Category: Business

Analyses of business related matters.

Boeing Scrambles for Contracts

Reuters writes

Boeing Co (BA.N: Quote, Profile, Research, Stock Buzz) on Monday filed a protest with the Government Accountability Office about a $1.1 billion contract for next-generation weather satellites won by Lockheed Martin Corp (LMT.N: Quote, Profile, Research, Stock Buzz) on December 2, a company spokeswoman said.

“Based on the information that we received, we felt that we had a superior product under the disclosed evaluation criteria,” Boeing spokeswoman Diana Ball told Reuters.

The contract, awarded by NASA and the National Oceanic and Atmospheric Administration (NOAA), calls for Lockheed to build two Geostationary Operational Environmental Satellite R-Series, known as GOES-R, and includes options for two additional spacecraft.

Chicago-based Boeing filed the protest with the nonpartisan congressional agency on Monday, meeting a five-day deadline to ensure a stop-work order against the program.

The five-day clock begins when a losing bidder receives a detailed briefing from the awarding agency about why it lost the bid. Boeing received its briefing last Wednesday.

The GAO has the authority to review government acquisition decisions and recommend corrective actions, including termination of contracts if they are deemed improper.

Ball said Boeing took the step only after careful consideration. Boeing rarely filed contract protests in the past, but it prevailed with a protest last June against a $35 billion contract for new refueling aircraft initially won by Northrop Grumman Corp (NOC.N: Quote, Profile, Research, Stock Buzz) and Europe’s EADS (EAD.PA: Quote, Profile, Research, Stock Buzz).

In that case, the GAO upheld Boeing’s protest, and the Pentagon later decided to scrap the competition and let the new administration redo the entire process.

Protests have become far more common against Pentagon contracts in recent years as the number of defense deals available to bidders has declined, and their relative size has increased.

Ron Sugar, chief executive of Northrop, which had also bid for the program, declined comment on whether his company would also file a protest. He spoke at the Reuters Aerospace and Defense Summit on Monday.

Northrop officials were briefed about the contract loss last Thursday, which means it must file a protest by Tuesday to ensure a stop-work order against Lockheed.

Northrop filed a protest last month against a set of U.S. Army contracts for prototypes of vehicles that could replace the U.S. Humvee fleet in a deal valued at up to $40 billion.

Defense analyst Loren Thompson described the contract loss as bad news for Boeing, given that it also recently lost out to Lockheed on a Global Positioning System satellite contract.

Boeing needed to reevaluate its financial investment in the space sector, but probably could not exit the business completely since it had several long-term classified contracts with the U.S. government, he said.

I already described the dire situation Boeing is in. The fact that Boeing sees no other way than to scramble for government contracts by legal means shows how desperately the company needs the money. If thay had other profitable activities going on, they wouldn’t be spending all this time for administratve bureacuratic work.

With the government deficit already stretched beyond sanity, how should any more money be left for new fighter jets and planes, especially under an Obama administration?

Boeing is a stock that is poised to collapse.

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Stock Valuation – Precision Drilling Trust (PDS)

Below please find an valuation of shares of the common stock of Precision Drilling Trust (PDS)

Free Cash Flow per share:

  • PDS’s FCF over the past 4 quarters was $171,670,000
  • PDS has shares outstanding of $125,760,000
  • Thus the Free Cash Flow Per Share is $1.37

Annual Growth Rate

  • PDS’s FCF fell from $324 million to $297 million from 2004 through 2007. Temporarily there was a significant spike in the year 2006 which was certainly due to the continuous rise in oil prices. However, due to this high volatility it is not possible to make any predictions based on the past 4 years.
  • Precision drilling certainly thrives in a high oil price environment. The higher the price the more explorations and thus more demand for drilling equipment.
  • But the oil price has been falling sharply over the past 5 months. Even though the money supply has begun to grow significantly again, the effects on the oil price will not be visible immediately. It may take another 1-2 years before oil bottoms out.
  • In order to make our calculation as conservative as reasonably possible we shall thus assume that the annual cash flow for PDS will continue to fall over the next 5 years, at an annual rate of 10%
  • Thereafter we shall assume a perpetual growth rate of 1%

Confidence margin:

We shall apply an confidence margin of only 30% in order to account for the fact that we did not make very elaborate research on the overall strengths/weaknesses and opportunities/risks that the company faces and hence are not very sure if the expected returns will be achieved. In addition to this, the past data indicates a high level of cash flow volatility.

Risk Free Rate:

Price:

Based on the data above, the fair price for PDS is $13.13, about double of the current price which is $6.66. And this is assuming falling oil prices and a continuously falling cash flow over the next 5 years at an extremely conservative confidence margin. If oil prices bottom out or even begin rising again over the next 5 years the stock has the potential to explode.

In any case, based on the above it is reasonable to be very bullish on Precision Drilling at the current price.

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Mac Donalds Stock Evaluation Example

This is how the concepts of stock evaluation can be applied to the example of the company Mc Donalds (MCD):

Free Cash Flow per share:

Annual Growth Rate

Confidence Margin

We shall apply a confidence margin of 50% in order to account for the fact that we did not make very elaborate research on the overall strengths/weaknesses and opportunities/risks that the company faces and hence are not very sure if the expected returns will be achieved. The more research one does, and the more certain one is regarding the returns, the higher this number can be.

Risk Free Rate:

Thus the formula is as follows:

Price(MCD)

= ($3.23 x 0.5 x 1.07 / 1.0265) + ($3.23 x 0.5 x 1.072 / 1.02652) + ($3.23 x 0.5 x 1.073 / 1.02653) + ($3.23 x 0.5 x 1.074 / 1.02654) + ($3.23 x 0.5 x 1.075 / 1.02655) + ($3.23 x 0.5 x 1.076 / (0.0265-0.01) / 1.02656)

= $1.68343887 + $1.754777975 + $1.829140217 + $1.906653709 + $1.987451991 + $125.5560159

= $134.72

This analysis suggests that Mac Donalds shares are currently available at a price below the fair price. If my estimations turn out to be true, or the company performs even better than estimated, I would most likely be realizing a gain from this investment.

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Stock Evaluation

Shares of common stock are claims to entrepreneurial profits generated by the factors of production employed in a business. How much one should pay for a share depends on the value preference one assigns to it. While consumer goods render various services the valuation of which highly depends upon one’s value preferences, a share in factors of production, only renders one benefit to its owner: It yields specific amounts of money over a specific amount of time at a certain risk, where risk means the uncertainty over the amounts of money to be received.

Thus these three factors need to be incorporated when assessing the price one would be willing to pay for a share.

Within a certain territory, a so called risk free investment is a credit transaction with the government. The interest rate that the government pays shall be considered the risk free rate. It is expedient to apply the interest rate on 10 Year Treasury Notes.

Every investment in factors of production has to be measured against this risk free rate. If one can expect a guaranteed $1100 in 1 year  by loaning $1000 to the government, then $1100 in a year returned by a business will certainly be worth less than $1000. Thus this money received has to be discounted by a confidence margin between 0(very uncertain) and 1 (100% certain). As a standard, all calculations are looked at in annual terms, but it is not mandatory.

The price estimation for money received in the future is called present value. A present value for money received in a certain number of years is calculated as follows:

Present Value = (Payment Amount X Confidence Margin) / (1+ Risk Free Annual Rate)(Number of Years)

Since it is very hard to foresee more than what will happen over the next 5 years, the expected money received over those 5 years shall be factored into the valuation, but all future expected money shall be estimated at a very low growth rate. Thus we shall resort to a perpetuity calculation. A perpetuity is an arrangement where one receives a certain amount of money every year at a fixed growth rate for all time. The fair price of an annual perpetual payment is estimated as follows:

Perpetuity Price = Annual Payment / (Risk Free Annual Rate – Fixed Annual Growth Rate)

The profit generated thus far by a business is reported for all publicly traded companies. But the reports might be misleading. What they report under the label “Profit” is a very manipulated figure that is the result of numerous accounting techniques. The closest approximation of what one can expect to be the actual money available to the business is the free cash flow. The free cash flow can be approximated by subtracting capital expenditures from the operating cash flow (Free Cash Flow = Cash Flow from Operations – Capital Expenditures). All these numbers are available on financial websites. Example: NEM

Based on the growth of the free cash flow over the past 5 years plus the overall expectations of whether or not consumers will still have a demand for the company’s goods over the next 5 years, one needs to come up with an estimated annual growth rate for the free cash flow over the next 5 years. After that we shall assume that the free cash flow returned in the 5th year will grow at a perpetual annual rate of 1% for all time.

Thus the formula to approximate a price one should  be willing to pay for a share of common stock is the following (where FCF = Free Cash Flow per share over the past 4 quarters):

Price = Present Value (FCF * Annual Growth Rate, 1 year) + Present Value (FCF * Annual Growth Rate2, 2 years) + Present Value (FCF * Annual Growth Rate3, 3 years) + Present Value (FCF * Annual Growth Rate4, 4 years) + Present Value (FCF * Annual Growth Rate5, 5 years) + Present Value of 1% Growth Perpetuity Starting in 6 years

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Boeing in Trouble

Marketwatch.com says Boeing may further delay 787 Dreamliner:

The online edition of The Wall Street Journal, citing unnamed sources, reported that Boeing officials are expected to announce later this month that first deliveries of the jet may not occur until as late as summer 2010.
Development of the jet has been hampered by a strike by the International Association of Machinists and Aerospace Workers that “forced Boeing to shut down its Seattle-area assembly lines for almost all of September and October,” according to the report.
In addition, the high volume of work on the project being outsourced has also created problems, according to the report.
In April of this year the story was:
“Our assessment for this delivery schedule is the culmination of detailed industrial engineering studies, on-site visits, partner negotiations … and at the end of the day, good old-fashioned management judgment,” Boeing’s Pat Shanahan said.
Boeing’s numbers show us the following:
– From 2005-2007 the company’s free cash flow (operating cash flow – capital expenditures) grew from $5.5 billion to $7.9 billion
– This year, so far, the company has generated a free cash flow of $389 million with the two past quarters yielding negative cash flows; unless the 4th quarter yields incredibly good results the overall free cash flow number for this year will look very bleak
– A look at the most recent balance sheet shows us that the company is among the highly leveraged ones with a 6:1 debt to equity ratio
– What stands out in particular that the company maintains an accounts payable balance of $27 billion versus a shareholders equity of $8.7 billion and a cash balance of $4 billion: the company is obviously making its vendors wait, the article above mentions that a lot of work is being outsourced
– Thus Boeing heavily depends on a lot of vendors that are (1) not being paid in a timely fashion and (2) will most likely not get paid anytime soon if the current economic trend hold up and the company keeps delaying deliveries and losing cash.
I am very bearish on Boeing and expect some seriously bad news for investors shortly. Surely Boeing will also be deemed “too big to fail” by US lawmakers. Obviously, the next step will be yet another bailout request.

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