Shares of Boeing (BA 0.39%) have been on a tear for much of the past year, rising 50%. In fact, Boeing stock has nearly doubled since bottoming out at the end of September last year. The stock extended its gains last week, rallying 13% as investors continued to grow more optimistic about the company's turnaround.
Improving financial metrics could help Boeing stock continue its rally into 2024 and beyond. That said, the shares seem priced for perfection, with lots of future growth needed to justify the current valuation. If that growth doesn't materialize, Boeing will disappoint long-term investors.
Staggering toward a turnaround
Boeing's recent second-quarter earnings report showed that the company's financial performance is stabilizing. Boeing generated $2.6 billion of free cash flow in the period and reiterated its full-year cash flow guidance. The industrial icon used that cash flow and some of its cash on hand to repay over $3 billion of debt last quarter.
On the other hand, two of Boeing's three major business segments lost money in the second quarter. Low production rates and elevated expenses continued to weigh on the commercial jets division, causing its operating loss to widen to $383 million. Meanwhile, cost overruns and supply chain disruptions led to a $527 million operating loss in Boeing's defense and space unit.
As a result, the company reported a core loss of $0.82 per share last quarter. That was even worse than its Q2 2022 core loss per share of $0.37. In short, Boeing is in better shape than it was a couple of years ago, but it's hardly a healthy business.
Recovery in sight
Boeing projects significant improvement in its business over the next two to three years. By 2025 or 2026, it aims to generate $100 billion of revenue at a 10% operating margin, implying $10 billion of operating profit. It also expects to generate $10 billion of free cash flow, up from an estimated $3 billion to $5 billion in 2023.
Image source: Boeing.
These targets appear achievable for 2026, if not for 2025. Boeing's services business has been firing on all cylinders. Furthermore, strong aircraft demand will enable Boeing to boost commercial jet production, supporting that segment's margin recovery. The biggest question mark is how long it will take Boeing to stabilize its struggling defense and space unit.
While Boeing stock trades for around 36 times the midpoint of its 2023 free cash flow estimate, that translates to less than 15 times the company's 2025-2026 free cash flow target. If Boeing can show clear progress toward its medium-term targets, the stock could continue to power higher -- at least if investors anticipate more growth beyond 2026.
Two major caution flags
Despite the company's projected financial recovery, there are two big reasons to avoid Boeing stock at its current valuation. First, although Boeing has reduced its debt by more than $10 billion from peak levels, it still carries approximately $40 billion more debt than it did five years ago.
Boeing Gross Debt (Quarterly), data by YCharts.
Boeing will have to devote all of its free cash flow to debt reduction until at least 2026 to repair its balance sheet. That means Boeing stock's performance will be driven solely by changes in the company's market cap, with no help from dividends or share buybacks. For Boeing to deliver 10% annualized returns, its market cap would have to jump to around $200 billion by the end of 2026.
Second, while aircraft demand currently exceeds supply, Boeing's management may be overconfident about how long that will last. Whereas Boeing only plans to restore aircraft production to around pre-pandemic levels by 2026, Airbus aims to deliver more than 1,100 commercial jets annually by then, compared to the previous record of 863 set in 2019.
Bulls anticipate that Boeing, too, can exceed pre-pandemic production rates by the late 2020s. However, air travel demand is already starting to moderate in some regions following a massive boom that began in 2022. If that trend continues, airlines will pivot to deferring or canceling orders rather than placing new ones, making it hard for Boeing to grow beyond its 2026 targets.
Too much risk for the potential reward
Boeing is in good position to return to profitability, boost its cash flow, and fix its balance sheet over the next several years. Those positive trends could keep Boeing stock's rally going for a while.
However, at some point in the next few years, moderating air travel demand will likely end the recent aircraft order boom. That will force investors to reckon with Boeing's limited prospects for growth beyond 2026, deflating Boeing stock.
