Is That Superman In The Sky? Not It’s A Boeing!

Investment Thesis

What happens when the leader of an industry sees several opportunities knocking on its doors at the same time? The stock surges like there is no tomorrow. Boeing (BA) is the leader in the commercial aircraft industries and benefits from several growth vectors at the moment. Its commercial airplanes division is booming with strong backlog, military expenses are pushing its Defense, Space & Security segment and management came with the idea of offering additional services to its clients securing recurring revenues.

Boeing looks like the perfect stock to hold right now. But what if you missed your flight, is still time to buy another ticket?

Understanding the Business

Boeing is well known for its commercial airplanes. The company is divided into 3 segments (% of revenue are coming from BA latest quarter):

Commercial airplanes: this segment counts for about 60% of BA business. In 2016, the company led the industry for a 5th consecutive year for the most deliveries (source annual report 2016).

Defense, Space & Security: this segment counts for about 23% of BA business. Boeing manufactures satellites, military aircrafts and weapons systems. 37% of this division revenue comes from international clients.

Global Services: this is a new segment introduced this quarter and represented 15% of BA business. It is dedicated to providing more agile, cost-effective and streamlined after-market support and services to its commercial clients. BA eyes also the maintenance business and plans to integrate spare parts, modifications, upgrades, and data analytics and other information based services to its offer.

Author’s chart, source BA Q3 2017 presentation

Revenues

Source: Ycharts

Boeing can count on a robust demand for commercial aircraft so support its growth. The company has currently 5,659 airplanes in backlog according to its latest numbers. Management is almost facing a production challenge in order to deliver all those airplanes on time. This is the kind of problems I like.

Its new service is picking-up quickly and it will lead to recurring revenues in the future.

As the defense sectors will be picking-up at the same time based on military budget increase, BA can counts on multiple growth vectors for the future.  As Chairman, President and Chief Executive Officer Dennis Muilenburg explained, Boeing’s future looks bright:

“In the third quarter we successfully launched our newest business segment, Boeing Global Services, leveraging our unique One Boeing advantages to offer complete lifecycle support across the commercial, defense and space sectors. We achieved a number of key milestones in the quarter with the delivery of a record 202 commercial airplanes, including 24 737 MAXs as we continue the smooth introduction of that airplane. On the defense side, we booked $6 billion in new orders, including an initial contract award for the Ground Based Strategic Deterrent program and an award from the U.S. Navy for 14 F/A-18 Super Hornet aircraft.”

Earnings

Source: Ycharts

EPS this quarter was lower than Q3 2016 mainly because of a tax adjustment that occurred last year. Management was pumped by its strong quarter and improve its guidance for the rest of the year:

Source: BA Q3 2017 presentation

In addition to spend billions in R&D, Boeing has become quite a shareholder friendly stock over the past 5 years. It has a massive share buyback programs in place which enabled management to repurchase over 20% of the outstanding shares in the past 5 years.

Source: Ycharts

Boeing’s generosity doesn’t stop there, it has also a quite aggressive dividend policy in place.

Dividend Growth Perspective

Following the 2008-2009 crisis, Boeing had to take a pause with its dividend growth policy. The dividend remained the same until 2012. Since then, management has been more than generous and the stock is now showing 5 consecutive dividend increases. This make it half way to be part of the elite Dividend Achievers list. The Dividend Achievers Index refers to all public companies that have successfully increased their dividend payments for at least ten consecutive years. At the time of writing this article, there were 265 companies that achieved this milestone. You can get the complete list of Dividend Achievers with comprehensive metrics here.

Source: Ycharts

Between 2012 and today, BA dividend growth has been phenomenal. We are talking about a 222.7% increase or a rhythm of 26.40% CAGR. You can’t obviously count the company will maintain such incredible trend. From what I can see, both current payout and future growth are assured for a while.

Source: Ycharts

You would think a company’s payout ratio would be hurt by such impressive growth. Both payout and cash payout ratio are under 50%. This gives enough room for management to continue a high single digit dividend growth policy over the long run. BA meets my 7 dividend growth investing principles.

Potential Downsides

The commercial aerospace is cyclical. While Boeing enjoys the best of both worlds right now (e.g. new orders from emerging markets + replacement demands from U.S. and Europe), both growth vectors will slow down eventually. When this airplane batch will be delivered, new orders might fall short. As the market has been utterly optimistic in regards to BA stock value (+261% over the past 5 years as at October 27th), the stock may fall upon weaker demand.

As production demands increase, another challenge is waiting for management. Once orders start to decline, economy of scale will diminish. Efforts that have been deployed to produce a larger amount of aircrafts will be left with less work.

Valuation

What can you expect from a stock that surged by over 250% over the past 5 years? Is Boeing really going to lift-up to higher level or is it just an icon of this never-ending (but dangerous) bull market? Let’s take a look to see if the current value is justified.

Source: Ycharts

At first glance, we can say that BA is trading at its highest PE level, but it has happened a few times since 2014. Still, I would be cautious about a PE getting close to 24.

I will use the Dividend Discount Model to get an idea of a fair value for BA. I think management will continue a double-digit dividend growth policy for the next 10 years as it will surf on important tailwinds. However, I reduced the growth rate to 6% later on assuming there will be a down cycle in the aircraft industry.

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $5.68
Enter Expected Dividend Growth Rate Years 1-10: 10.00%
Enter Expected Terminal Dividend Growth Rate: 6.00%
Enter Discount Rate: 9.00%
Discount Rate (Horizontal)
Margin of Safety 8.00% 9.00% 10.00%
20% Premium $509.51 $335.56 $248.78
10% Premium $467.05 $307.59 $228.05
Intrinsic Value $424.59 $279.63 $207.32
10% Discount $382.13 $251.67 $186.59
20% Discount $339.67 $223.70 $165.86

Please read the Dividend Discount Model limitations to fully understand my calculations.

Interesting enough, there is will room for growth for BA. We are talking here about a potential upside of 8%, but could satisfy many investors in this highly valued market.

Final Thought

I do not hold shares of BA and the idea of looking into this company came from one of my reader (you can always click on my name and send me message; I just love talking about the market!). Overall, I think it’s a very good hold, but at the moment, I’m still a bit uncomfortable with the valuation. The DDM proves me wrong, but I’m having a hard time to jump in an airplane that has already took-off.

Disclaimer: I do not hold BA in my DividendStocksRock portfolios.

NextEra Energy : Investing in a Clean Utility

What Makes NextEra Energy (NEE) a Good Business?

NextEra Energy is an electric power company divided into 2 different businesses: Florida Power & Light (FPL) which 89% of its customers are residential (11% commercial) and NextEra Energy Resources (NEER), a clean energy utility with 75% of its assets producing wind energy. Along with Xcel (XEL), it is a leader in the clean energy production in the U.S.

Most of FPL energy is generated through natural gas (70%) and nuclear (23%). FPL counts for 60% of NEE earnings (2016 annual report).

As you can see in the map above, NEER is mainly a wind energy company and it is mostly active in the central U.S., with some activities in California. As regulation around coal energy becomes more restrictive, a play in the clean energy through NEE sounds like a good idea.

Revenue

Revenue Graph from Ycharts

When I dug deeper in the revenue trend, I noticed that revenues and earnings didn’t jump between 2015 and 2016, they just receive a temporary boost as explained in its press release:

“Adjusted earnings for these periods exclude the mark-to-market effects of non-qualifying hedges, the net effect of other than temporary impairments (OTTI) on certain investments, operating results from the Spain solar project and merger-related expenses. Adjusted earnings for 2016 also exclude the gains on the sale of natural gas generation facilities.”

How NEE fares vs My 7 Principles of Investing

We all have our methods for analyzing a company. Over the years of trading, I’ve been through several stock research methodologies from various sources. This is how I came up with my 7 investing principles of dividend investing. Let’s take a closer look at them.

Principle #1: High Dividend Yield Doesn’t Equal High Returns

My first investment principle goes against many income seeking investors’ rule: I try to avoid most companies with a dividend yield over 5%. Very few investments like this will be made in my case (you can read my case against high dividend yield here). The reason is simple; when a company pays a high dividend, it’s because the market thinks it’s a risky investment… or the company has nothing else but a constant cash flow to offer its investors. However, high yield hardly comes with dividend growth and this is what I am seeking most.

Source: data from Ycharts.

When a utility shows a low yield around 2.50%, you usually find the reason behind it with the stock price. As you can see, NEE shares soared from the $50’s in 2010 to over $150 in 2017. The dividend yield remains attractive, but the stock appreciation plays a big role here.

NEE meets my 1st investing principles.

Principle #2: Focus on Dividend Growth

Speaking of which, my second investing principle relates to dividend growth as being the most important metric of all. It proves management’s trust in the company’s future and is also a good sign of a sound business model. Over time, a dividend payment cannot be increased if the company is unable to increase its earnings. Steady earnings can’t be derived from anything else but increasing revenue. Who doesn’t want to own a company that shows rising revenues and earnings?

Source: Ycharts

NextEra Energy  has successfully increased its dividend for 22 years, making it part of the elite Dividend Achievers list. The Dividend Achievers Index refers to all public companies that have successfully increased their dividend payments for at least ten consecutive years. At the time of writing this article, there were 265 companies that achieved this milestone. You can get the complete list of Dividend Achievers with comprehensive metrics here.

NEE meets my 2nd investing principle.

Principle #3: Find Sustainable Dividend Growth Stocks

Past dividend growth history is always interesting and tells you a lot about what happened with a company. As investors, we are more concerned about the future than the past. This is why it is important to find companies that will be able to sustain their dividend growth.

Source: data from Ycharts.

The company uses more the payout ratio than the cash payout ratio. Most utilities are known to distribute a good part of their earnings, but I would like to see a cash payout ratio under 100% going forward. At this time, the dividend payment is not at risk and management expects strong dividend growth for the upcoming years as earnings should grow at a 6-8% rate towards 2020.

NEE meets my 3rd investing principle.

Principle #4: The Business Model Ensure Future Growth

An investment in NextEra Energy is an investment in the future. I usually appreciate the steady component in any utility business model. But with NEE, you also had a clean energy segment that will ensure growth in the future. As it will get more complicated and costly to produce energy from coal, wind and solar energy production will improve. This is where NEE will benefit from its leader position.

Also, NEE is well served in a healthy state such as Florida with FPL. This segment of business is expected to generate 7%-9% earnings growth.

On the down side, NEE faces the classic issues coming for any utility company: raising debts during a raising interest rate environment. The company must invest lots of money in its power plant, especially to make wind and solar energy even more productive. Therefore, raising debts with higher interest will obviously hit NEE margins and profitability. This could slow down its progression. In other words, do not expect the stock price to surge by another 150% in the next 10 years.

NEE still shows a strong business model and meets my 4th investing principle.

Principle #5: Buy When You Have Money in Hand – At The Right Valuation

I think the perfect time to buy stocks is when you have money. Sleeping money is always a bad investment. However, it doesn’t mean that you should buy everything you see because you have some savings aside. There is valuation work to be done. In order to achieve this task, I will start by looking at how the stock market valued the stock over the past 10 years by looking at its PE ratio:

Source: data from Ycharts.

In term of PE valuation, I’m not ready to declare NEE as the deal of the month. However, compared to others like WEC Energy Group (WEC)(21.80), Xcel Energy (XEL) (21.77) and Duke Energy (DUK)(22.03), NEE price/earnings ratio looks like a good investment.

Digging deeper into this stock valuation, I will use a double stage dividend discount model. As a dividend growth investor, I would rather see companies like a big money making machine and assess its value as such. As management is confident to post a 7%-9% earnings growth, I used an 8% dividend growth rate for the first 10 years and reduced it to 6% afterward.

Input Descriptions for 15-Cell Matrix INPUTS
Enter Recent Annual Dividend Payment: $3.93
Enter Expected Dividend Growth Rate Years 1-10: 8.00%
Enter Expected Terminal Dividend Growth Rate: 6.00%
Enter Discount Rate: 9.00%

Here are the details of my calculations:

Discount Rate (Horizontal)
Margin of Safety 8.00% 9.00% 10.00%
20% Premium $297.11 $196.81 $146.72
10% Premium $272.35 $180.40 $134.49
Intrinsic Value $247.59 $164.00 $122.26
10% Discount $222.83 $147.60 $110.04
20% Discount $198.07 $131.20 $97.81

Source: how to use the Dividend Discount Model

According to the DDM, NextEra Energy is trading at a 7% discount. This doesn’t give much room for error, but it is still a good pick considering the overall market.

NEE meet my 5th investing principle with a potential upside of 7%.

Principle #6: The Rationale Used to Buy is Also Used to Sell

I’ve found that one of the biggest investor struggles is to know when to buy and sell holdings. I use a very simple, but very effective rule to overcome my emotions when it is the time to pull the trigger. My investment decisions are motivated by whether or not the company confirms my investment thesis. Once the reasons (my investment thesis) why I purchase shares of a company are not valid anymore, I sell and never look back.

Investment thesis

NEE makes the bulk of its income from a flourishing state, Florida. Going forward FPL will continue to produce steady growth. The company benefits from a territorial monopoly and enjoy economy of scale. NEE also counts on investments in clean & renewable energy through its wind and solar power plants. Those are the energy of the future and NEE has definitely taken a step forward compared to many of its peers. The company has been increasing its dividend for 22 consecutive years and management shows its commitment to continue this streak in the future.

NEE shows a solid investment thesis and meet my 6th investing principle.

Principle #7: Think Core, Think Growth

My investing strategy is divided into two segments: the core portfolio built with strong & stable stocks meeting all our requirements. The second part is called the “dividend growth stock addition” where I might ignore one of the metrics mentioned in principles #1 to #5 for a greater upside potential (e.g. riskier pick as well).

As I mentioned before, I don’t expect NEE stock price to surge by another 150% in the next decade. Like any utilities, this is a better fit for a conservative or core portfolio. There will be growth, but don’t expect this company to bring your portfolio to higher levels by itself.

NEE is a core holding.

Final Thoughts on NEE – Buy, Hold or Sell?

Considering a market where everything looks overpriced, at this point an investment in NEE looks like a sound decision. There is still upside potential and the dividend payment is rock solid.

Disclaimer: I do not hold NEE in my DividendStocksRock portfolios.

30 years ago…

30 years ago today, while I was getting upset about having to go to another day at school, investors had another reason to be upset:

Source: Ycharts

In a single day, the market lost over 20%. It took over a year for the market to recover from this single fatal day:

Source: Ycharts.

I’m writing this article before the market opens today. While I acknowledge some strange movement on the stock market this week (notably both GWW and IBM surging by 10% upon the release of their quarterly results), I doubt we are going to celebrate this dark anniversary with another crash. It doesn’t hurt to get back in time and learn from what happened, though.

What happened on October 19th 1987?

I did some reading about this event over the past two weeks and tried to understand what happened to the world when the most important thing that went through my mind that morning was to make sure I could play with the firetruck in kindergarten. I was disappointed that the recipe for the worst day on the stock market contained the same ingredients as the soup we had in 2008. And we might as well be cooking our next crash, since we are following the exact same recipe again.

An overheating market

There was a  party on the stock market for a good 5 years prior to the crash. After over a decade of bad returns (the S&P 500 went up by 36% between October 1st 1965 and October 1st 1982), investors were finally rewarded for their patience. Between October 1st 1982 and October 1st 1987, the market jumped by 168%:

Source: Ycharts

As the market kept reaching new highs, investors started to get nervous (does this rings a bell?). Everybody was expecting the worst… and then it happened.

Automatic trading

From as long as I can remember, human beings have had a weird obsession about technology making everything better. Although it is often the case, we still think that technology will magically solve ALL of our problems. Wall Street was trying a new technology at large on that day. It was meant to protect investors from downsides on the market by using automatic trading and option writing. What really happened then was that this marvelous technology created a downward spiral of automatic selling.

As the panic spread, margin calls started to happen, forcing additional sales. Investors were withdrawing their money from the market, forcing mutual funds companies toward massive sell-offs to reimburse their units holders. In other words, 1987 was just a simplified version of what happened in 2008.

What is going to happen now?

We are now 30 years and 900%+ points since the market crash of ’87. To put things in perspective, I’ve used a log scale chart to show you what has happened on the stock market since then:

Source: Ycharts

The gray areas represent recessions. As you can see, there was a decade between the recessions in the 90’s and the 2000’s. Then, the 2008 recession came faster and lasted longer. As you can see on this graph, the 2008 crash doesn’t look that bad anymore. But off course, this is only valuable if you intend to invest over the next 30 years.

While investors have been getting nervous lately, they have something to calm them down. The U.S. economy keeps growing and the FED raises the interest rate accordingly. Even better, it has also put a stop to the QE madness by withdrawing money as investing products expire.

The earnings season started out on the right foot with many companies declaring sales and profits beat. Just to name a few: JPM, IBM, GWW, JNJ, etc.  Let’s hope this continues in the upcoming weeks and that we will have another sign that the current bull market is here to stay. This is what I believe:  I think we will continue to ride a bull market for at least another 12 months. There is nothing telling me otherwise. As long as companies continue to show growing revenues, earnings will follow and dividend increases will continue.

In the meantime, I continue to invest money