Analysis: UAL LUV BA

Boeing (BA) reported a much better than anticipated second quarter earnings result Wednesday morning. Revenues of $16.998 billion (+44% YoY) exceeded Wall Street expectations of $16.597 billion, and to the delight of shareholders, the company posted a surprise non-GAAP EPS profit of $0.40 against expectations of a $0.83 loss.

"We continued to make important progress in the second quarter as we focus on driving stability across our operations and transforming our business for the future," Boeing President and CEO David Calhoun said in the earnings release.

"While our commercial market environment is improving, we're closely monitoring COVID-19 case rates, vaccine distribution and global trade as key indicators for our industry's stability. As we continue to position for a robust recovery, we remain committed to safety and quality, while investing in our people, products and technology. I am proud of our team's resilience and commitment as we work to rebuild trust, improve our performance and deliver for our commercial, defense, space and services customers," Calhoun added.

In addition to the surprise profit - by the way, this was Boeing's first quarterly profit in almost two years, the company delivered a clean result with zero pre-tax charges. This lack of negative surprises represents another major step in the right direction for Boeing.

Before discussing the segment results, it is important to go over cash flow and the company's current debt balance. Since there are little earnings to speak of, free cash flow measurements have become one of the big drivers of the stock price.

Operating cash flow in the quarter was -$483 million, representing a massive improvement from the -$3.387 billion result in the first quarter and -$5.280 billion one year ago. It was also better than estimates of -$1.4 billion. Free cash flow trended in the right direction too. The company's -$705 million result was far better than the -$3.678 billion outcome in the first quarter and was an improvement upon last year's $5.628 billion result. Boeing's FCF burn was also much smaller than estimates of -$2.8 billion. On the call, management reiterated its expectation that free cash flow will turn positive in 2022. With every quarter down we are one step closer to that highly anticipated inflection point, which ahead of has historically been a very good time to buy the stock.

Boeing ended the quarter with $8.2 billion in cash, up from $7.0 billion in the first quarter, while marketable securities of $13.1 billion were lower than the $14.9 billion figure in the first quarter. In total, cash ended the quarter at $21.3 billion, down from $21.96 billion at the end of the first.

On the debt side, Boeing ended the second quarter with total consolidated debt of $63.6 billion, which is the same figure as at the end of the first quarter. That being said, management continues to expect to have a lower total debt position by year end.

The potential for an equity raise has been something we have been mindful of - especially with the CFO transition - as a way for Boeing to quickly raise cash and retire debt. Management did not provide any indication that an equity raise was imminent, however they did say on the call that they continue to consider all aspects of their capital structure. Here is where we have been torn about Boeing selling stock. On one side, we understand the negative impact it would have to shareholders because of the dilutive impact to earnings. But on the other hand, we think there would be a part of the market that likes the cleaned-up balance sheet because it would mean the company is one step closer to reinstating the dividend. This is something to contemplate in the months ahead.

Segment Results

By segment, Commercial Airplanes revenue was $6.015 billion (+268% YoY), edging estimates of $6.0 billion, with the YoY revenue growth driven by the big increase in commercial airplane deliveries. Boeing delivered 79 commercial airplanes in the quarter, up from 20 one year ago. The segment reported a loss of operations of $472 million in the second quarter, and that was smaller than estimates of a $654 million loss as margins improved significantly due to lower period costs and higher delivery volume.

Boeing's Commercial Airplanes backlog ended the quarter valued at $285 billion (up from $283 billion last quarter), containing 4,155 airplanes. Boeing picked up more than 290 additional orders in the quarter, including big ones from United Airlines (UAL) and Southwest Airlines (LUV) .

On production rates, Boeing said the 737 MAX program is currently producing at a rate of approximately 16 per month. Management continues to expect this rate to gradually increase to 31 per month in early 2022, with further gradual increases tied to market demand. As a reminder, Boeing recently announced a temporarily reduction in its 787 production rate because they have reprioritized production resources to support the inspection and rework on undelivered 787s.

Defense, Space & Security revenues came in at $6.876 billion (+4% YoY), better than estimates of $6.777 billion. Earnings from operations came in at $958 million at an operating margin of 13.9%. Those earnings were much better than the $668 million estimate and the margin was higher than the 9.85% expectation and 9.1% in the quarter last year. Management said the operating margin expansion primarily reflected the absence of a charge last year and a favorable non-U.S. contract adjustment.

Meanwhile, the backlog at this segment was $59 billion (down from $61 billion last quarter) and 32% of the backlog represents orders from customers outside the United States.

Global Services revenues of $4.067 billion (+17% YoY) was stronger than estimates of $3.695 billion. Earnings from operations came in at $531 million at a margin of 13.1%. The result represents a significant turnaround from last year's loss from operations, but it makes sense because commercial services volumes have picked up in the reopening. By the way, Boeing's earnings and margin result here was higher than estimates of $341 million at 9.2%.

Let's talk about China next. Management reiterated its expectation that the region will recertify the 737 MAX this year. Should this happen, we would see this as a huge catalyst event because the region represents about one quarter of the industry's growth over the next decade. Trade tensions will always create risk, but Calhoun said on the call that they "remain in active discussions with our Chinese customers on their fleet planning needs and will continue to engage with leaders in both countries to urge a productive dialogue, reiterating the mutual economic benefits of a strong and prosperous aerospace industry."

What about the state of the airline industry? "With the toughest impacts appearing to be in the rearview mirror, airlines are shifting their focus to medium-term fleet planning," Calhoun said. "The number of aircraft being retired from the active fleet is significant, with around 1,500 airplanes and growing, retired or announced, to be removed since the onset of the pandemic. We anticipate this trend will continue as our customers focus on replacing the oldest, least efficient airplanes with new airplanes that will be as fuel efficient with commensurate reductions in emissions." This should be positive for Boeing as well.

Bottom Line

Overall, we had very low expectations heading into this print because we thought Boeing still had one more downbeat quarter to go, and we feared the risk of an equity offering. But what a positive surprise this was. We are pleased to see Boeing report a profit, and the progress made on the cash flow front was the evidence we wanted to see for the upcoming inflection point.

The Delta variant still brings some uncertainty, and the precise timing of when China will recertify the 737 MAX remains a big unknown, but on a more positive note, the orders for commercial airplanes keep coming in, and we believe the company will quickly move past some of its recent inspection issues. Boeing must execute going forward.

Shares are trading up about 5% in response to the quarter, a welcomed sight to see given the recent weakness in the stock. Our long-term outlook remains favorable, and if the stock comes down a bit (we are always hesitant to chase an earnings gap up) we would look to buy it.