Boeing's Greed Won't Queer The Market

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Boeing 737 MAX. Photo credit: ASSOCIATED PRESS

Everyone’s smiling in Boeing’s annual report to shareholders. It’s one of the puffiest documents I’ve read in a long time. Management continuously pats itself on the back for a job well done. My recommendation to the board of directors is that headman Dennis Muilenburg should be terminated with extreme prejudice along with Kevin McAllister, in charge of commercial airplanes. Let’s claw back eight figure bonuses, too.

No mention in the annual report that a couple of 737 MAX aircraft had crashed, hundreds of innocents killed. Evidence is piling up on a rush for certification of this aircraft, particularly new software. The annual, I noted, was filled with smiling faces, 12 pages, with its stats a single page in smaller type size. The 10-K report to the SEC ran 136 pages, but shareholders could easily opt to pass it by.

I read on. My favorite metric, operating cash flow, practically doubled over the past four years to $15.3 billion. So the stock is worth what it’s selling for today, even assuming sizable expenses for corrective assembly and delayed deliveries. Boeing isn’t debt ridden. Dividend yield is around 2% with over $7 billion in cash equivalents. Playable, not breakable. Its GAAP earnings are greater than non-GAAP results, a felicitous situation, unlike internet operators where it’s vice versa.

Boeing’s accounting conventions are forever tricky because billions of R&D gets classified as inventory and written off over a block of aircraft deliveries. Profit margins on the 787 bolstered 2018 results.

Boeing’s proxy report is 67 pages long and I was a little cross-eyed parsing through it, particularly the page on compensation of executive officers. Muilenburg’s comp came in at $17.4 million for 2018. This is no more nor less than headmen garner at major industrial corporations and financial houses. If they truly leverage their company’s earnings power long term, they’re worth it.

Boeing’s free cash flow past year hit $13.6 billion, not much less than core earnings. I had this number going to $20 billion for 2019, but no longer. My entry point on Boeing at $300 was based on this key metric at 15 times its market cap. Far too low for a growthie industrial with position on the board. Maybe this is a 2020 event but forget about 2019. Management might call this a transitional period, but that’s a bland assessment, yet to be demonstrated.

When I dug right down to the bottom of my shoes what did I feel? Was this event more extensive than unrealized profits going up in smoke, or in this case going down in smoke? Having flown in “flying boxcars” as an airborne officer during the Korean War we called our C-119s “old reliable.” Over a couple of years and dozens of jumps I learned to love this aircraft. Any aircraft mishap, anywhere, resonates for me and my condolences to the families of the crashed 737 MAX’s passengers is deeply felt.

These crashes never shoulda happened, but they did and an almost impeccable aerospace operator, Boeing, can never live this down. At the least, it should impact its valuation structure as to the multiple of earnings and free cash flow. The board should claw back all incentive payments past 3 years.

Is Boeing an early warning shot at what the stock market could look like if an unforeseeable geopolitical event occurs or financial markets get knotted up in political chaos domestically? Consider sudden massive redemptions on passive investments like index funds and ETFs in technology. Maybe, a couple of more General Electric’s get uncovered.

Think of major auto makers that massaged their numbers on air pollution, of Johnson & Johnson being sued big time over talcum powder health hazards, that OxyContin made by Purdue Pharma is massively addictive, leading to tens of thousands of fatalities. There was Bernie Ebbers, fudging his numbers to make them look as pristine as AT&T’s. Bankruptcy for WorldCom, the jail yard for Bernie.

All this reminds me that we shareholders are forever on the outside looking in with limited visibility. If management wants to take us, we get taken. The SEC isn’t staffed to sniff out gross under-disclosure on fanciful allocations to reserves against losses. Think of American International Group during the financial meltdown in 2009. I’m not even sure they knew what hit them, but their London office had guaranteed trillions in credit default swap paper for minimal fees.

Stupidity gets reflected in low price-earnings ratios for bad operators. General Electric was numero uno in the S&P 500 Index in 2001. Who could know it was destined for single digits? The Street, I thought, had its fill of conglomerates like Gulf & Western, Ling Temco Vought, WorldCom, American International Group, et al. Managements knew better but didn’t care.

Remember when John Gutfreund, headman at Salomon Brothers, allowed his bond traders to manipulate the auction market for Treasuries? Warren Buffett took over to protect his investment and straightened out Solly. Lehman Brothers recklessly leveraged themselves in illiquid real estate.

I’ll leave aside huge management lapses at Chrysler, General Motors, even Buffett’s beloved Geico that mispriced auto premiums going for share of market, driving the stock down to two bucks a share. Merrill Lynch had a hand in the 2008-09 financial panic, too, underwriting gobs of iffy mortgage paper.

President Kennedy destabilized financial markets with his quarrel with Roger Blough, headman at U.S. Steel who raised prices on steel while the country was struggling in a slow growth setting. During the demoralizing days of 2002, serious financial scandals surfaced. Think of Enron, Quest Communications and of course WorldCom. The economy had drifted back to 1% GDP growth from 3% (sound familiar?). Credit the bursting of the tech bubble as a major contributor.

Bar none, Wall Street, normally is its own worst enemy. The unwinding of the tech bubble in 2002 caused a serious recession and crushed price-earnings ratios. The mid-cap tech index dropped from 50 times earnings to 30 times earnings. Meantime, the foolish metric of the capitalization of revenues dropped from 10 times to mid-single digits. My rule of thumb is own controversial properties at one times their growth rate. Boeing may qualify but get the timing right. Surely, corporate greed and overvaluation got out of hand in 2007 and practically caused a second Great Depression during 2008-09.

Shorting growth stocks during the 1973-74 recession was as rewarding as shorting Nasdaq at the top early in 2000 when this index peaked at 5,000. It bottomed in the spring of 2003 at 1,000, thereby creating a giant sombrero formation. Only the 4,000 level was regained by 2014. Past December, this index traded below 6,000, but currently ticks over 7,500. It took 15 years for Nasdaq to come back from its bubble peak in 2000.

The only way I’ve learned to deal with exuberance is to hold no more than 60% of assets in equities while leveraging with impunity the high-yield bond market going out 10 years in duration. My problem with Boeing is I’m sleepless so I’ve sold down to my sleeping level.

Sixty years ago, I knew a family with $1 cost IBM. Wealthy people then bought or inherited stocks that were put away forever. Selling was deemed vulgar. But IBM has dwelled in a trading range these past 20 years. From the mid-80s, IBM periodically disappointed shareholders.

Earning stagnated while its gross plant account doubled. This is a bad, telltale metric. Lou Gerstner was called in from the outside to straighten things out. Lou shredded layers of management and cut the time lag on decision making to weeks, not forever. Nothing is forever.

Does anybody but me remember that over 50 years ago Douglas Aircraft’s commercial aircraft division, located in California, sank the company because they couldn’t deliver finished DC-9’s on their order books at contracted prices? Think of it. They went out of business because of too much business.

Sosnoff and / or his managed accounts own: Boeing & AT&T.