Boeing vs Lockheed Martin Corp vs Airbus vs Northrop Grumman Corp - Research Proposal Example

Finance Stock Recommendation Boeing vs. Lockheed Martin Corp vs. Airbus vs. NORTHROP GRUMMAN CORP Executive Summary An analysis of the major players in the US aviation industry- Boeing Company (BA) and Lockheed Martin Corporation (LMT) highlights the financial strengths and weaknesses of the two companies. The financial statements for the years 2009, 2008 and 2007 have been analyzed to give an idea about the financial performance of the companies in the last three year period. Total Revenue of both BA and LMT has increased by nearly 10 percent in the year 2009 as compared to the previous years. The profitability position of the companies is fairly good as is evident from the positive gross profit and net profit figures over the last three years. In terms of valuation metrics like PE ratio, P/CF ratio, P/S ratio and P/B ratio Boeing looks favorable than LMT. The price multiples of BA is higher than the industry average, however, for LMT the price multiple is lower than the industry average. Like the PE ratio of BA is 38.08 and that of LMT is 10.56 indicating that the market is highly valuing the stock of BA. This suggests that the market expects the earnings growth of BA to be higher than LMT in the future. A high growth rate in earnings signifies that the company will be able to generate higher amount of business profit thus raising the value to the shareholders. Based on this parameter a rational investor must invest his money in the stocks of BA. But it is not prudent to base the investment decisions entirely on the valuations measures as there is a chance that the company may manipulate the earnings to raise the price of its stocks. For this reason other important fundamentals like ROE, profit margin, leverage, interest coverage ratio, current ratio etc must also be taken into consideration at the time of making an investment. In terms of liquidity both BA and LMT have successfully maintained a current ratio of more than one indicating sound short term solvency. The gross profit margin of BA is higher than LMT indicating better management of operating expenses. ROE of both BA and LMT is higher than the industry average but here again the ROE offered by BA is higher than LMT. While ROE of BA over the last twelve months is 108.68 percent this ratio is nearly 84.85 percent for LMT. The investors are generally interested in the returns that the company is able to generate on their funds. In this regard they chose the company offering the highest ROE. Based on the financial analysis of Boeing Company and Lockheed Martin Corporation the former looks more attractive. This is because the valuation metrics of BA is higher than the industry standards. Moreover the ROE, Interest coverage ratio, profitability margin etc present a strong financial picture of the company. The market share of the company is also higher than LMT as indicated by the higher revenues and market capitalization. For all these reasons Boeing Company appears to be a better investment proposition. Table of Contents Executive Summary 1 Table of Contents 3 Stock Selection 4 Industry, Company, and Competitor Descriptions 7 Financial Analysis 11 Reference 16 Bibliography 21 Stock Selection The stock analysis is done using tools like- fundamental analysis and technical analysis. These tools guide the investor in taking the necessary position in the stock of a particular company. But there exist differences in these two schools of security analysis. The fundamental analysis is based on a thorough scrutiny of a company’s financial statements (Yao, et al., n.d.). This gives an idea about its financial strength and future growth prospects. Ratios like efficiency ratios help in determining the management efficiency with which the management manages the shareholders’ funds. A rise in the efficiency ratio or a higher efficiency ratio as compared to the industry norms is a good financial indicator. Turnover ratios like Asset turnover ratio, Inventory turnover ratio etc form important turnover ratios. The other types of ratios include liquidity ratio, profitability ratio, solvency ratio and leverage ratio. Among the liquidity ratio comes the current ratio which is a measure of firm’s liquidity position i.e. whether the firm is capable of meeting its short term obligations. Net Profit margin and Gross Profit margin are important profitability ratios. These ratios give an idea about the profitability position of the company. A rise in the profitability ratio over the historical period indicates that the company is able to monitor its costs more efficiently or has successfully widened its revenue base. Interest coverage ratio indicates the financial strength of the company. A high interest coverage ratio indicates that the company is capable of meeting its debt obligations whereas a low interest coverage ratio indicates that the company is overburdened with debt. For the purpose of stock selection the analyst chooses the company that is financially sound. A company with low coverage ratio is considered to be financially weak and is discarded for the purpose of investment. Various other ratios derived from the financial statements like debt-equity ratio, Return on equity (ROE), Dividend Yield, price earning (P/E) ratio etc are used for the purpose of analyzing the worthiness of the stock. The analyst chooses the company that has strong market fundamentals for investing funds. Besides ratios the fundamental analysis also involves the computing the intrinsic value of the security and comparing the same with the market price. If the intrinsic value of the stock is more than its market price then the stock is “undervalued”. To make a gain out of this mispricing an investor can take a long position in the stock. Similarly, if the intrinsic value of the stock is less than its market price it indicates that the stock is “overpriced”. To make a gain out of this the investor can take a ‘short’ position in the stock. The method of calculating intrinsic value of the stock includes Dividend Discount model (DDM), Free Cash Flow (FCF) approach and Relative Valuation. The DDM method of equity valuation is used for the companies with a track record of dividend and when the company is to be valued from the ‘shareholders’ point of view. For companies that do not have a track record of dividend one can use the FCF approach under which the value of the equity is measures using the free cash flows that are available to the investors after taking account of any rise in the working capital, capital expenditure etc. Relative valuation involves the comparison of the company fundamentals with that of its peers. The multiples used here are price earning ratio, price to sales ratio, price to cash flow ratio and price to book value ratio. Here the average price multiple of the industry is obtained which is then compared with the company. Fundamental Analysis is suited for investors with a mid to long term perspective. But this cannot be used by the day traders as this requires an extensive amount of research but these traders enter into and exit from a position within a very short time. These traders base their judgment on the price movements exhibited by the stock in the past commonly referred to as Technical Analysis. This is not concerned with the study of company fundamentals rather it analyses the trading patterns of the stock through trend lines, charts, support and resistance levels and other analytical tools to predict the movement in the security’s price in the future (Rhode Island College, n.d.). Technical Analysis is based on the premise that the price of the stock reflects all the available market information. It views that the stock price movements do not move randomly rather they move in a trend that often repeats itself. Technical analysis helps in taking a position in a particular stock. Like a decision to “buy” is taken on the basis of three successive peaks in the stock price (Nesbitt & Barrass, 2002). A number of indicators have been designed that give an indication about the overbought and oversold zones like Relative Strength Index and Moving Averages. But these technical indicators cannot be considered to be infallible (Rhode Island College, n.d.; Mayes, n.d.). Oscillators are tools that measure the momentum of a stock. Momentum refers to the speed at which the stock prices move in a certain direction. If momentum is high during an upward or downward trend it indicates bullish or bearish signal. A loss of momentum indicates trend reversal. The oscillators give advance signals regarding overbought and oversold positions. Relative Strength Index (RSI) and Moving Average Convergence and Divergence index (MACD) are important oscillators. MACD is obtained as- Short term EMA/ Long Term EMA Taking the reference line as 1 if the MACD lies above the reference line it indicates strong bullish signal whereas if it lies below the reference line it indicates strong bearish signal. RSI measures the internal strength of a stock against itself. This is stated as- RSI = 100 – 100 (1+RS) RS = Average of ups/ Average of downs This lies between 0 to100. 70 to 100 is overbought zone indicating ‘sell’ signal and 0 to 30 is oversold zone indicating ‘buy signal’. Industry, Company, and Competitor Descriptions Overview of aviation industry- Air travel is a growing industry. It facilitates world trade, economic growth and tourism and is thus at the centre of globalization process. Over the last ten years air travel witnessed an annual growth of nearly 7 percent. There has been a rise in both leisure and business travel across the world. Business travel has grown on account of investments, production and sales of the companies acquiring an international dimension. International Air Transport Association (IATA) has forecasted an annual growth of 5 percent from 2000 to 2010 in worldwide air travel. The profitability of airlines’ depends on the level of economic growth. Successful airlines are those that are able to manage their costs efficiently, improvise their products enabling them to secure a strong position in the aviation markets (Department of Aeronautics and Astronautics, n.d.). Major US airlines- Boeing Company (BA) is a leading airline in the US aviation industry. The company faces indigenous competition from Lockheed Martin Corporation (LMT) and Northrop Grumman Corporation (NOC). Boeing develops designs, manufactures and supports jetliners, satellites, military aircraft, missile defense etc. The company operates in segments like Boeing Military Aircraft (BMA), Commercial Airplanes, Boeing Capital Corporation (BCC), Global Services and Support (GS&S) and Network & Space Systems (N&SS) (Yahoo Finance-a, 2010). Lockheed Martin Corporation is engaged in design, research, development, integration manufacture, sustainment and operation of advanced technology products and systems in US and across the globe. It operates in segments like Electronic Systems, Aeronautics, Space Systems and Information Systems & Global Services (IS&GS) (Yahoo Finance-b, 2010). Northrop Grumman Corporation offers services, integrated solutions and products in the electronics, aerospace, shipbuilding sectors and information & services. (Yahoo Finance-c, 2010). With a market capitalization of $18.15 billion NOC ranks third after BA and LMT. The total revenue of the company was $32018 million in 2007 that increased to $33887 million in the following year. There was a marginal fall in the revenue of the company in 2009. Despite a rise in the revenue in the year 2008 the gross profit of NOC fell from $6214 million in the previous year to $6189 million. In 2008 the company incurred a net loss of $1262 million. In this year the company incurred a non-recurring expense of $3060 million which can be one of the main reasons for the losses. But the profitability position improved in the next year with the company reporting a net income of $1686 million (Yahoo Finance-d, 2010). Boeing Company reported total revenue of $68281 million marking an increase of more than 10 percent over the last year’s total revenue of $60909 million. The company earned gross profit of $13280 million in 2007 on a revenue base of $66387 million. In the year 2009 there was a fall in the gross profit of the company despite a rise in the revenue. This was mainly on account of higher cost of operations. There was a fall in the Operating Income of BA as well as is evident from a fall of more than 50 percent in the Operating Income from $5937 million in 2007 to $2096 million in 2009. This can be explained by a steep rise in the Research & Development cost of BA that nearly doubled over the period of three years from $3850 million in 2007 to $6506 million in 2009 (Yahoo Finance-e, 2010). The total revenue of Lockheed Martin Corporation (LMT) has continuously maintained an upward trend over the last three years. In the year 2007 LMT reported total revenue of $41862 million that rose to $45189 million in 2009 marking a rise of nearly 10 percent. The gross profit of LMT however fell in the 2009. In this year the company spent heavily on Selling, General and Administration reporting a selling expense of $242 million. For 2007 LMT reported a net income of $3033 million that rose to $3217 million in the following year falling thereafter to $3024 million in 2009 (Yahoo Finance-f, 2010). In terms of revenue base Boeing Company looks strong as its revenue is higher as compared to its competitors. Moreover the company spends heavily on research as is evident from its financial statements. This is a good sign as it indicates that the company aims at making its technology more advanced. Based on its technological expertise the company is in a position to manufacture sophisticated and modern aircrafts. This can bring in cost-efficiency as a sophisticated design of the aircraft can result in lower fuel costs and higher capacity. Financial Analysis Boeing company- The price earning (PE) ratio of BA is 38.08. This is higher than the industry PE ratio of 16.42. PE ratio is measured as Market Price of the share/Earnings per share (EPS). A high PE ratio indicates that the investors anticipate higher future growth in the earnings of the company. This ratio is referred as ‘multiple’ as it shows the amount that the investors are ready to pay for every dollar earned by the company. Boeing’s PE ratio of 38.08 indicates that the investor is ready to pay $38.08 for $1 earnings of BA. This ratio is higher than the industry PE ratio indicating that the market has high expectations from the company. BA has to deliver as per the market anticipations by increasing the earnings substantially failing which the price of the company’s stock will fall (Stanford University, n.d.; Reuters-a, 2010). The Price to Cash Flow of BA is 16.38 whereas that of the industry is 10.22. It indicates that the company is trading 16.38 times it cash flows. The Price to Cash Flow is a measure of the market’s expectations of the financial health of the company in the future. As this measure deals with the company’s cash flows it removes the effects relating to depreciation and non-cash items. Other than earnings and cash flows other value drivers are book value and revenues, but the earnings and the cash flows are more popular valuation measures (Liu, et al., 2007). Price to book value ratio (P/B) is generally used when the EPS of the company is negative as the PE ratio based on a negative EPS is meaningless. This is obtained by dividing the market price by the book value per share. A low P/B ratio suggests that the stock is undervalued but it can also means that the company is not sound fundamentally. P/B ratio of BA is 16.28 as compared to the industry P/B ratio of 4.66. This suggests that the company is financially sound. Price to Sales ratio (P/S) is subject to less manipulation as compared to EPS and book value. While it is possible for the management to distort the EPS through accounting decisions but the same is not true for the top-line. As sales are stable than earnings, P/s is more stable as compared to P/E. P/S ratio of BA is 0.72 as compared to the industry P/S ratio of 0.97. One of the major limitations of this ratio is that as it does not take into account expenses it fails to give a complete picture of the company’s financial position. The gross profit margin of the company is 18 percent whish is very close to the industry average of 19.34 percent. This shows that the company has effectively managed its administrative expenses. The net profit margin of the company based on an average of the last five years is 4.1 which is fairly close to industry average of 5.0 during the period (MSN Money-a, 2010). Return on Equity (ROE) which indicates the return generated by the company for its shareholders is an important factor that is looked into by the investor. ROE of BA is 108.68 percent as compared to the industry ROE of 32.69 percent. This means that Boeing is managing its funds quite efficiently resulting in a high ROE. The current ratio of the company is 1.10 over the industry current ratio of 1.43 suggesting that the liquidity position of the company is fairly stable. This means that the company is well positioned to take care of its short term obligations. The leverage position of the company is higher than the industry at 21.4 but this does not make it less attractive as the leverage ratio is generally high for industries like aviation. Considering the risk that is associated with this kind of investment theses companies raise most of the funds in the form of debt i.e. reliance on equity is limited. Moreover the operations in the aviation industry require huge capital investment thus raising the leverage position of the company. In this regard the interest coverage ratio gives an important indicator of the financial strength of the company to honor its debts. A high interest coverage ratio indicates that the company is capable of taking care of it interest payments. This ratio is 15.4 for Boeing suggesting that the earnings of the company are fairly high and can support the debt related expenses of the company (MSN Money-b, 2010). Lockheed Martin Corporation (LMT)- In terms of market capitalization LMT comes close to Boeing Company. A comparison with LMT has been done to analyze the company that is more profitable for an investor. PE ratio of LMT is 10.56 which is less than the industry average PE ratio of 16.42. This is also less than the PE ratio of Boeing suggesting that the market does not have much growth expectations from LMT. P/ B ratio of LMT is 7.35 which is higher than the industry average indicating that the company is financially good. P/CF ratio of the company is 7.88. This means that the stock of the company is trading at 7.88 times the cash flows. P/S ratio of LMT is 0.65 which is close to the industry average of 0.97 but less than the P/S ratio of Boeing (Reuters-b, 2010). In terms of the above valuation ratios Boeing looks attractive than Lockheed Martin Corporation but the investment decisions must not be entirely based on theses decisions. This is because there are chances that the earnings or cash flows of the company have been manipulated by the company to present a rosy picture to the investors. For all these reasons other financial ratios measuring profitability, liquidity and solvency must also be taken into account at the time of making an investment. The liquidity position of LMT is 1.20 indicating that the company is capable of meeting its short term liabilities. This is important as a company with a low current ratio may face difficulty in meeting its day to day expenses. The gross margin of the company is 9.14 percent which is less than the industry average of 19.34 percent. This suggests that the cost of operations of the company is fairly high or the company fails to generate adequate revenues resulting in high low gross profit margin. Net profit margin of the company based on an average of the last five years is 6.6 percent indicating that the efficiency of the company’s management in controlling the administration expenses (MSN Money-c, 2010). ROE of LMT is 84.85 percent is higher than the average ROE of the industry but this is less than Boeing Company thus making the latter more attractive to the investors. The investors are generally concerned about the returns that the company is able to generate on their funds. If one company is generating higher returns than another then the investors prefer to part their funds in the company generating higher ROE. The leverage ratio of LMT is more than double the leverage position of the industry at 9.0 as compared to the industry average of 3.9. This amount of leverage is acceptable as the proportion of debt in aviation industry is high as they have to undertake manufacturing activities involving huge amount of capital. Therefore the interest coverage ratio of an airline is an important indicator of its solvency position. This ratio is 13.9 for LMT indicating that the company earns sufficient amount of income so as to honor its obligations (MSN Money-d, 2010). Reference Department of Aeronautics and Astronautics. No Date. INDUSTRY OVERVIEW. The Airline Industry. Retrieved on May 24, 2010 from http://adg.stanford.edu/aa241/intro/airlineindustry.html Liu, J. Nissim, D. Thomas, J. (2007). Is Cash Flow King in Valuations?. Financial Analysts Journal Volume 63. Retrieved on May 24, 2010 from http://www.som.yale.edu/Faculty/jkt7/papers/global%20multiples.pdf Mayes, R.T. NO Date. Introduction. Technical Analysis. Retrieved on May 24, 2010 from http://clem.mscd.edu/~mayest/FIN3600/Files/FIN3600_8.ppt#3 MSN Money-a. (2010). 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