Columbia Threadneedle: Boeing bonds bound to bounce back?
With $60 billion of outstanding corporate bonds, the business is among the largest non-financial IG issuers, and it wants to reduce its leverage. But with that being unlikely anytime soon, investors have a decision to make.
30.09.2024 | 06:46 Uhr
Key Takeaways
- Despite a difficult period, the business retains good access to liquidity, has in-demand products and benefits from its position in an oligopolistic market structure
- With nearly $60 billion of outstanding corporate bonds, it is among the largest non-financial issuers in the USD investment grade market, and wants to reduce its leverage
- Given the state of Boeing’s production lines and related cash generation, this is unlikely anytime soon – although it could look much improved in 12-18 months
- With product safety a critical driver of bond spreads, and the potential risk of airplane failure (regardless of fault), investors have a decision to make
Boeing is an iconic name. It enjoys high levels of political
support in the government of its single largest customer, the United
States.1 It produces the president-carrying Air Force One,
makes the ubiquitous commercial airliners, influences space exploration,
produces military equipment and maintains significant nuclear
capabilities for the US. This relationship is a substantial pillar of
support for the credit. But Boeing has had a tumultuous few years. The company clearly
has significant room for fundamental improvement, and hardly a week
passes without it being in the news. However, it also has the benefit of
substantial liquidity, products which are very much in demand, and a
privileged position within an oligopolistic market structure (alongside
Airbus). This presents active investors with a material opportunity. Boeing maintains in excess of $10 billion of cash on its balance
sheet, as well as bank lines of $10 billion. In 2024 it has used
significant amounts of cash as it slowed its delivery schedules, built
up inventory in anticipation of soon being able to operate at
significantly higher rates of production, and experienced some
reluctance from customers to make cash payments without greater clarity
over the delivery schedule. It has also raised $10 billion in the bond
market.2 Management has come a long way in its thinking since
January, speaking openly about raising capital by issuing shares if
that were necessary to retain its investment grade credit rating.
Because of the high demand and the lack of an alternative, we think it
could receive funding from either the bond or equity markets. Another worry for Boeing management and stakeholders is the
dispute between the firm and the International Association of Machinists
and Aerospace Workers.3 At the time of writing we do not
know the impact of the strike. Boeing is highly motivated to make it
short – a stance that is known to negotiators on both sides, which makes
this a difficult situation. As company analysts we call this a “known”
risk factor and evaluate it in the context of a company whose financial
metrics are not going to be the near-term driver of bond performance,
with or without the labor dispute. Ultimately the strike is a question
of cost, and Boeing will have to assess that cost versus the cost of
delay and of issuing equity. As Boeing’s management has said it would defend its investment
grade rating with equity issuance if necessary, we think the economic
incentives are consistent with that pledge. Beyond the short term, there
is far greater demand for Boeing’s products over the next couple of
years than the company can satisfy. Its total backlog of orders was more
than $500 billion as of the end of 2023. The order book for the 737 Max
is in excess of 4,700 planes, and the firm produced just under 400 in
2023.4 Not only are Boeing’s planes in very high demand, but
its main competitor Airbus has a similar situation vis-à-vis its
customers and commercial planes. So, Boeing has more than enough orders to keep it busy for a long
time, and its customers cannot readily leave and get their planes
elsewhere. This unusually benign supply/demand situation is beneficial
for Boeing’s bonds. With about $60 billion of outstanding corporate
bonds5, Boeing is among the largest non-financial issuers in the USD investment grade market. Something we debate is how to manage the potential risk that
another Boeing aeroplane experiences a material problem. Commercial
planes are fiendishly complex, and there are thousands of them in the
sky at any given moment. Equipment can fail for a multitude of reasons
including manufacturing problems, equipment maintenance and operation,
and latent defects in materials. A manufacturer or airline could execute
very well in all aspects under its control, and yet a plane could still
experience a failure. As company analysts we call this an “unknown”
risk factor. In the case of Boeing, product safety is a critical driver of
bond spreads. We have to balance our understanding of measures the
company has taken to improve its safety outcomes versus the possibility
that one of its planes suffers a major accident – regardless of fault.
We weigh this issue, and the level of compensation the bonds offer,
relative to what else we know about the company and relative to
alternative investment opportunities. Other key drivers of bond spreads include demand for products,
competition and market share, and decisions of management to increase
debt in order to either invest substantially more in capital
expenditures, buy a competitor, or buy back its own company shares. Each
of the items on this non-exhaustive list could cause the bonds of a
company to significantly underperform the broader market. For Boeing, we
believe none of these non-safety items has a meaningful probability of
harming bondholders in the next few years. So, although there is a
substantial unknown that we must factor into the investment case, there
is much greater certainty about other aspects than we would normally
have. So, how to weigh this all up? We have a process based on
independent and critical thinking. It encourages and facilitates candid,
collaborative discussions among teammates with significant experience
in their areas of expertise, as well as substantial time working
together. We have procedural mechanisms like meetings and other formal
communication methods. But the real value-add in complex investment
situations is the ability to have meaningful conversations, which lead
to enhanced situational understandings used in portfolio construction
and position management. Boeing has recently announced a new CEO.6 Its
factories have been under intense, on-site scrutiny for a long time –
from its customers as well as the Federal Aviation Administration.
Because Boeing sells items with long shelf lives, and because the market
structure means customers have very little flexibility about where they
get their planes, we expect it to eventually deliver on its orders.
With a commercial backlog of more than $400 billion, that represents a
significant amount of future cashflow and debt repayment capacity. Many investors talk about their long-term investment philosophy
and deep understanding of the companies in which they invest; Boeing may
be the perfect case study for understanding to what degree this is
true.Investment questions
1 The US government accounted for 35%-45% of Boeing’s revenue
from 2021-23. Source: Boeing Annual Report 2023 Form 10-K, 27 January
2023
2 Reuters, Boeing taps debt market to raise $10 billion, sources say, 29 April 2024
3 FT.com, Boeing workers begin strike after rejecting 25% pay rise, 13 September 2024
4 Boeing, Boeing Reports Fourth Quarter Results, 31 January 2024
5 Bloomberg and company accounts
6 Boeing, Boeing Board Names Kelly Ortberg President and CEO, 31 July 2024
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