital changes and this dips to about 28.5%.

Again this see Boeing easily producing a cash return well ahead of my target. As such, Boeing earns another PASS here.

3: FCF to Debt Ratio

Debt is the next focus. What I want to see here is total debt to be covered at least 25% by FCF. In other words, in theory, the company could repay its entire debt load in four years using just its FCF. So how does Boeing do?

Well, Boeing has decreased its debt levels since 2011. Indeed, 2015’s debt was about $2.5 billion (or about 20%) lower than in 2011:

Combined with growing FCF over the same period it leaves Boeing with very strong looking FCF debt coverage:

In 2015 they saw their debt covered nearly 70% by FCF. Excluding changes in working capital, the coverage still sits at an excellent 51%. This means in theory it could repay its debt load in less than two years just using FCF.

For me that is comfortably above my target of 25%. Consequently, Boeing has pulled out another PASS here.

4: FCF Yield

Now we come to the all-important dividend. In order to pass this FCF test, Boeing needs to produce a FCF yield (that is, the yield if all its FCF was paid out as a dividend) of 3.5% or more. Similarly, I like to see a FCF payout on the current yield of 75% or less.

After all the adjustments above, here I am going to focus on the standard FCF figures (with changes in working capital included).

Does Boeing manage to pass these tests? Yes, it certainly does:

With a FCF yield of over 8.1% and a payout ratio down below 36.9%, Boeing easily flies past my dividend targets. (For those curious, excluding working capital would have produced a FCF yield of 6.04% with a FCF payout ratio of just 49.7%: still a comfortable pass). Therefore, Boeing has a pretty generous 3% yield, which is well-covered by FCF with plenty of scope for growth. Great news.

Boeing puts together another excellent PASS.

5: FCF Valuation

Finally we come to the matter of valuation. Here I use the enterprise value to FCF ratio. The enterprise value is the company’s market cap with debt added and cash subtracted.

Over the last five years its EV/FCF has averaged 15.84:

Now I use this EV/FCF figure and multiply it by my FCF predictions over the next two years. I get these predictions by taking the five-year average FCF/Revenue ratio (5.9%) and applying this to the consensus predicted revenue over the next two years. I then average these two predicted FCF figures and use it to calculate a fair value share price based on the historic EV/FCF valuation.

Doing so suggests that Boeing’s FCF fair value sits at around $135. That is about 5.5% higher than today’s $128 share price.

On the valuation front, therefore, Boeing again manages to achieve a PASS.

Conclusion

Boeing did very well against my FCF tests. Indeed, it passed all five quite comfortably. I was actually rather surprised by this. Sure, I was not surprised to see it sail past the first four. Yet the valuation test pass was not expected after both Lockheed Martin and Dover Corp failed on this last hurdle.

Boeing, therefore, looks pretty attractive to me. Certainly, I plan to look a little more deeply into the company taking in more than just its FCF metrics. The reality is that it is a dominant brand in a number of industries with strong economic moats. These are all attractive traits that help it to produce the compelling FCF figures seen above. Combined with what appears to me a not unduly expensive share price at present and robust yield, Boeing could prove a lucrative long-term income buy right now.

There is still more I’d like to look into about the company before I settle on a concrete conclusion. Yet, at this stage, Boeing looks like a compellingly high-quality business in a robust and attractive industry.

Notes

Unless otherwise stated, all graphs and tables and the calculations contained within them were created by the author. Creative Commons image reproduced from Flickr user Wesley Nitsckie.

[via seekingalpha]