Chit Chat Stocks - Boeing (Ticker: BA) Not So Deep Dive

Episode Date: May 23, 2023

Boeing (BA) is a global aerospace company that manufactures commercial airplanes and defense systems but has encountered setbacks such as the 737 MAX grounding and pandemic-related impacts on the aviation industry. At the end of the month, we will publish an Arch Capital episode that will cover the company: Dropbox. Listen closely as Brett and Ryan go through the history, financials, and future prospects of Boeing. Enjoy the show! ****************************** Subscribe to our Substack to receive free show notes and charts that go along with every episode: https://chitchatmoney.substack.com/ Want updates on future shows and projects? Follow us on Twitter: https://twitter.com/chitchatmoney Contact us: [e-mail] Timestamps Company Background | (2:03) Industry | (19:45) Management & Ownership | (24:25) Earnings | (32:40) Balance Sheet | (38:37) Valuation | (41:47) Our Analysis | (43:17) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guests is not formal advice or a recommendation. Now, please enjoy this episode. Welcome into Chit Chat Money. My name is Brett Schaefer, and I'm joined by my co-host, Ryan Henderson. Today is our Tuesday not-so-deep-dive episode where we analyze

one stock by covering its business model, ownership, financials, future growth opportunities, and much, much more. Today, after listening to the episode, we hope that you'll get a better perspective on a company that you're maybe researching or get inspired to research further. Also, side note, I know a lot of people ask about this when looking at either watching the video or when we share the screen or reference any charts that we're looking at when doing analysis later in the episode. If you want to see those charts and read them maybe after you listen or before you listen you can subscribe to our free newsletter which is linked in the show notes wherever you are listening okay today we are covering boeing a company that i think every

listener has heard of and if not you have definitely well not definitely but have likely seen one of their products before i think this is yeah the last step yep this is the last one in our defense and aerospace month so if you like any of these type of companies we covered rocket lab last week and then general dynamics the week before and next week we're kind of going to be covering dropbox but that's getting ahead of myself ryan let's talk about boeing first section what do they do and what is what is their history boeing is one of the world's largest aerospace manufacturers or you'll see the term oem original equipment manufacturers for the aerospace industry basically they build aircrafts they also build some other stuff but the book their business

is building aircrafts um and similar to general dynamics which we talked about earlier this month month they're probably known for one thing which in this case is uh airplanes but there is a lot under the umbrella that is not just manufacturing airplanes so we'll talk about that as well but they split the business into four parts so the first one and this is what most people probably think of when they hear the name Boeing is commercial airplanes so uh abbreviated as BCA This segment develops and produces a range of different cargo and passenger jet aircrafts, and it's all for commercial customers. And last year, they delivered 480 planes in total, or about 40 planes a month.

Back in 2018, they were delivering substantially more planes. We'll talk about the history here in a second. The majority of those planes are 737s, which generally carry less passengers. And there's a range of different 737 models, but it's a single aisle configuration. It's anywhere from usually 150 to 200 passengers. And then the other, and those account for about 81% of their deliveries. And then the other largest is a 787s that accounts for about 6.5%. This is more of a wide body plane, but really the bulk of the commercial business right

now is just the 737 model. yeah and but for reference the 787 will have higher revenue per unit but yeah it's still not gonna it's not gonna be that much to outpace the 737. and then the on the other side they and i've attached a visual that they had in their investor deck for anyone that reads the sub stacks or whatever and it just goes through the different models of planes they have just basically just think that they have freighter planes so cargo planes that they sell to commercial customers as well, but really the bulk of the commercial airplane segment is the sale of 737s and 787s. There's some other ones in there as well, but I mean, it's mostly that. And then this segment

as a whole accounts for 39% of revenue. And then I'm going to reference 2018 probably a couple of times throughout the show, because I think that's the year when... That's the last year financially where the reporting was at its peak, I guess. Operationally, they were at their peak. So I would call that the last normal, I'm putting normal in air quotes, year. So in that year, BCA or commercial segment accounted for 65% of operating income. So when this segment is really humming along and kind of at max productive capacity, it drives the majority of Boeing's business. Right now, it is losing money, but that's for a plethora of reasons, which I'll get into later. But the second segment here is defense space and security. So this is the defense

contractor side of Boeing. They design and produce a number of vehicles and weapons for the US government and some of its allies. This includes fighter jets, helicopters, missile defense systems. I attached another visual here, but just basically think government aircrafts and different government air vehicles, as well as weapons. The margins are generally a lot thinner. It's kind of like general dynamics, how we talked about the cost plus model where you're basically, and some of them are fixed price contracts where the margins can vary, but they have a lot of cost plus contracts where the government just pays you the costs of development and then plus a little margin on top. So the margins are thinner, but it's

more predictable. That accounts for 35% of revenue and about 13% of operating income in 2018. So at kind of its best. The last segment, and Brett, feel free to pitch in here if you have anything else you want to add. Last segment here is just global services. This refers to the aftermarket services that Boeing provides for its customers, both commercial and government. These include things like spare parts, maintenance and modifications, engineering support, pilot training, really anything. I mean, after you buy a plane from Boeing, there's probably a whole lot of different services that you're going to need after that. It isn't just kind of a one-time, all right, we'll take it and do our own thing. You're going to contract out to Boeing

and say, hey, there's a spare part we need. Can you find this? Can you supply it? Can you help our pilots get up to date? All that kind of stuff. That's a much higher, well, not much, but it's a higher margin offering for Boeing. So in that 2018 year, it accounted for 21% of operating income, despite being a much smaller chunk of revenue. And I don't know if I put it down here, but I believe it's mid-teens percentage operating margin as opposed to commercial at its best was like 12% operating margins. Anyway, that segment is just a lot more predictable for Boeing and more profitable. And then the last one here, and I know I'm going a little long, but this is Boeing Capital. They have to break this out just because

it's basically its own arm, but it's tiny. It's 1% of revenue, less than 1% of operating income. It's just helping their customers finance the purchases mostly of Boeing's products. So just giving them, extending them loans to acquire it, and then they pay it back over time. Sort of a buy now pay later of Boeing side. I guess. Yeah. But it's a, yeah. For any, any investor, it doesn't really matter. Exactly. And then I want to talk, so we live in the area, like the Seattle area and Boeing's really prominent here. This is a business that we probably either know a lot of engineers at, or just know people who work there. And so I do want to give some context on the size of Boeing's physical footprint, because I think it helps

paint maybe a picture around how difficult this would be for another company to replicate. So Boeing, as of the last 10K, had roughly 87 million square feet of floor space. 65 million of that, or 75%, is owned by Boeing. A lot of companies will lease the majority. Boeing actually owns the majority of their property. So for reference, that is more than 1,500 football fields to paint that perspective for anyone that wants to think about it that way. And then it's also more owned space than Amazon. Amazon has a lot more space under its leases, but in terms of true ownership of their space, Boeing has more than Amazon. Other important thing that's important to understand for Boeing is that, and this is really important as of late, it's a very global

business they have not only customers but suppliers all around the world they have a lot of suppliers from asia a lot of suppliers in china which did have some in russia not they did yeah they uh what was it titanium that they were mostly sourcing from there um but they uh they've had to relocate a number of their uh suppliers there's been a lot of near shoring a lot of reshoring that could lead to potentially some increase in cost of goods sold um but i i guess it's just important to understand that also we're at risk yeah also selling products to china they i believe and again this isn't going to be too important for the episode but there's two like i don't think the chinese are buying boeing products at the moment or if they're specifically

not buying the 737 max if you're really interested in the stock i'd probably look at that more closely and well actually in their guidance they say that they're basically getting for no china recovery and then also the chinese government are trying to build their own airbus which ryan might be getting into the history here yeah and i'll say that there have been a lot of governments over the last century that have tried to compete and it's not just a capital problem trying to build like an actual competitive uh airplane manufacturer it's very much like an expertise issue and trying to get up to the same level of quality and and uh yeah or like well maybe up to the last five years but we'll get into that and it's similar probably to taiwan semiconductor

Yeah, agreed. Anyway, I'll briefly explain how Boeing was founded, but there are a lot of better resources out there for Boeing's full history. There's so many articles now, documentaries, books written, especially after the recent crashes about kind of the full history. So feel free to just check those out if you want, but I'm going to try to focus more on the last five years. However, just kind of for founding story context, I think some people maybe find this interesting. In 1916, an American timber merchant named William Boeing founded the Pacific Aero Products Company in Seattle, Washington. They got their start as a government contractor. They were building flying boats for the Navy, basically seaplanes, but they call them flying

boats in World War I. Over the next, I'd say, three or four decades, they acquired and slowly evolved the business into the kind of commercial manufacturer that they are today. I'm going to fast forward here to 2017 because I think that's when, if you're an investor or you're considering investing, that's the history you should probably most be concerned about. So entering 2017, the 737 MAX 8 was a plane that had a lot of buzz for Boeing. It was a single aisle configuration, could seat more than 180 people. They were allocating a lot of their production resources to this model. And their first delivery was May of 2017. They put it in their investor deck, kind of bragged about it, very excited as they kind of should be.

And then by the fourth quarter of 2018, so I guess that's probably five quarters past their first delivery, they were delivering 40 737 MAXs each month. So they really ramped up production quickly on that business. However, as a lot of people probably now know, on October 29th, 2018, Lion Air 737 MAX plane crashed in Indonesia. It killed 189 people. The FAA and Boeing both went in and evaluated it, and they said, we're going to try to push out a software update in the next six to eight weeks. However, shortly after, four months, I think it was about four months after, it was March 10th of 2019, another 737 MAX plane crashed, this time killing 157 people. This was Ethiopia Airlines. And three days later, the entire 737 MAX fleet was grounded.

Less than a month later, officials said, and at the time, people weren't sure kind of what the impact would be. they said that the max could be grounded for as long as two months. Well, it wasn't until 20 months had passed. It was November of 2020 that the FAA officially lifted its grounding orders. So they just kind of slowly... And I was going through the different investor decks from Boeing over those kind of during that time period. And it's like, okay, we're cutting 20% of the 737 max production. Okay. We're going to do a little more. Okay. We're not producing any 737 maxes. And it was just a slow grind down of that entire fleet, which was a big part of their plans for probably the next five to 10 years. And then in the meantime, COVID hit and completely halted air travel.

Customer orders halted. Or reversed even. Yeah, and in a lot of cases reversed. And by the third quarter of 2020, Boeing was delivering just 28 commercial planes for the quarter or every three months versus the Q3 two years prior to that, they were delivering 190 planes. So basically 80% reduction. Yeah, on the same fixed cost. Yeah, so the same physical footprint. Yeah. I mean, there were obviously layoffs associated with COVID as you would expect, but they didn't do, I mean, they still have a massive employee base. I think it's grown over the last two years. So yeah, the fixed costs were huge and they're delivering essentially 20% of the planes they once were. This led to them burning $20 billion that year.

um fortunately they were able to get some financing cheap financing at a time when they really really needed it i think if this would have happened in any other time period when interest rates weren't where they were um it maybe would have been catastrophic for the business but they were able to raise um yeah i i think they would have been able to raise some very a lot of equity, or they could have raised a lot of cash from equity offerings, but they might have been very poor deals for outside shareholders as it probably would have been heavily diluted because I could see a lot of banks, a lot of investment banks saying, look, we'll give you an equity offering. And personally, my gripe was that I think the government should have forced them

to do this during the pandemic instead of giving them money. They would have done it, but it would have been a really sweet deal for the investment banks or any sort of other financier out there. Yeah. And then I guess two other important points in Boeing's history, and I'm going to ask you a question associated with this. In 1997, Boeing acquired McDonnell Douglas for $13 billion in stock. And then four years later, Boeing relocated its headquarters to Chicago because according to the CEO at the time, it was, and here's a quote, a location central to our operating units, customers, and the financial community, but separate from our existing operations. They intentionally separated themselves

from their manufacturing side. And there was just this, I think it marked probably a transitioned focus to making shareholders happy. But my question to you is, what do you think was a more pivotal moment for the company's culture was it that mcdonald douglas acquisition because apparently that was an integration nightmare and that was i people should watch the netflix documentary we'll have a link in the newsletter i believe if you search boeing netflix documentary it'll pop up that was do you remember if that's when they said that like accelerated the quote-unquote mbaification of the executive team was the mcdonald douglas integration Yeah, I remember them saying that basically just marked this huge shift in the culture.

But do you think that was a bigger moment? Or do you think the move to Chicago kind of marked it? I think that probably impacted the Chicago part. But I think Chicago was much more important because they detached themselves literally physically from their important employees, the engineers, the manufacturing team, the quality assurance team, all that stuff. And they talk about it again. in the documentary i remember in seattle they basically used to bring this up once every single day in the news when there's union talks about the chicago headquarters they go oh the executive team in their chicago headquarters said that you know it's it's a whole big thing

but yeah it is kind of an interesting i mean maybe if the next 20 years didn't play out like the the way they did you wouldn't have have thought much of the shift, but now you look back and it's such like a point in time you can literally point to and just say, here's the shift. Here's when the focus moved to pleasing financial analysts over building high-quality planes and not trying to guide for the specific quarter. Yeah, exactly. I'll hit industry and competition.

I will have more, and I'm sure Ryan will as well, to say on the management team and the specifics once we get to the highlights and lowlights, but we kind of want to give context on how the business works and what their ownership structure and management structure is first. But yeah, let's hit the industry and competition. The commercial aircraft market right now is valued at over $100 billion a year. Boeing projects it to grow at 3.8% annually. I think the number I pulled out might have been only North America and Europe or something like that. But either way, it's a large market opportunity and as we'll discuss later, or actually I'll discussed right after this, the competition is just one other company. They project demand for

around 40,000 new planes around the world for the next 20 years. And again, as one of the only manufacturers out there, a lot of this demand can go to them if they can grow their production rate and get back to that 200 a quarter or something like that. Yeah. And then they also think that the cumulative revenue opportunity for them within the commercial aircraft production market is in the trillions of dollars from now until early 2030s. For defense and aerospace, which again, as Ryan mentioned, is a significant part of this business from a revenue perspective, but from an earnings perspective, a little bit less so, but can still drive losses and cash flow for the company. They are basically selling similar to how we discussed with General Dynamics

to the US government and its allies. If you listened to that episode, go back and listen to that. Or excuse me, if you haven't listened to that episode, go back and listen to it. There's a lot more details on how that industry works. I would reference the chart for the market opportunity as basically showing that the US government spends around $850 billion or more per year on the Department of Defense. So there's a huge market opportunity there. If we look at the competition in aviation in the 10K, Boeing says things all the time, and Ryan can attest to this as well, that the aviation field is highly competitive,

but they only named one competitor and that is airbus which is the european champion they also mentioned china a few times who is trying to build like i mentioned before and subsidize its own state-run aircraft manufacturer but they haven't had much success here the question i want to ask is i think some people know this but maybe other investors that are just getting interested in this company will be uh i don't know want to know why does this industry have such high barriers to entry well i mean there's an i think there's a number of reasons probably the first one is it's expensive to build it's expensive to build a plane it's very expensive to build a lot of planes at the same time um not only do you have to like you know afford the

equipment. You also have to afford the labor. You have to buy the talent. In some cases, there's single departments or people at Boeing where it's really difficult to replicate that expertise that they've developed over 20 years. There are examples where China, I believe, has tried to re-engineer existing planes from boeing and they can't it's i mean there's like i guess i don't know the specific reason why it's impossible to do this but it's just a number of the i mean the scale the size the labor the expertise support staffs at all the different airports and wherever you're working on planes as an airline customer relationships yeah yes i think there's a number of reasons it's difficult to replicate yeah it's got a extremely high boat which was definitely a

bet it's a huge benefit for the company but was also probably part of its lacks you know how it kind of lost track of itself over the last 20 years we look at uh the competition in defense and aerospace uh or basically just defense and space there are many companies there's lucky martin there's raytheon spacex even rocket lab which we discussed last episode as a startup in the space industry. They actually have a partnership with Lockheed Martin and Spaceflight called the United Launch Alliance. It's only mentioned four times in the annual report. The Boeing stake is valued at $587 million on its balance sheet, so not too relevant, but something I may need to track or keep an eye on, see if there's any development there.

But this industry is much more competitive. It's not a hyper competitive industry. There's only a handful of companies and then some startups that are trying to get funding to inch their way into the market, but it is much more competitive than the aviation market, which just has two companies. All right, let's move on to management and ownership. I think this is important here for this company. The CEO of Boeing today is David Calhoun. He was appointed in early 2020 after those 737 MAX disasters and the poor execution from the prior executive teams. as a highly technical company i think it is important to look at the biography of boeing ceo and their technical expertise or lack thereof calhoun graduated from virginia tech with a degree

in accounting he then worked at ge for 26 years then nielsen holdings then blackstone so he's not a stem executive or a stem person which by that for anyone that knows the science technology engineering medicine, I think medicine, whatever. I think it's medicine, but either way, he's not an engineering or manufacturing CEO. He's very much an MBA executive. If you want to put it that way, I find this to be a big negative when evaluating Boeing as a potential investment. I also didn't like, and it may be, look, they moved their headquarters from Chicago to Virginia just recently. And I think that makes sense because you're close to the government, right i think that's important for a company like this but also i didn't like that this guy

is from virginia tech they just wanted to be close to his college i found that to be a bit uh not like a huge deal but i was like why why virginia why virginia tech why are we moving close to this campus huh what do you think brian is it a big negative for you that this guy is just a ge accounting guy and then a blackstone guy i'm yeah i'm probably more wary of him being the whole jack welch disciple kind of a ge guy um as opposed to the headquarters relocation i'd be surprised if it had that much to do with him going to college in the area um It's a coincidence though. I got to say that's a coincidence.

I listened to an interview with him and I think there's a whole bunch of people that came out of GE that are like the blueprint for what you don't want as a CEO. And Jack Welch did a good job there, but I think he also deferred a lot of problems and you really can't have that at a business like this. i think you're right i think you need an engineer at the helm i think you need to stay in touch with the manufacturing side of the business as much as you can um and live and being in virginia or being in chicago when the bulk of your business is in south carolina or and seattle yeah seattle i don't know yeah i don't really like that and then you're about to get to the proxy but i really didn't like that either okay yeah i'll get to that now so like uh i don't think we need to talk about the board of directors pay as people might expect uh they get paid highly

but it's not gonna matter for a company that's such a big one like boeing to look at executive compensation and say with me everyone that's listened to all their shows they have base salaries annual bonuses and long-term equity awards and you can guess it they use a compensation consultant that we have found employs the same uh they give the same strategy to every company um i'd also like to look at this quote because i think what's interesting about boeing is yeah they've had some hiccups one was definitely self-induced the 737 max disaster one could be a bit of excuse the covet 19 pandemic so their earnings and financials and all their hurdles that they're supposed to hit have been low for their annual bonuses and their equity

awards but here's a quote from their annual report or excuse me the proxy statement quote as was the case in prior years and to better reflect the core operating performance of the company the compensation committee retained discretion to adjust the results under one or more of these metrics to account for blah blah blah it keeps going what this means is that they lowered the hurdles for getting their bonuses because the results were worse and they're blaming the macroeconomic environment. Maybe that's true. The macroeconomic environment was poor, but I don't think that means you should be getting bonuses. Call me crazy. The annual bonuses are a bit complicated, but generally, they go down to earnings power,

free cash flow stuff, not a huge concern there. Combined, the company hit its free cash flow targets last year in 2022, missed its earnings targets, but they still got over 100% of the annual payouts one question i have here is when i focus on free cash flow and maybe we'll talk about those when we get to the balance sheet are they rewarding themselves for depleting inventory because their inventory has grown a bit over the last few years yeah it isn't down that much in 2022 but there were some other let's call it tricks um yeah build up of accrued liabilities uh funding 401k contributions with treasury stock right yeah good point um to boost cash flow so yeah it's slightly concerning it just makes me kind of sick to my stomach to just picture this

boardroom when they're like all right here were our goals for the year and they're like we didn't meet any of them all right let's reduce them let's reduce them and uh good job team great year Or why don't we actually make adjustments for all our costs that were real costs and just pretend they didn't exist? Yeah. And then for anyone that's going to read the newsletter, I'm going to put in backlog and inventory as a long-term chart because I think that's important. Their inventory has risen since before the pandemic and before the 737 MAX disasters. The only other thing I have in management ownership as we try to move along here is that total executive compensation was $59 million over five named executive officers in 2022. Although they did change one out, so they technically had six people on that list, but they have five named executive officers.

They have minimal insider ownership. They have large employee ownership via this Newport Trust Company. It's a little bit confusing, but that's what I believe it was. I did a little bit of research into that. So the employees own 7.4% of this company. I think that's probably a good thing over the long term. The union can be, hey, look, we want the stock to do well. We want to keep management aligned.

And they've tried to do that, I think, but have been unsuccessful until the 737 MAX disaster hit a boiling point. Here's the question I want to talk about before we move on to financials. Is it possible for the cultural problems at Boeing to get fixed? Ryan, I know it's a giant question, but what are your thoughts? Do you lean yes or do you lean no? Yeah, that's tough. I think it's possible.

I don't think Dave Calhoun is the guy. I agree. I think having some, and maybe I'm wrong about him. Maybe it's just kind of his resume that gives me an icky vibe. Um, I think I was not a fan of, I read that book. Um, I forget what it's called, but the, the one about how GE kind of fell apart. Oh yeah. I mean, and he's probably a part of that, right?

Had to have that. Yeah. I think he left when he wasn't chosen to be Welch's successor. Um, I could be getting some of this wrong, so I don't want to talk too much about it, but it just, it feels like the guy who looks like he's great for the job, but can really masquerade issues under that are going on i think you do need an engineer at the helm i think you need someone who's like maniacally focused on production and the production side of things and i'm just not sure calhoun's that guy yeah all right we'll talk about that a little

bit later as well yeah because we think it i think it's probably the most important part of this episode in this company but let's move on earnings ryan this is a tough one there's a lot of numbers, a lot of moving parts. So what are the important things for any investor to know about when at this... They're coming out of the crossroads, but it's a weird time for the company financially. Let's put it that way. Yeah. And adjustments galore on this one. Speaking of GE, hey, right? Yeah. I guess do what you got to do to get that bonus. But 67 billion dollars in revenue for 2022 that's up seven percent year a year production improved but they are still at a fraction of the size they were in 2018 in terms of how many units they're

moving uh this year they generated three and a half billion dollars in operating losses that's minus five percent operating margins all of this is an improvement over the last kind of two years but still significantly reduced relative to what they once were. And obviously they have to get to profitability if this investment is going to work. Negative $5 billion in earnings before taxes. This is important because we're going to talk about the balance sheet in here in a second. They took on a lot of debt during the crisis and the operating income does not encapsulate the interest expense, which is big for them.

It's a big chunk. You can see there, the discrepancy is a billion and a half dollars between operating income and earnings before taxes. So important to kind of look at either, I would use probably the earnings before taxes figure because they are probably going to have some tax offsets, thanks to all the losses they've had over the last couple of years. So I think that's probably a good figure to use. However, as we talked about, there's a big discrepancy between gap earnings and operating

cashflow. So they had positive $3.5 billion in operating cashflow. However, as I kind of look through it, my initial thought was, okay, they had a big buildup of inventory. They weren't delivering any 737 maxes. So they were probably sitting in different hangars waiting to get delivered. But inventories really didn't come down a whole lot. Instead, one of the biggest differences is depreciation and amortization, right? That's a gap figure, but it's not accounted for in the cashflow statement, they have $78 billion in aircrafts sitting on their books. So naturally there's going to be some depreciation obviously there. Stock-based compensation was a fairly big one, but the other one was they, I want to make sure I get

their explanation for it. They said they issued $1.2 billion worth of treasury shares to fund the company's portion of 401k contributions so essentially sbc yeah yeah i kind of think about that as sbc now i do think maybe that's the right move and keep in mind they do like i think they have a 401k match program probably so there you know it is a positive i guess for employees um but and doing it in stock at a time when the company needs the cash maybe that makes sense But when you're compensated on certain free cash flow targets and you hit it because of this, it kind of just, I don't know, it makes me think that maybe it wasn't all well-intentioned, I suppose. Other one here is the buildup of accrued liabilities. They recognize there's something called forward loss recognition, which is accounted for in their gap statements.

It's basically just losses that they haven't booked. So that was a buildup as well. Basically, cash flow is positive because they've done a decent job managing their balance sheet, which is good. Right now, they need the cash, but that is not shareholder earnings. You shouldn't look at that as a proxy for cash that's available to you as shareholders. I guess for this year, they're projecting $3 to $5 billion in free cash flow. They want to hit $10 billion in free cash flow by 2026. maybe 2025 they said either or but they're probably going knowing them 2026 yeah and then

the total backlog is 411 billion dollars i mean the backlog's strong uh demand i mean travel demand is still quite strong which means airlines are they want more planes they're signing a lot of contracts the press releases the that's like the biggest highlight right now ryanair huge contract saudi arabia airlines turkish airlines love stanza a lot and i mean well they're the only place that people can go outside of airbus so yeah i mean the demand is there it's a matter of getting productive capacity uh we should talk about they did something yeah they stopped something they found a problem with the 737 a very small one that they addressed yeah something um that wasn't like a safety concern apparently although i don't know how

much i want to trust them now because they are a bit of a boy who cried wolf but they said that's gonna be a hiccup in production for the next few months so definitely track that because they've gone from saying things are going to be a hiccup in production for a few months to two years and yeah it seems like the problem they said was solved but it also watch keep watching yeah they did not have to, and they made sure to clarify, they did not have to retrofit the planes they had already delivered. It was planes that they were building out currently. But yeah, they've said before, the 737 MAX could be grounded for two months and it was grounded for 20. So that wasn't really up to them as much, but it seems like production problems keep surfacing, which

which is, I mean, that's going to determine what their profitability levels are. As for the balance sheet and liquidity, they've got $15 billion in cash and short-term investments. As for inventories, they've got about $78 billion in inventories on the balance sheet. That didn't come down much year over year. However, relative to 2018, they were operating with about $63 billion in inventory. So it is elevated. I imagine some of that might just be price increases over time. And I don't think they gave a figure on how many planes or units they're holding, like what that equates to, but just something to keep track of because it leads to typically a big difference between the cashflow and the gap earnings. Liabilities though, this is probably

based on current numbers, the most heavily indebted business we've looked at on the show, they have $55 billion in total debt. $8 billion of that is short-term. However, pretty much half of that debt is due in 2059 and 2060. And that accrues interest at a fixed rate between 4% and 6.6%. Who signed that deal? The other side of it. A good deal for Boeing, I think. Yeah. I mean, good on them. And I think it's a testament to probably the durability of the business. But over the last 12 months, they've only generated $2.6 billion in EBITDA. So if they're going to continue to have production problems and that's their, call it normalized EBITDA, and if it is, this stock's going to come down a lot. But that would imply a net debt to

EBITDA ratio of 15 times. However, if you believe that they can recover back to the 2018 levels of profitability, they were doing like $12 billion in operating income that year, that'd be three times net debt to EBITDA. It becomes much more manageable. The interest expense wouldn't be too crazy given that it's fixed rate. And I guess the bummer is that they have a lot of cash needs right now. So it's not like they're earning... It's not like they've taken that debt and put it into treasuries and they're earning more than they pay out in interest expense, they have to use that cash and they can't really earn as much on the cash balances right now. So the balance sheet is tricky. Obviously, if they run into problems again, this is going to be a huge issue.

They've got to pay down that debt over time. But I guess my overall thoughts here are the fact that they were able to borrow 40 years into their future at a fixed 4% to 5% interest rate, probably, weighted average it's a testament to their moat if a storm of bad news hits them like it did in the last five years they're going to be in much bigger trouble and they're going to what are they going to borrow out to 2080 it yeah i don't know the government won't let it fail but we'll see what happens to the equity if that happens it's yeah and also i'll talk about this later too they have less optionality for r&d and product development all that stuff with this balance sheet than they would have had historically all right i think that's it for

balance sheet let me move to valuation quick ev right now is about 161 billion dollars if we add back that net debt if we're earnings or earning any earnings multiples it's tough because they're not you know the trailing numbers are going to make it look very inflated but they should have an inflection over the next few years i just wanted to look at what their ev to free cash flow would be if they hit $5 billion, which is one of their stated goals in trailing free cash flow. And then if they hit $10 billion, which is their 2025, 2026 goal, they hit that $5 billion goal, their EV to free cash flow at current levels is about 32. So quite elevated. If they hit that $10 billion goal, it is 16.2. So it seems to me like the market is saying that they believe the

$10 billion goal is achievable. And if you want to invest in this company, you got to think that they're going to do more um is that a good way to put it right you think yeah you have to believe that that 10 billion dollar figure is accurate and it's going up higher yeah yeah significantly most likely um all right go ahead i'm surprised this stock isn't cheaper yeah well it's a bull uh this is one that a lot of people own a lot of indexes own there's a lot of people that i think own this that don't you know what i mean there's no insider ownership passive ownership yeah a lot of passive ownership a lot of dividend funds yeah but i agree with you all right anecdotal devins what do you think brad well yeah i saw what you had written down here and i think that's

accurate at least you know we grew up in the area where boeing i think at one point in seattle they They were like an employer of like one in five or one in six people. Yeah, I think that was in 1970, but still, that's huge. Yeah, I mean, it's a huge corporation here. And I think they've always had a pretty solid reputation, at least for engineers. Big connection to the big engineering universities, yeah. Yeah, just taking care of their employees. i know a lot of people that have been for lifers there basically um a lot of kind of

tenure mentality and just like staying there for a long time uh they have a lot of good benefits take care of their employees a lot of good engineers want to be there so i i don't know i think it's still relevant if you're an engineer in today's world my concern kind of is that especially growing up around here there it's almost like this idea that they can't fail that like it's so important to the government it's so important to air travel globally that it's kind of just going to be around for a while i wonder if that's what it felt like at and very different situation the big investment banks it always feels like that before like before the great financial crisis, you know, once you're like a part of it, you think there's no way

this could go down. You probably have ownership in the business. You see all these really smart engineers around you. You kind of believe that it's better position than maybe it really is. Yeah, that's a good point. Yeah. The end elements I have is I do. And again, I was in a mechanical engineering program. So I do have boots on the ground here. Good engineers still want to work at Boeing. They dominate the university market. People talk about all the time. Did you get a mowing internship blah blah blah blah it's very hard to get it's still very prestigious for someone to get that um and work there as an engineer at least in some of the areas i think the problems likely start and begin with the fact that with the executives they have become detached

by distance and philosophy from the boots on the ground designing and building the airplanes i don't like like we mentioned before how they moved the headquarters to virginia although maybe that's a better location than chicago which seemed like the absolute worst location because either you want to be here an aviation company you either want to be near washington dc which they are now or on the west coast which is the center of aviation they were neither beforehand they were kind of like the complete you know let's make it the worst possible city to choose but that's besides the point we don't have to hit uh much on that let's move into future growth opportunities ryan what do you think here uh you have increased production which i guess simple but the most

forth but yeah i was honestly thinking of this one for a while like what to say here and the only way that they get back to like a stable business that can invest in other branches start to invest and invest more in the space initiatives and other projects and maybe uh new models things like that is to get back to better productive uh capacity and and stable earning and so that you're not worried about that. The only way to do that is to increase production. But I wonder if it's not like these people aren't doing anything. It's not like there's just a whole bunch of unused space where they're like, oh, we just got to hire more people and stuff like that. I wonder how difficult of a problem it is to really ramp that back up.

I imagine there's a lot more, I don't want to say red tape because it sounds like it shouldn't be there i imagine there's a lot more procedures safety procedures involved after the the crashes um but that's probably a good thing but they yeah they must have had like they've had a lot of technical deck do the executive stuff which we've harped on and which everyone kind of knows about at this point uh do the the changing culture that really ruined their whatever leadership and engineering but the question is can i get back to that i don't know yeah i just wonder if like some post-grad finance person through eight in their 2026 guidance said we're going to get back to 800 deliveries just to please the financial community and then they went and

brought this to some manufacturing lead and was like we need to get to this figure can we do that yeah and they're like absolutely not you know yeah or they said yeah they would i wonder if they said that or they went to the manufacturers first which they should do and say look how many planes can you get out the door that aren't you know are going to be high quality and then going with that number um i think they need to take a field trip to asia and go check out taiwan semiconductor toyota and just say hey look yeah right like let's learn from you guys they need really they've lost their touch but i'll uh i'll take one that's maybe a bit more exciting and this is the one that's only going to be possible if they get back to generating profits

from the aviation division so they need to increase production like brian mentioned that is the key thing that needs to happen and i have fully embracing space flight as their next avenue for growth i would look at that united launch alliance um it doesn't seem to me that they're taking that seriously as a company i'm sure the people working there are incredibly smart and doing good work but as a company this seems to be one of their lower priorities when spaceflight seems to be the future of the industry. It's only mentioned four times in the annual report and really only in passing to mention why their investment portfolio was written down. If I am a shareholder in Boeing or a prospective shareholder, which I guess we all are,

I want the company to stop talking about free cash flow, which they seem to mention 20 times in their investor presentation, and talk about investing in cutting-edge aerospace, spaceflight technology, taking that operating cash earnings or whatever it is, the gross profit that they generate from these production lines and invest in cutting edge aerospace, spaceflight technology to compete with SpaceX, Rocket Lab, all these other competitors. They have clearly built up technical debt over the last 20 years, like we talked about. I think it would be a very big positive indicator for me if they said something along the lines of, we're not going to lose money. We're not going to go deep into the red here, but we're going to take a lot of

our cash flow and double our research into these future end markets. Because again, I'll mention it by lowlights, we haven't heard a peep about a new product from the aviation line. And it seems like that's something that needs to happen because, and maybe they just haven't announced it, but these things take 10 to 15 years to get to market. Yeah, I don't think it's surprising that that's probably an afterthought now relative to getting aviation production back up and running yeah but i think like when they talk about their 2025 2026 goals and they say we're going to generate 10 billion dollars in free cash flow i i just don't

like that because that's showing that they're going to take the old products and again the 787 is the best out there right but it is going to age eventually they got to get some of these stuff out there to market and maybe these updated products will be fine but yeah i i still see that as they got to keep the r&d aggressive and i don't think they're doing enough all right ryan let's move to highlights and lowlights as we kind of close things out here what did you like dislike about looking at boeing yeah we've talked a lot about the advantages already but it's clearly a difficult business to replicate governments have not been able to do it and that is without you know that's with kind of unlimited funds they've done it once yeah did it with airbus but it took multiple

governments to do it yeah that was kind of a consortium of i guess it was really just germany and france wasn't it yeah i can't remember i believe england was in and maybe backed out but mainly france and germany yeah but the yeah and i i guess you know boeing's a government contractor so maybe they've had more government uh help than they they give themselves credit for um but i mean they've obviously built out the commercial side as well i don't know it's it's impossible to replicate no one's going to build this in the us at boeing's scale am i wrong there's no way someone can do that right i would say never say never but extremely low likelihood, right? It's kind of like another TSMC in Taiwan, like that's not going to happen,

right? Yeah. Other parts, other highlights, I guess, and market growth. Historically, air traffic has grown at about two times GDP. It's a little bit lumpy, but this should serve as a lasting tailwind for demand for Boeing's products. Last one is this is not a business the government wants to let die, that does not mean shareholder returns are going to be good. But I could see some situation where they just pay off debt indefinitely and they continue to get easy financing because they want the business to keep running, but the free cash flow per share never... Yeah. It could give you a margin of safety somewhat, but maybe not for these prices, maybe from those more discounted prices a few years ago yeah and then low lights for me i guess

if they have another crash or any other scenario god forbid uh that mirrors what they saw in 2018 2019 the debt load is going to be extremely difficult to service they're going to run pretty low on cash they just can't have that happen again and rates are higher today so you kind of have to have sort of an ideal next decade like i don't want to say flawless but you can't have another crash like that where it's something boeing caused and and expect good shareholder returns that's just kind of one of the risks you take by owning the shares in boeing uh the other part is the proxy adjustments disgust me i yeah not great especially when they've killed people because not indirectly indirectly killed people i should say uh talk to our lawyers that we don't

have but the uh you know right they were paying these fat bonuses didn't they pay themselves fat bonuses in 2019 i believe mullen had a ridiculous severance payout that was the guy that got fired who was the problem yeah the ceo well there was a bunch of people that got fired but do you really need this guy's clearly got a lot of money 59 million dollars this year as executives really when you're when you're do you have negative earnings yeah dave calhoun i'm sure is doing just fine it just feels like out of touch with what really matters 100 100 all right my highlights i mean there's a lot To be honest, we've been harping on the problems here.

And I think it's because at its core, there's so much to like about this business. One, there are huge barriers to entry, like we talked about, and minimal competition, which I think is probably due to the huge barriers to entry. I mean, it's fantastic. And the end market is growing in aviation. So you have a duopoly and growing end market. If this company gets humming, I mean, it's like guaranteed earnings, honestly. And maybe that was their issue there, the rest of them.

laurels low lights though i have a few unpredictable cash flow we talked about that you know the the balance sheet stuff look at that look at the cash flow look at the cash flow management um you have inventory buildups you could have you know cyclicality with customer demand stuff like that second low light they haven't shown signs of ramping up r d for a new product since the 787 and i guess i wrote this kind of twice but like their r&d spend looks solid as a percentage of revenue it stayed stable over time it ramped up during the 787 build out but i wish they would kind of trend that r&d as a percentage of revenue higher given the nature of the two industries they operate in which are you need a technological lead to continue and i think really the big

for me is dropping the ball over the last 20 years in general on product development you know the 787 turned out to be a great product but for anyone that lives in the pacific northwest every day they would talk about how the 787 was way behind schedule when it was coming out and this is the only big product they've released in the last 20 years yes they've had the updates for the existing products but again it's not going to be you know i don't know like and maybe those took a lot of r&d but uh i just i just don't like here's the question i have how was it possible that they were crushed by a startup like spacex in spaceflight it might not be hyperbole to say that they were the premier engineering institution outside of government agencies and labs in the

world for the second half of the 20th century and then they just lost to these startups in spaceflight which they should have had an easy market to go into because they were the leader at you know commercial aviation they should have been able to move into spaceflight i think or they were the ones set up the best to move into spaceflight maybe lucky as well i really think that in order to retain their former glory they need to drastically up their r&d spend um which isn't happening and then the last one we talked about already don't trust the management okay bull case ryan you ran through some of the numbers what do you got for the listeners yeah hardly i it's more just the guidance they issued which

it doesn't like 10 billion dollars this isn't some well thought out guidance it's just an objective so take it as such if it was well thought out it wouldn't be 10 billion dollars on the dot yeah like we mentioned this is not a good company to have a cash flow guidance that you target because of the, you know, the need for quality assurance, the need for R&D, like we've talked about like time and time again, right? Once you say like, you can't have that number where, oh no, we're going to cut costs to hit that number. Well, that's how the 737 backs up.

Yeah. So at their investor conference, they stated that their objectives are 800 annual commercial aircraft deliveries by 2026. They want mid single digit growth for their services business and low single digit growth for their defense business. These together would get Boeing to $100 billion in revenue, a figure they've been at in the past. And they are striving to reach 10% operating margins. So $10 billion in annual operating income. Between 2010 and 2019, which was a great decade for them, they traded at an average EV to EBIT multiple of 13 times. It was more like 15 to 20

times in their later years, right up to 2019. So let's assume it does trade back to 20 times. That would be a $200 billion market cap on theoretical operating income figures. Today, the enterprise value is $160 billion. And keep in mind, operating income does not include the interest expense, which they'll have to pay. I think you really have to assume they're going to grow without a hiccup over the next five years, get production back to 800 commercial aircrafts a year, and they get valued at 20 times for this to even be a discussion of whether or not it's a high-performing investment. Because $160 billion EV, I didn't do the math, but 160 to 200 over four years, we're

making some big leaps to make that happen or big assumptions that wouldn't be great returns there will be some cash you could add on there but that just helps it a little bit yeah i don't know the bulk i think a lot has to go right and that 10 billion dollar figure has to look small in two decades. Yeah, or seven years. Yeah. I don't know. I guess, yeah.

Why don't you hit your bull case first? Yeah. I mean, I think if they hit $10 billion in free cash flow a year and that's consistent, the stock will be fine, but it's not going to be a home run. The question is, what's the quality of that free cash flow, we talked about with the balance sheet changes is it just an inventory drop is it just sbc is it just working capital right um seems like they're trying to hit those numbers by not actually

generating earnings which continue to be negative uh bear case ryan what do you think it seems like we have the same ones which is the stuff that happened over the last five years continues to happen. Yeah. I mean, that is the big one. If they have continued difficulty expanding production or worse, they try so hard to meet their production goals. I mean, the executives push so hard for the manufacturing to churn out 800 a year that there's a slip up in the process, that there aren't the checks needed and it leads to a 2018 2019 like mistake or not even maybe definitely one it just leads to one where that pauses production yeah i mean that i don't know the downside seems huge here i don't think they'll ever die because the government probably won't let

them but i think shareholder returns could be abysmal over the next decade it's certainly possible, especially if anything goes wrong. Yeah. I have the same bear case. I think the question investors should ask here is if these product and quality issues happened for the last five years, why should we expect anything different to happen for the next five? They are really in prove it mode in my book. And I don't know why they're trading at this theoretical 20 times earnings. So it's kind of crazy what the stock trades have made. Maybe we're outlining a short here. We don't short. So honestly, if you're a short seller or someone that shorts and listens, to this honestly i'd say looking at this further i i would not uh now that we do here's a

recommendation but this seems like very overvalued in my book given where they're at and given that they are in prove it mode i i would think for the entire investment community i mean they gotta they gotta get to that 10 billion dollar figure that's that's theoretical yeah it should trade Like it's a trade at a discount, not a premium to theoretical cashflow. Yeah. Well, you're preaching to the choir, Ryan. All right. More or less interested. Let's close things out. Ryan, what are your final thoughts on this business? It's a no for me. I'm less interested. I think it is one of the highest barriers to entry, but so many things can go wrong management is not my favorite that the and maybe it's more just

indicative of the culture overall but i thought the proxy adjustments were like the cherry on top for me to just say like you guys are out of touch with what this business should be focusing on yeah i agree i am not interested i don't trust management at the right price and with the right management team focused on the right things i think this is a great buy it's an easy buy because the moat is so strong but it's not there today so i it's one that you don't even need to put on your watch list because it's you know it's always there but it's you know something changes over the next decade in stock it's the let's say this current management team doesn't do well like we're outlining they bring in some real engineers to lead them or manufacturing people and they say

look we're going to fix this thing maybe there's an opportunity there but at this price with this management team that happened no way am i touching this thing all right that's going to close out this episode next week we have our monthly recurring arch capital episode and we are going to go through not as exciting of the company as last time or the time before which is nintendo and match group and it is the software company dropbox however we think polarizing stock it is polarizing stocks so i think it'll be interesting to go through our bull case and try to refute some of the bear cases which uh we will admit probably during the episode could have some validity so it'll be a fun one to go through we're very excited about that one all right for anyone

that's listening remember if you didn't live here before and you want access to the show notes and the charts subscribe to the newsletter the link is right in the show notes below where you're you're listening on your device right now. Give us a review on Spotify or Apple Podcasts to support the show. That's the best way to do it. We are not financial advisors. Anything we say on the show is not formal advice or recommendation. We are general partners at Arch Capital. The clients may have securities discussed in this podcast. Thank you all for tuning in. We'll see you next time.