Undervalued Dividend Growth Stock of the Week: Boeing Co. (BA)

I’m a huge proponent of the dividend growth investing strategy.

After all, what’s not to like?

One is basically investing in the best businesses in the world – companies so routinely increasingly profitable that they basically regurgitate cash flow. They produce so much excess profit that they can’t efficiently reinvest it, so they give much of it back to shareholders in the form of dividends.

And since profits are generally growing over the long run, so are the dividends.

This might at first seem unbelievable to some – how can a company possibly increase its dividend for 30, 40, or 50 years in a row?

Believe it: you can find more than 700 dividend growth stocks by checking out David Fish’s Dividend Champions, Contenders, and Challengers list.

That’s an invaluable compilation of all US-listed stocks with at least five consecutive years of dividend growth.

It seems like such a difficult task to grow a dividend for years on end, right?

Well, it is.

That’s why I love investing in these businesses – I have my own hard-earned cash invested in almost 100 of these dividend growth stocks.

So I’m not just writing about these stocks; I’m investing alongside you readers.

However, I focus on two things within this subset of stocks.

Quality.

And valuation.

Specifically, I want a high-quality dividend growth stock at a good value.

Both can be somewhat subjective, but we can use objective data to come to a reasonable conclusion on both aspects.

When I think of a quality business, I think of one that’s growing at a healthy clip, isn’t drowning in debt, has excellent profitability, sports significant competitive advantages, sells products and/or services that should remain in demand for years to come, isn’t facing some kind of obsolescence, and has the ability and willingness to pay and grow dividends for years on end.

Much of this information is objective.

But what about valuation?

Well, a stock’s price simply tells you how much you’ll have to pay for a share.

But value tells you how much the stock is actually worth.

While price is extremely easy to come by – a stock quote takes seconds to pull up – value is a bit more difficult to ascertain.

However, the good news is that investors in this day and age have readily available a number of systems that are designed to help facilitate the process.

One such system was actually put together by fellow contributor Dave Van Knapp, and it can be specifically tailored to the dividend growth stocks we’re talking about here.

Now, there’s a mix of subjectivity and objectivity here again.

One investor might assign more value to competitive advantages than another. Or one person might think a company can grow faster than another person looking at the same stock.

However, much of the valuable input is objective in nature.

For instance, I use a dividend discount model analysis when I value stocks, which I’ll go over later.

And you’re using hard numbers like a company’s own dividend. You’re also looking at hard growth rates over the past to make assumptions about the future. You’re also using a hard discount rate, which is one’s desired rate of return.

But the reason why valuation is so important in the first place is because one should always attempt to buy a stock for a price as far below as fair value as possible.

The reasons why are quite simple.

All else equal, a lower price on a dividend growth stock will mean an investor is locking in a higher yield.

Price and yield are inversely correlated. So absent some kind of change in the dividend at the company level, a lower price will always mean more income in an investor’s pocket.

Better yet, this also favorably impacts one’s dividend growth.

While a company announces dividends based on business performance, a cheaper price on a stock means a higher yield and possibly even more shares for the same amount of money.

That boosts not only one’s immediate income by virtue of a higher yield but also the potential income growth over the life of the investment.

And we can obviously see how one’s long-term total return could be favorably impacted here by the higher yield.

In addition, the more undervalued a stock is, the higher the potential upside.

If a stock is worth $50 but priced at $40, you could be looking at solid upside.

If it’s priced at $35 or even $25, it becomes like a coiled spring. The more undervalued, the bigger the margin of safety and the greater the chances that the stock is aggressively repriced down the road.

And this all comes at reduced risk.

It’s simple.

When looking at the same exact stock and assuming no changes in the fundamentals, a cheaper price means less risk.

It’s just like buying any other asset.

If, all else equal, a house that was priced at $200,000 last week is now priced at $175,000, is it less risky?

Of course it is. You’re risking $25,000 less.

With all of this in mind, I’m always on the lookout for high-quality dividend growth stocks that are also undervalued.

And I may just have found one…

Boeing Co. (BA) is an aerospace company that manufactures commercial aircraft and defense equipment. They also have a finance segment via Boeing Capital.

Boeing is one of the most well-known companies in the world, operating in an industry with just two major competitors (the other being Airbus Group SE).

Since long-term trends point to the world flying more as the world continues to grow in size and wealth, Boeing’s jets should remain in demand for some time.

Moreover, there’s no likely replacement for airplanes as they exist now. So the risk of obsolescence remains very low.

As a dividend growth stock, Boeing qualifies to be on Mr. Fish’s CCC list by virtue of five consecutive years of dividend raises.

Their streak would be much longer than that, but the financial crisis put a damper on Boeing’s business and caused the company to freeze its dividend for a few years. That said, they didn’t cut the dividend, allowing shareholders to collect solid cash flow during the largest economic setback in a generation.

Making up for lost ground in a big way, the five-year dividend growth rate of 16.7% shows that the company is committed to dividend growth and returning cash to shareholders.

As soon as they felt comfortable increasing the dividend, the company did. And they’ve been aggressive with that ever since. I believe this shows a strong willingness once the ability was restored.

baHowever, that big growth has led to a payout ratio that’s just moderately high.

At 58.6%, it’s not immediately concerning.

If this were a company that sold consumer products or provided utility services, I wouldn’t even blink. But I think operating in a cyclical industry like aerospace, a lower payout ratio is more prudent. Nonetheless, they’re comfortably covering the dividend right now.

What’s really wonderful is that the stock is paying out a really appealing yield of 3.70% right now.

Substantially higher than the broader market, that also compares extremely favorably to the stock’s five-year average yield of 2.2%.

Now, that’s largely because of that frozen dividend at the outset of this period and the aggressive dividend growth thereafter.

But you can see how investors buying in today are taking on more yield than what’s typically been available over the last five years. In fact, this yield is near an all-time high for the stock, not traditionally known as being a high-yield stock.

The dividend metrics here are really appealing.

You’re getting a yield near 4%, really impressive dividend growth coming out of the financial crisis, and a moderate payout ratio. The only potential concern here is the cyclicality of the business and how that might impact the company’s ability to support such a big dividend if a recession were to hit again.

But in order to really value the stock, we need to also know what kind of underlying growth to expect. This will tell us a lot about the health of the business, the sustainability of the dividend, and what the stock might be worth.

Looking at 10 years’ worth of data for any company is the most prudent approach because it tends to smooth out temporary headwinds or short-term economic cycles.

Boeing’s revenue increased from $61.530 billion to $96.114 billion from fiscal years 2006 to 2015. That’s a compound annual growth rate of 5.08%.

Fairly solid stuff here considering the period.

Meanwhile, earnings per share is up from $2.85 to $7.44 over this period. That’s a CAGR of 11.25%.

Really impressive. The company’s profitability metrics are, overall, better now than they were a decade ago. And a ~12% reduction of the outstanding float by way of regular stock repurchases has helped drive that excess bottom-line growth.

The only drawback here is the fact that the cyclicality does show up: EPS barely budged from FY 2007 to FY 2013.

Again, perhaps not totally fair to make too much of a judgment call on that seeing as how rare an event like the Great Recession tends to be.

Looking forward, S&P Capital IQ believes Boeing will continue with a similar growth rate across its bottom line over the next three years, predicting 12% compound annual EPS growth over that time frame. This would jibe with what we see above.

What should help this forecast materialize is a combination of regular buybacks and a backlog of almost 6,000 commercial aircraft.

To the point of the former, Boeing increased its buyback authorization to $14 billion in the fourth quarter of FY 2015. Notably, that’s almost 18% of the entire market cap of the company.

One aspect I look at when determining the quality of a company is the balance sheet.

Boeing doesn’t disappoint here.

The long-term debt/equity ratio is 1.34, while the interest coverage ratio is just over 27.

It’s a capital-intensive business with a lending division, so the balance sheet is really quite clean. Furthermore, there’s been no marked deterioration over the last decade, which is quite reassuring considering that many companies over the last decade haven’t been so prudent.

Profitability metrics are also really solid across the board.

Over the last five years, Boeing has averaged net margin of 5.41% and return on equity of 88.35%.

It’s difficult to compare Boeing because of their unique business model and industry. Nonetheless, these metrics, along with return on invested capital well into the double digits, should entice most investors.

I think Boeing passes the quality aspect with flying colors.

However, there are a few risks to keep in mind.

Primarily, there’s the cyclicality of the industry. It’s difficult to determine where Boeing is relative to that, but EPS is up significantly over just the last few years. With their exposure to defense spending, Boeing could be vulnerable to any broader economic downturns and negative changes in domestic defense spending.

In addition, the SEC just recently announced that it opened an investigation into Boeing to see whether the company properly accounted for costs and expected sales of certain jet platforms.

With all of this in mind, I think investors should seek out a very solid margin of safety.

Is Boeing cheap?

The P/E ratio is sitting at 15.83 right now. That’s not only well below the broader market but also below the industry average and Boeing’s own five-year average P/E ratio of 17.3. Investors are also paying much less for the company’s cash flow compared to the recent historical average. In addition, you’re looking at a sizable difference between the yield on the stock today compared to what’s usually been offered over the last five years.

It does seem cheap. But how cheap? What would be a fair price for the stock?

I valued shares using a dividend discount model analysis with a 10% discount rate and a 7% long-term dividend growth rate. I think this growth rate is rather conservative when looking at Boeing’s dividend growth rate, its long-term EPS growth rate, and forecast for underlying growth moving forward. We want a conservative figure due to the cyclicality of the business. The DDM analysis gives me a fair value of $155.51.

The reason I use a dividend discount model analysis is because a business is ultimately equal to the sum of all the future cash flow it can provide. The DDM analysis is a tailored version of the discounted cash flow model analysis, as it simply substitutes dividends and dividend growth for cash flow and growth.

It then discounts those future dividends back to the present day, to account for the time value of money since a dollar tomorrow is not worth the same amount as a dollar today. I find it to be a fairly accurate way to value dividend growth stocks.

Unless Boeing’s long-term growth rate slows down considerably, shares appear to be rather undervalued right now. But what do some professionals that track this stock think about that?

Morningstar, a leading and well-respected stock analysis firm, rates stocks on a 5-star system. 1 star would mean a stock is substantially overvalued; 5 stars would mean a stock is substantially undervalued. 3 stars would indicate roughly fair value.

Morningstar rates BA as a 4-star stock, with a fair value estimate of $129.00.

S&P Capital IQ is another professional analysis firm, and I like to compare my valuation opinion to theirs to see if I’m out of line. They similarly rate stocks on a 1-5 star scale, with 1 star meaning a stock is a strong sell and 5 stars meaning a stock is a strong buy. 3 stars is a hold.

S&P Capital IQ rates BA as a 4-star “buy”, with a fair value calculation of $130.20.

Looks like all three opinions are quite favorable, though mine is the most favorable. I like to blend all three numbers together and average them out, which tends to smooth out numbers too high or too low. That averaged valuation is $138.24, which would indicate the stock is potentially 17% undervalued right now.

ba scBottom line: Boeing Co. (BA) is a high-quality company operating in an industry that supports a strong duopoly. A huge backlog, low risk of obsolescence, and a very appealing yield all make this stock a great candidate in general. But the possible 17% upside makes it an even better long-term investment idea right now. There are risks to strongly consider, but there appears to be a sizable margin of safety on shares right now to counteract that. If you’re looking for exposure to aerospace, it’s tough to beat this stock.

— Jason Fieber

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