On the surface, Boeing (NYSE: BA) looks as though it has all the ingredients of a potential millionaire-maker investment. The aircraft market is growing, competition is minimal, and government contracts are plentiful. But despite its many advantages, this aerospace leader has lost 60% of its value in half a decade. Has that decline created a buying opportunity for this once-stellar business, or should it be viewed as a warning to investors to stay far away?
A spectacular economic moat
The phrase “economic moat” — popularized by investing legend Warren Buffett — refers to certain types of durable competitive advantages a company can possess that make it difficult for potential rivals to make inroads against it. Boeing’s moat is as deep as they come. In the large passenger aircraft market, it competes in a duopoly with European rival Airbus, with a market share of around 40% for large passenger aircraft (compared to Airbus’s 60%). It also plays a notable role in U.S. defense contracting, supplying weapons systems like the iconic Apache helicopter.
Investors shouldn’t expect the duopoly to end anytime soon. The large passenger jet manufacturing industry has an incredibly high barrier to entry because of the capital investments required, intense regulatory oversight, and the business relationships between manufacturers and major airlines that may be unwilling to experiment with new suppliers.
Over the very long term, a Chinese rival like COMAC could leverage lower labor costs and support from the Beijing government to claw its way into the industry. But the International Bureau of Aviation (IBA) expects the upstart to capture only around 1% of the opportunity by 2030. With industry disruption potentially decades away, Boeing’s biggest threat might be itself.
Could cost-cutting turn things around?
In the third quarter, Boeing’s revenue dipped by around 1% year over year to $17.8 billion, with results dragged down by its commercial airplane segment, where sales dropped by 5% to $7.44 billion. This core business was grappling with a host of problems, including a seven-week labor strike by the International Association of Machinists and Aerospace Workers (IAM) that ended this month.
The new contract stipulates a 38% pay rise for workers over the next four years, along with more generous retirement benefits, putting even more pressure on this loss-making business. For context, Boeing’s commercial Airplane segment generated a third-quarter operating loss of $4 billion, so higher labor costs are likely the last thing shareholders want to see right now.
Image source: Getty Images.
Just weeks after the new IAM contract, federal filings revealed Boeing will lay off 2,200 workers across the U.S. This move will likely be the first salvo in its plan to cut 10% of its global workforce (17,000 jobs) announced during the strike in October. As a mature and slow-growing company, aggressive cost-cutting will help Boeing to maximize long-term shareholder value.
More importantly, the company will have to increase production volume to take advantage of economies of scale. But this might be easier said than done because Boeing is already struggling with quality control issues according to the FAA.
Stay far away from Boeing
In the best-case scenario, Boeing will successfully cut costs and streamline its way into operating profitability while avoiding future labor-related disruptions in its production lines. But even if the company manages to pull this off, it will have to reckon with the $53.2 billion mountain of long-term debt on its balance sheet. Retiring those liabilities will drain its cash flow, limiting potential investor returns.
In the third quarter alone, Boeing’s interest expenses totaled around $2 billion. And as an aircraft maker, it also faces massive outflows for research and development (about $3 billion in the first three quarters of this year alone). It will be difficult to cut that development spending without putting the company at risk of falling behind technologically. With all this in mind, Boeing looks to be far from a potential millionaire-maker stock. Instead, it will likely underperform the S&P 500 for the foreseeable future.
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Will Ebiefung has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.