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Morningstar | Charges Mask Dynamite Commercial Airplane Margins at Boeing

KC-46 tanker and legal charges weighed on what was otherwise a strong second quarter for wide-moat Boeing. The company registered 5% consolidated sales growth on the back of higher revenue in its defense and global services businesses and, per our estimates that exclude the tanker charge, it achieved 190 basis points of operating margin expansion. Boeing retained its midpoint guidance of $16.50 and $14.40 for 2018 GAAP and core EPS, respectively. An expectation for higher volume in defense and global services combined with strong commercial airplanes profitability allowed management to hold the line on its earnings outlook.

We plan to increase our $309 fair value estimate due to commercial airplanes performance, which we think points to higher margins in 2019. The time value of money inherent in our valuation methodology will also increase our fair value modestly. We expect our new fair value to land at around $315 per share.

Although we're not ruling out another KC-46 tanker charge, we think another sizable hit to profitability (this quarter's charge stood at $418 million pretax) is unlikely since Boeing has completed flight tests. Excluding the tanker charge, Boeing’s commercial airplanes unit posted operating margins of 13.5%, the highest ever achieved. Although a 787 block extension--Boeing upped it by 100 aircraft--boosted margins, we’re still impressed with underlying profitability. Investors shouldn’t be concerned that sequential 787 deferred production burn-down slowed this quarter to only $449 million--compared with four consecutive quarters of over $500 million sequential decreases--because the block extension adds to the total.

While not as impressive as commercial margins, the defense business still posted operating margins north of 11% without the tanker charge, and revenue grew nearly 9% year over year. Operating margins contracted at global services, but revenue grew 15%, indicating that Boeing's push into the aftermarket is bearing fruit.

Given Boeing's use of program accounting, we think cash flow continues to be a focus for many investors. Operating cash flow fell to $4.7 billion, down from $4.9 billion last year but the comparable is a tough one given the timing of predelivery payments and other cash receipts this time last year. As a result, we’re maintaining our full-year forecast for operating cash flow at the high end of Boeing guidance calling for $15 billion-$15.5 billion of operating cash flow.