News & Our Thinking

Ward Brown explains why the aerospace industry remains a solid investment, despite the quality and safety issues recently experienced by the Boeing Corporation. When evaluating a business for an investment opportunity, it’s important to consider the capital allocation of the management team. Maximizing shareholder value while simultaneously running a solid business is critical for sound investments.

Transcript

Hello, I’m Ward Brown. It seems like there’s a new negative headline for Boeing every week.

Quality control issues continue plaguing the aircraft manufacturer’s MAX program limiting its delivery of airplanes that major airlines need. It’s a giant mess, but Boeing ,and another aerospace company many are hard pressed to even pronounce, do shed light on our risk management and stock selection process. Let’s take a look.

At Argent, we owned Boeing in our Dividend Select portfolio for many years. We first purchased the company in early 2017. At the time, Boeing was undergoing a strategic turnaround that prioritized improving profitability and cash flows.

Several of its peers like, Lockheed Martin, had undergone similar transformations, increasing our confidence that Boeing could do the same thing. They succeeded. Cash flow generation and margins expanded significantly.

When we evaluate a business, one of the considerations is capital allocation, or basically, what they do with the cash that the business generates. For Boeing, the management team prioritized capital allocation in the form of returning it to shareholders through both share buybacks and dividends. The stock liked it a lot, and shareholders benefited handsomely, including us.

At the same time, there was significantly less reinvestment back into the business than they had the prior years before the transformation began. Whether or not the focus on profitability, including cost controls, ultimately led to the quality and safety issues today, when the MAX jet was grounded in the spring of 2019 after the second crash in less than six months, everything about our investment thesis changed.

We could no longer measure progress as we intended. Uncertainty was and remains the predominant theme for the company. We elected to sell the position in response to the grounding several years ago. The consequence was recognizing a significant gain in the process because the stock had done so well for so long before that. This is an extreme case, of course, but we are always mindful of the gains being assumed in the sale.

Our priority is portfolio performance, but we are sensitive to taxable gains in our assessment of the forward outlook for the businesses we own. When the risk profile increases beyond a certain degree, our process will trigger a sale, gains included. This year would be no different than that.

But while we won’t always get it right, it was a wise decision in the case of Boeing. The stock has underperformed the S&P 500 by a significant degree since the MAX troubles began. While Boeing and the major airlines have struggled, there is still a lot to like about the aerospace industry.

More broadly, Transdigm, and yes, there are consistent questions on the pronunciation and that “G” throws people off, is a stock we recently added to the Large Cap portfolio. There are obviously a ton of parts on an airplane and Transdigm makes a lot of them for the commercial business and defense aircraft.

Some of it’s real sophisticated stuff like parts for power and control system, and then also parts for the cabin like cockpit displays and audio systems. Transdigm also gets about a third of its sales from the aftermarket, which is the replacement and maintenance parts that aircraft constantly require. It includes things like seat belts that I know that I click open and close about 25 times on any given flight. Transdigm’s aftermarket business is benefiting substantially from the lack of new planes being delivered and the upkeep needed for the existing fleet. Management is paid very well to generate operating performance, plus an accretive capital allocation plan, which for Transdigm involves paying a fair price for businesses they acquire in its active acquisition strategy. There is an important distinction in a management team’s ability to maximize shareholder value while running the business well.

Despite the issues at Boeing, aerospace is a growing industry with a constant demand for a refreshed and updated fleet of aircraft. It is good for all of us if Boeing gets back on track, and the management changes that they recently announced could be a first step.

Thanks very much for watching.

Disclaimer: Performance returns cited represent past performance, which does not guarantee future results. Returns assume reinvestment of dividend and interest but returns do not reflect the effect of taxes and/or fees that an investment would incur. References to specific company securities should not be construed as investment advice. Not all Argent clients may own each company’s stock discussed. Argent portfolio managers may recommend the purchase or sale of these and other securities for their client’s accounts.  A list of all stocks recommended by Argent during the past year is available upon request.  Some data represented in this article is derived from non-affiliated sources Argent deems reliable. However, Argent does not perform any independent research to determine the accuracy of such information. Please visit our compliance page for additional details and disclaimers.