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Financial Analysis –

Airbus & Boeing

2014

Boeing vs

Airbus

2014

Taposh Dutta Roy & Team

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I. Corporate Governance Analysis Boeing Boeing’s history starts in 1910 when founder William Boeing turned a shipyard into an airplane factory in Seattle, Washington. It’s now a leading manufacturer of commercial jetliners and military aircraft and is the world’s leading aerospace company. Beyond aircraft, Boeing designs and manufactures missiles, satellites, launch vehicles and advanced information and communication systems and provides support services to the military and commercial airlines. James McNerney has served as CEO and chairman of the board since July 1, 2005. Before joining Boeing, he was chairman of the board and CEO at 3M, and before that he served in several high-profile positions at various locations at GE. For 2013, McNerney’s salary was $1.9 million with $3.7 million stock award and $3.7 million stock option grants and an incentive bonus of $12.8 million. There are 10 other people on the board of directors; except for the chairman, none are insiders. They all have executive experience in many different industries, but most are the head of private equity firms or hold government positions. The newest member has served for three years while the member with the longest tenure has served for seven.

According to reports Boeing filed with the SEC, in regards to payment, “…the Board’s compensation should be a mix of cash and equity-based compensation with a significant portion of such compensation in the form of the Company’s stock or stock-equivalent units. Non-employee directors receive a substantial portion of their compensation in deferred stock units, which must be held until retirement or other termination of Board service,” (SEC.GOV). None of the individual board members or the companies for which they work owns a disproportionate share of stock; although many of the top investors are other equity firms. Out of a total of 747 million shares outstanding, none of the managers are part of the top shareholders at Boeing. There are 20 analyst firms that cover Boeing. At Boeing, a true corporation incorporates three main elements: the products and services, its business practices, and its community engagement. One third of what defines Boeing as a “corporation” is its fulfillment of its social obligations. Boeing’s website says it indeed does have a responsibility to its stakeholders, but also to the communities in which its employees live. Boeing compiles a yearly Citizenship Report detailing its contributions to education, environment, arts and culture, and other volunteering activities (Boeing.Com - Corporate Citzenship). Most recently the disappearance of flight MH370, a Boeing 777 aircraft, has made the company a target of blame. Boeing has offered its help in investigating what went wrong and what it can do to help. Boeing released the following statement on April 4: Our thoughts and deepest sympathies continue to be with the families and loved ones of those aboard Malaysia Airlines Flight 370. Under the international protocols established for aviation accident investigations, Boeing continues to serve as a technical advisor to the U.S. National Transportation Safety Board, in support of the Malaysian authorities (Murdoch).

Airbus Airbus was founded in 1970. Its headquarters is in Blagnac, France. Airbus roots date back to 1967 where a consortium of European aerospace firms formed to compete with US firms such as Boeing and

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McDonnell Douglas. In 1970 Airbus Industrie formed, backed by French, German, Spanish, British government backed entities and becomes a global pioneer in aeronautics, space and defense related services. In 2001 the consortium was merged as European Aeronautic Defense and Space Company (EADS). The company was rebranded as Airbus Group on January 2, 2014. Airbus Group unites the capabilities of Airbus, Airbus Defense and Space and Airbus Helicopters. Airbus recently transformed its corporate governance. With its origins as a consortium to compete with U.S. aviation firms, the firm evolved as a collaboration of European government funded entities. Prior to December 2012, the governments of Germany and France had effective veto power over management decisions. The two countries each controlled 22.5 percent of the company through a mix of state holding companies and private-sector owners which acted as proxies for the governments (CLARK). In December 2012 the company reached an agreement to overhaul its ownership. Following a series of ownership restructurings and divestments, the company’s ownership structure is now a more “normal” shareholder democracy, as we will detail in the Shareholder Analysis section of our paper below. Over 70% of shares are now in free float versus a prior 49% compared to the previous year. Government controlled interests now hold 28% of the stock and the board has adopted rules limiting the size of state shareholdings. The board has also implemented simple majority voting, and veto rights have been eliminated.

Airbus has twelve board members. Eleven are independent. Corporate governance rules call for at least nine independent members and a non-executive chairperson. Six of twelve board members are new since 2012. Three of twelve board members are retired banking executives - each from Germany, France or Spain - this is consistent with the governments still holding 4% or more of shares. Airbus’ CEO is Thomas Enders. He has been CEO since May 2012 and served as CEO of the Airbus Division from 2007-2012. He joined Airbus from DaimlerChrysler Aerospace at the merged formation of the company. In 2012, Mr. Enders earned €817K in salary, €1.23M in variable pay and was granted €50,300 in options vesting over four years. Airbus is headquartered in France and listed on German, French and Spanish exchanges. Total number of outstanding shares for Airbus is 783,258,500 (780,423,379 with voting rights). No insider holds more than 1% of Airbus stock. 28 analysts cover the company. Airbus Investor Relations posts a fairly robust set of information on its website and goes beyond the typical financial reporting to include profiles on hedging, debt, shareholding structure and long-term incentive plans. Airbus is also closely followed in the press due to its significance the commercial aircraft market and intense competition with Boeing. In summary, Airbus’ shareholding structure, and the free flow of information about the company, does not suggest management would not be responsive to shareholders. Still, it is notable that Airbus’ shareholding structure, while recently overhauled to be more “democratic” is still atypical in that it is held at a 28% level by state entities. We’d expect the French and German governments behind these entities to still have meaningful influence on Airbus’ business decisions. Corporate Social Responsibility is highlighted on the Airbus Group website and the company publishes a Corporate Responsibility and Sustainability Annual Report (EADS). In its report, Airbus details goals for greenhouse gas reductions that are being set by the airline industry. It does not go so far as to set its own, more aggressive goals. The company cites product innovation efforts in fuel-efficient aircraft and

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research for sustainable alternative fuel production as CSR initiatives for the firm. A Reputation Institute 2013 study tracking CSR perception ranked Airbus as 71 of the top 100 companies in CSR (Smith).

II. Shareholder Analysis Boeing Boeing is listed on the NYSE with 68.30% of the stock held in North America. The company’s shares are distributed between institutions, mutual funds, and individuals. Insider ownership is very small, totaling .0008% of outstanding shares. 72.6% of Boeing stock is held by institutional investors and funds as noted in Figure II-1.

Figure II-1: Boeing Holding Summary

Source: (E-Trade) Institutional trends over the last quarter show a reduction in share ownership. Net institutional share change in the last quarter is down 358.8 million shares. Fund ownership is down 12 million shares (McAllister).

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Table II-1: Top Boeing Shareholders

Capital World Investors 68,078,000 9.35%

Evercore Trust Company 51,502,260 7.06%

Vanguard Group, Inc. 36,252,807 4.97%

State Street Corporation 33,680,904 4.64%

Price (T. Rowe) Associates Inc 32,936,583 4.52%

Washington Mutual Investors Fund 24,320,000 3.34%

BlackRock Institutional Trust Company 18,527,570 2.54%

FMR, LLC 15,254,350 2.09%

American Balanced Fund 13,275,000 1.82%

Fundamental Investors Inc 11,695,000 1.60% Source: (Yahoo Finance)

Figure II-2: Boeing Owner Activity

Source: (McAllister) Airbus As stated earlier, Airbus has undergone a recent transformation of ownership structure. The majority of Airbus stock and voting rights are now held by the public. However French, German and Spanish government entities hold large shares of Airbus capital and voting rights. See figures II-3,4 for a breakdown of the ownership.

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Figure II-3: Airbus Shareholding Structure & Influence

Source: (Airbus Group)

Figure II-4: Airbus Evolution of Ownership

Source: (Airbus Group)

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Airbus stock is traded on the below indices: ● CAC 40 (French key index) ● MDAX 50 (Index of German MidCap Companies) ● Eurostoxx 50 ● DJ Stoxx 600 – Industrials

Company insiders including Sogepa and GZBV, French and German state owned entities. These insiders held sway over major board room decisions, such as the failed merger between Airbus and BAE Systems. Just recently, these insiders’ control was relinquished allowing Airbus more freedom in major business decisions. Company employees hold about 2.13% of the company capital. Overall, company insiders have been selling shares of the company. In fact Spain is planning to sell its entire stake in the company whereas France and Germany are considering selling portions of their stake. Investors have approved an option for Airbus to buy back up to €5.1B in capital depending on market conditions.

Table II-2: Airbus Institutional Investors

Other Institutional Investors Shares % of Capital

Capital & Research & Management Co. (World Investors) 34,498,718 4.40%

Government of Russia 22,614,753 2.89%

Capital & Research & Management Co. (Global Investors) 13,244,592 1.69%

Lyxor International Asset Management SA 12,372,267 1.58%

BlackRock Fund Advisors 9,223,954 1.18%

Amundi SA (Investment Management) 8,717,782 1.11%

The Vanguard Group, Inc. 6,924,458 0.88% Source: (Airbus Group)

III. Risk and Return To analyze the risk profile for Boeing and Airbus, we looked in to their returns for last 5 years. For Boeing we ran a regression with S&P 500 while for Airbus we ran regression against CAC40. Regression detail is in Appendix Figures 1 & 2.

Table III-1: Regression Results

Boeing Airbus

Market S&P500 CAC40

Beta 1.276 0.958

Intercept of Regression 0.035% 0.412%

R-Squared 0.561 0.386

This beta is computed using the data for last 5 years April 2009 – April 2014. The beta values will differ if we use a different date range. For this time period we see that Boeing is better correlated to S&P500 market while Airbus is hardly correlated to CAC40.

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Slope of the Regression For Boeing we used S&P500 Index SPY as our independent market variable, while for Airbus we used Paris Stock Exchange Index CAC40. We found the slope of regression for Boeing to be 1.29 while that of Airbus 0.12. Intercept of the Regression For Boeing the intercept of regression was -0.11%. This is a measure of Boeing's performance, when it is compared with Rf (1-β). The weekly risk-free rate (since the returns used in the regression are weekly returns) between 2009 and 2014 averaged 0.27%, resulting in the following estimate for the performance:

Rf (1-β) = 0.27% (1-1.276) = -0.075%

Intercept - Rf (1-β) =-0.03% - (-0.075%) =0.111% This analysis suggests that Boeing performed 0.12% better than expected, when expectations are based on the CAPM, on a weekly basis between April 2009 and April 2014. This results in an annualized excess return of approximately 5.97%.

𝐴𝑛𝑛𝑢𝑎𝑙𝑖𝑧𝑒𝑑 𝐸𝑥𝑐𝑒𝑠𝑠 𝑅𝑒𝑡𝑢𝑟𝑛 = (1 + 𝑊𝑒𝑒𝑘𝑙𝑦 𝐸𝑥𝑐𝑒𝑠𝑠 𝑅𝑒𝑡𝑢𝑟𝑛𝑠)50 − 1 Annualized Excess Return = 5.686%

By this measure of performance, Boeing did better than expected during the period of the regression. Note, however, that this does not imply that Boeing would be a good investment looking forward. It also does not provide a breakdown of how much of this excess return can be attributed to ‘industry-wide’ effects, and how much is specific to the firm. To make that breakdown, the excess returns would have to be computed over the same period for other firms in the Airline industry and compared with Boeing’s excess return. The difference would be then attributable to firm-specific actions. In this case, for instance, the average annualized excess. For Airbus the intercept of regression was 0.41%. This is a measure of Airbus's performance, when it is compared with Rf (1-β). The weekly risk-free rate (since the returns used in the regression are weekly returns) between 2009 and 2014 averaged 0.05%, resulting in the following estimate for the performance:

Rf (1-β) = 0.05% (1-0.41) = 0.002%

Intercept - Rf (1-β) = 0.41% This analysis suggests that Airbus performed 0.36% better than expected, when expectations are based on the CAPM, on a weekly basis between April 2009 and April 2014. This results in an annualized excess return of approximately 19.7%.

𝐴𝑛𝑛𝑢𝑎𝑙𝑖𝑧𝑒𝑑 𝐸𝑥𝑐𝑒𝑠𝑠 𝑅𝑒𝑡𝑢𝑟𝑛 = (1 + 𝑊𝑒𝑒𝑘𝑙𝑦 𝐸𝑥𝑐𝑒𝑠𝑠 𝑅𝑒𝑡𝑢𝑟𝑛𝑠)50 − 1 Annualized Excess Return = 22.7%

By this measure of performance, Airbus did better than expected during the period of the regression. Note, however, that this does not imply that Airbus would be a good investment looking forward. It also

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does not provide a breakdown of how much of this excess return can be attributed to ‘industry-wide’ effects, and how much is specific to the firm. To make that breakdown, the excess returns would have to be computed over the same period for other firms in the Airline industry and compared with Airbus’s excess return. The difference would be then attributable to firm-specific actions. In this case, for instance, the average annualized excess. R squared of the regression For Boeing, the R-squared of regression or fit is 56.1%. This statistic suggests that 56.1% of the risk (variance) in Boeing comes from market sources (interest rate risk, inflation risk etc.), and that the balance of 45.9% of the risk comes from firm-specific components. The latter risk should be diversifiable, and therefore unrewarded in the CAPM. For Airbus the R-squared of regression or fit is 38.6%. This statistic suggests that 38.6% of the risk (variance) in Airbus comes from market sources (interest rate risk, inflation risk etc.), and that the balance of 61.4% of the risk comes from firm-specific components. We believe this is due to the large ownership share by Governments and the decrease risk of fault. We expect Airbus to become more reactionary to market conditions as the public gains increase share of ownership. From Betas to Costs of Equity To get from the beta to the cost of equity, we needed two other inputs. For the risk-free rate, we used a long term Treasury bond rate (which at the time of the analysis was 2.73% and 2.43%). For market risk premium we use the geometric historical risk premium for stocks over long term treasury bonds of 5.0% and 5.6% and add the country risk spread.

Re = rf + (rm – rf) * β

Table III-2: Boeing & Airbus Cost of Equity

Boeing Airbus

β 1.28 0.95

rf 2.73% 2.43%

(rm – rf) 5% 5.60%

Cost of Equity 9.11% 7.44%

Thus, 9.11% is the return that potential investors would require as a rate of return for investing in Boeing and is also the cost of equity for Boeing. Whereas, 7.44% is the return that potential investors would require as a rate of return for investing in Airbus and is also the cost of equity for Airbus. Costs of Debt To estimate Boeing’s and Airbus’s cost of debt, we obtained the current bond rating of the companies. Moody’s assigns a rating of A2 to Boeing’s traded debt and A2 to Airbus’s traded debt. Based upon the long-term U.S. Treasury and French Treasury bond rates of 2.73% and 2.43% respectively, and an estimated default spread of 1.0%, we estimate a pre-tax cost of borrowing of 3.73 and 3.43% for Boeing and Airbus.

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Table III-3: Boeing & Airbus Cost of Debt

Boeing Airbus

β 1.28 0.95

rf 2.73% 2.43%

(rm – rf) 5% 5.60%

Cost of Equity 9.11% 7.44%

Bond rating (Moody’s) A2 A2

Estimated Spread 1.0% 1.0%

Treasury Rate 2.73% 2.43%

Cost of Debt 3.73% 3.43% Source: (Moody's; Airbus Group)

Market Value of Debt Using the rating and default spread method, the current risk free rate is 2.73%. Because Boeing is rated as AA with 1.00% rate, the pre-tax cost of debt is 3.73%. Calculating the after-tax cost of debt comes out to 2.24%. Conversely, using the long-term yield to maturity method, the rate for Boeing is 7.95% with a maturity date of 8/15/2024. Therefore, this method calculates a yield to maturity of 3.27%. Because Airbus’s risk free rate is 2.43% and it has a rating of AA, the pre-tax cost of debt comes to 3.43%. After accounting for tax, the after-tax cost of debt is 2.06%. Using a rate of 2.7% and a maturity date of 8/15/2024, the yield to maturity of 3.30%.

IV. Measuring Investment Returns A Typical Project Boeing and Airbus revenues are dominated by aircraft for commercial and defense, space and security segments. Combined, these two segments make up 85% or more of each company’s revenues. Therefore, most projects within these firms take on long lives as aircraft and defense systems development are time and capital intensive. As an example, Figure 9, shows projected “go ahead” to initial delivery timeframes for Boeing’s projects in development in 2013. The average is seven years for these projects. Figure IV-1: Boeing Go-ahead to Delivery Roadmap

Source: Boeing 2013 Annual Report

Boeing and Airbus each spend over $3B year in R&D. Costs of a new aircraft are typically front-loaded as new facilities are added for manufacturing. Boeing’s ambitious 787 aircraft, which has been plagued by production issues and several problems, is estimated to have cost Boeing $32B for development. Each plane is currently estimated to cost $200M to produce, while each sells for $116M (McAllister). Project

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returns in the industry are therefore back-loaded in the project lifecycle when/if production efficiencies are achieved and output volumes ramp. Measuring Past Returns We use Return on Equity (ROE) and Return on Invested Capital (ROIC) to analyze project returns for Boeing and Airbus relative to Cost of Equity and Cost of Capital. Here, we assume the book value of assets and equity reflects the current capital and equity invested in existing projects, leaving the values unadjusted for R&D. Each company has spent approximately $3B in R&D in the prior two years. Five year performance for ROE and ROC and presented in the figures below. We compare 2013 value for Cost of Equity and Cost of Capital and to the broader Aerospace & Defense sector. For Boeing ROE, 2009 was omitted. Our calculations use average book values and in 2008 Boeing book value of equity was negative making our ROE calculation meaningless. We will rely on ROC as our Boeing return measure for 2009. Over the previous three years, Boeing’s ROE has declined by roughly 40% each year. However, ROE still far exceeds Boeing’s Cost of Equity of 9.11%. Boeing is also exceeding the sector ROE average of %. Figure IV-2: Boeing Return on Equity

Source for sector values: A. Damodoran, http://pages.stern.nyu.edu/~adamodar/

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Boeing ROC performance reflects consistent returns on projects that exceed Boeing’s Cost of Capital of 7.22%, yet Boeing lags the industry sector average of 58%. Figure IV-3: Boeing Return on Capital

In the prior three years Airbus ROE has exceeded Airbus cost of equity of 7.44%, reflecting good projects

for the firm. When compared to the broader Aerospace & Defense sector average ROE Airbus is

underperfoming the sector.

Figure IV-4: Airbus Return on Equity

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Airbus’ ROC performance has exceeded Airbus’ Cost of Capital of 7.0% over the prior four years, though marginally better. Figure IV-5: Airbus Return on Capital

The EVA calculations below demonstrate surplus value created by existing projects for each firm. Only in the recent two years has Airbus created value at the Firm level. Table IV-1: Boeing Equity & Firm EVAs

Boeing EVA's

$ in millions 2013 2012 2011 2010 2009

Return on Equity 44.21% 83.14% 127.94% 135.15% 314.63%

Boeing Cost of Equity 2013 9.11% 9.11% 9.11% 9.11% 9.11%

Equity Return Spread 35.10% 74.03% 118.83% 126.04% 305.52%

Book Value of Equity 14,875

5,867

3,515

2,766

2,128

Equity EVA 5,221

4,343

4,177

3,486

6,501

2013 2012 2011 2010 2009

Return on Capital 23.68% 25.90% 27.99% 24.17% 21.07%

Boeing Cost of Capital 2013 7.22% 7.22% 7.22% 7.22% 7.22%

Capital Return Spread 16.46% 18.68% 20.77% 16.95% 13.85%

Book Value of Capital 24,510

16,276

15,886

15,187

15,052

Firm EVA 4,035

3,041

3,299

2,573

2,084

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Table IV-2: Airbus Equity & Firm EVAs

Airbus EVA's

€ in millions 2013 2012 2011 2010 2009

Return on Equity 13.64% 12.73% 11.65% 5.84% -6.91%

Airbus Cost of Equity 7.44% 7.44% 7.44% 7.44% 7.44%

Equity Return Spread 6.20% 5.29% 4.21% -1.60% -14.35%

Book Value of Equity 11,054

10,420

8,870

8,936

10,641

Equity EVA 686

551

373

(143)

(1,527)

2013 2012 2011 2010 2009

Return on Capital 8.20% 7.48% 6.98% 4.79% -3.61%

Airbus Cost of Capital 7.00% 7.00% 7.00% 7.00% 7.00%

Capital Return Spread 1.20% 0.48% -0.02% -2.21% -10.61%

Book Value of Capital 16,655

15,199

13,974

13,214

15,937

Firm EVA 200

72

(2)

(292)

(1,690)

Assessments for the Future Boeing and Airbus essentially make up a duopoly in supplying aircraft to the commercial airline industry. The outlook is strong for both companies as barriers to entry are high in the industry. Passenger traffic is outperforming GDP growth and air travel has been resilient to global economic crises. Projects in the future are expected to be similar to projects in the past. Each firm has been through a recent period of significant investments in new technologies as platforms and fleets turnover in favor of more efficient aircraft. Still, each firm faces significant risks. Each relies heavily on supplier relationships, growth from emerging economies where orders are subject to higher risk of cancellation, and dependency on realizing production efficiencies that reduce costs and increase output in order to achieve profitability on new product investments. The defense and aerospace segments of their businesses face risk from downturns in government and military spending.

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V. Capital Structure Choices Boeing Boeing currently has the following mix of short-term and long-term debt on its books: Table V-1: Boeing Current Debts

Unsecured debt securities Book Value, $

Variable rate: 3-month USD LIBOR plus 1 basis point due 2014 $ 150

0.95% - 5.00% due through 2023 $ 4,832

5.80% - 6.88% due through 2043 $ 2,392

7.25% – 8.75% due through 2043 $ 1,672

Non-recourse debt and notes

6.98% - 7.38% notes due through 2021 $ 233

Capital lease obligations due through 2017 $ 151

Other notes $ 205

Total debt $ 9,635

Of the debt shown above, $1.56 B is due in the coming year, leaving $8.07 B of long-term debt payable over the course of the next 30 years. Boeing most predominant method of capital acquisition is through long term bonds which represent 73% of the long term debt, the remainder is through third-party loan programs. Boeing reduces its risk to interest rate hikes, with only 2% of total debt with variable interest rates. As another safety measure Boeing currently has $4.8 billion of unused borrowing capacity on revolving credit line agreements, which is to serve as backup liquidity to support general corporate borrowing needs.

Utilizing market values Boeing’s debt to capital ratio is approximately 30%. Boeing’s advantages and disadvantages this debt level is:

· Tax Benefits – Boeing’s 27% tax rate reduces the impact of the tax savings due to interest payments on debt. This reduces Boeing’s likelihood to take on debt for tax savings

· Management Discipline – With a debt to capital ratio of 30% this is large enough for investors to be mindful of and ensure that management acts responsibly. With a debt reduction of $4.1B in 5 years this seems to be effective.

· Bankruptcy Costs – Boeing has a strong balance of future orders so should expect stable cash flows from the commercial airline business. However, the indirect cost of any indication of bankruptcy could force airlines to cancel orders severely impacting cash flows. There is also uncertainty of future U.S. government defense spending making the defense department’s cash

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flows less than certain. The bankruptcy risk is likely low for a company of Boeing’s size but something for management to be mindful of.

· Agency Costs – For a company like Boeing the agency cost are likely low for the commercial airline sector as Boeing becomes more efficient at building the 787. The agency cost for the defense sector is also low as the government typically covers over budget defense R&D and spending.

· Future Flexibility –Boeing is limited by the long-term bond debt but maintains $4.8B of borrowing capacity for short term borrowing.

Boeing’s current debt level seems to be appropriate for this size of company. Boeing has made a strong effort to reduce its debt by over $4B in just years. As the learning curve comes into effect for the 787 operating efficiencies should increase net earnings and promote the current trend of decreasing debt levels.

Airbus

Airbus currently has the following long-term debt on its books:

Table V-2: Airbus Long-term Debts

Type of Financing Book Value , € Maturity Date Interest Rate

EMTN Programme (Bond) 500 9/25/2018 5.500%

EMTN Programme (Bond) 1,000 8/12/2016 4.625%

USD Bond (144A / RegS) 728 4/17/2023 2.700%

European Investment Bank Loan 307 8/1/2014 5.121%

European Investment Bank Loan 524 8/1/2021 3.200%

European Investment Bank Loan 295 2/1/2020 3.300%

Development Bank of Japan (Loan) 160 1/1/2021 4.760%

Total Long Term Debt 3,514

This long term debt represents about 70% of the company’s total debt level. In the next 5 years, 58% of the company’s long term debt will be due. Airbus method of capital acquisition is typically bonds or loans at less than a 5.5% interest rate.

Utilizing market values Airbus’ debt to capital ratio is approximately 11%. Airbus’ advantages and disadvantages of this debt level are:

· Tax Benefits – Airbus’ 27% tax rate reduces the impact of the tax savings due to interest payments on debt. This reduces Airbus’ likelihood to take on debt for tax savings

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· Management Discipline – With a debt to capital ratio of only 11% management could become complacent but the ongoing technical and construction issues with the A380 will keep management focused

· Bankruptcy Costs – Airbus is struggling to sell the A380 with only half of the orders necessary to break even. The bankruptcy risk could be considerable if the A380 continues to struggle. With further divestment by Spain, France and Germany this will only increase this risk.

· Agency Costs – Agency costs may be significant if shareholders and management continue to pour money into the poor performing A380.

· Future Flexibility – Airbus maintains a low debt level and has considerable future flexibility. Airbus has a very low debt to capital ratio of 11%, as it is substantially lower than Boeing’s ratio. Airbus would increase tax benefits if it took on more debt especially as the majority of its current long term debt is paid off in the next 5 years.

VI. Dividend Policy

Boeing

Boeing has issued dividends consistently since the year 1937. In addition to dividend payments the

company has at times issued dividends as stock. Historically Boeing has issued a stock dividend 15

times. The most recent issue was in 1997.

Boeing’s current stock repurchase program is worth $10 billion. The previous program, worth $7 billion,

was suspended between 2009 to January 2013 due to cost overruns related to the 787 and 747-8

programs.

Table VI-1: Boeing Dividends

Boeing 2013 2012 2011 2010 2009

Cash Dividends $1,642 $1,360 $1,263 $1,245 $1,233

Dividend per Share $2.19 $1.81 $1.70 $1.68 $1.68

Stock re-purchase $2.8 B 0 0 0 $50M

EPS 6.03 5.15 5.39 4.49 1.89

Price per Share 132.22 70.52 60.85 68.21 52.63

Payout Ratio 0.36 0.35 0.32 0.37 0.89

Dividend Yield 2% 3% 3% 2% 3%

source: Boeing Annual Report, 2009, 2010, 2011, 2012, 2013

Boeing’s payout ratio over the past five years averages to .46. This is higher than Airbus but can be

explained by the fact that the company held its dividend in 2009 even while the company was struggling

with program challenges that impacted net earnings. As a result the company’s lower $1.89 EPS

translated to a .89 payout ratio in that year. Setting aside 2009 performance, the company’s payout

ratio is generally lower than Airbus. When considering the marginal Boeing investor they will likely

prefer the policy of issuing dividends and buying shares. Boeing made a significant purchase of shares in

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2013 of $2.8 billion. Additionally their payout ratio has been relatively consistent. In 2013 their stock

price reached a high of $132.22.

Airbus

Airbus has issued dividends in each year since 2001, with the exception of 2009 when the company

suspended dividend payments because of the steep decline in Aircraft demand that was a result of the

global economic crisis. Airbus has maintained a share buyback program in every year since 2004. The

only exception was in 2009.

Table VI-2: Airbus Dividends

Airbus 2013 2012 2011 2010 2009

Dividend payout €587 €492 €366 €178 --

Dividend per share 0.75 0.6 0.45 0.22 0

Stock re-purchase €500M €31M €12M €40.5 M 0

EPS €1.85 €1.50 €1.27 €0.68 €(0.94)

Price per Share €52.78 €35.19 €27.54 €23.35 €14.10

Payout Ratio 0.41 0.40 0.35 0.32 0.00

Dividend Yield 1% 2% 2% 1% 0%

Source: EADS Annual Report, 2009, 2010, 2011, 2012, 2013

Airbus’s 5-year average payout ratio is .30 and is lower than the same average for its primary

competitor, Boeing. Unlike Boeing, Airbus did not hold its dividend payout in 2009. The company

suspended dividends in that year because of challenges with some if its programs. These challenges

pushed the company to a loss for 2009.

The act of suspending the 2009 dividend sent a clear signal that the company was facing challenges. In

early 2009 the company’s share price dipped below $10. The price has steadily grown from that time to

a high of $55 in 2013. While both Boeing and Airbus faced challenges during this time only Airbus

suspended their dividend. The fact that their marginal investors were government entities at the time

may have played a role in their decision. Recently the company has reduced the role of government

shareholders. This policy can help explain the company’s more aggressive policy to buy back shares and

increase dividends in 2013, €500M and $.75/share respectively.

18

VII. Framework for Dividend Analysis Boeing To evaluate how much Boeing could have paid out in dividends between 2009 and 2013 we estimated the free cash flows to equity for each year. The following table summarizes our results:

Table VII-1: Boeing Free Cash Flows to Equity

Source: Morningstar.com Boeing’s 5 year average debt ratio of 19.80% was used to compute the free cash flow to equity each year during the period. Table VII-2: Boeing Debt to Equity Ratio

19

The details of FCFE, maximum possible dividend, and actual dividend paid are shown in the table below.

Table VII-3 & Figure VII-1: Boeing Dividend Analysis

Based upon this analysis, Boeing could have returned a maximum of $2,499 million as dividends to its stockholders. However Boeing returned $1309 million to its shareholders.

20

Airbus To evaluate how much Airbus could have paid out in dividends between 2009 and 2013, we estimated the free cash flows to equity at Airbus each year. The following table summarizes our results: Table VII-4: Airbus Free Cash Flow to Equity

Airbus 5 year average debt ratio of 20.81% was used to compute the free cash flow to equity each year during the period. Table VII-5: Airbus Debt to Equity Ratio

21

The details of FCFE, maximum possible dividend and actual dividend paid are shown in the table below. Table VII-6 & Figure VII-2: Boeing Dividend Analysis

Based upon this analysis, Airbus could have returned an average of 83.13 million euros as dividends to its stockholders during this period. However Airbus returned 384 million euros as dividend to its shareholders. During this period they have returned more dividends than they made equity to their shareholders. Comparing Dividend Policies Table VII-7: Comparing Boeing & Airbus Total Dividends

22

Boeing pays lower dividend as compared to the free cash flow to equity. There is more room for Boeing to pay higher dividend to its shareholders. Airbus has maintained a consistent dividend policy and has paid more than their free cash flow. We recommend that Boeing first consider investment in positive NPV projects before paying more dividends. We recommend that Airbus maintain their current dividend to shareholders.

Industry Comparison Table VII-8: Industry Comparison vs. Boeing/Airbus

VIII. Valuation

We valued Boeing and Airbus using a stable growth model. This is because there is strong competition in

each of the markets in which the companies compete. However there are also high barriers to entry and

significant growth expected in the next twenty years in China and India. Growth should be stable,

however, due to competitive forces and new entrants in the commercial airline industry, we do not

project high growth. In addition, we valued the companies using a FCFF model because we expect each

company’s debt ratio to change over time. We projected FCFF out five years and calculated a terminal

value at year 6. We based projections on 5 years of historical financial data for each firm. Please see

valuation calculations in the appendix for details.

Valuation

The present values of the free cash flows to the firm plus the present value of the terminal period are:

Boeing: $202,744MM

Airbus: $64,590MM

Subtracting the market value of existing debt from each firm and dividing by shares outstanding as of

Dec. 31, 2013 we get the value of equity per share:

Boeing: $202,744MM – $43,428MM = $159,316MM / 747.4 shrs outstanding = $213.16 per shr

Airbus: $64,590MM - $4,260MM = $60,330MM / 780.3 shares outstanding = $77.32 per shr

23

Table VIII-1: Valuation Assumptions

Our projections suggest that each company is currently undervalued in the stock market. Detail

valuation calculations are in Appendix 3-6.

Improvements to the Firms

We found that Airbus had weaknesses in controlling costs and also experienced significant cash outflow

to working capital. Inventories at Airbus have been accumulating as it has been developing its large,

wide body A380 aircraft. In order for Airbus to improve its cash flows it needs to bring down costs and

improve ROC and ROE.

Boeing has historically run with a very high debt to equity ratio, however they have brought that down

to industry levels over the past five years. Boeing should continue to keep the company leveraged at

industry levels to reduce risk in case of downturns in the airline industry.

A-1

Appendix

Regressions for Beta

Appendix 1: Regression Graph - Boeing vs S&P 500

Appendix 2: Regression Graph - Airbus vs FCHI

2

Valuation Calculations

Appendix 3: Boeing EBIT & FCFF

Appendix 4: Boeing Valuation

Dollars in millions

Revenues: 2013 2012 2011 2010 2009

Total revenues 86,623$ 81,698$ 68,735$ 64,306$ 68,281$

Total Costs & Expenses (73,268)$ (68,665)$ (55,888)$ (51,843)$ (56,540)$

SGA, R&D and other costs (net) (6793) (6743) (7024) (7492) (9645)

Earnings from operations 6,562$ 6,290$ 5,823$ 4,971$ 2,096$

EBT 6,232$ 5,910$ 5,393$ 4,507$ 1,731$

EBITDA 8,462$ 8,163$ 7,545$ 6,533$ 3,529$

EBIT 6,618$ 6,352$ 5,870$ 5,023$ 2,070$

Depreciation and amortization 1,844$ 1,811$ 1,675$ 1,510$ 1,459$

Capital Expenditure (2,098)$ (1,703)$ (1,713)$ (1,125)$ (1,186)$

Changes in Working Captial (1,078)$ (880)$ 2,135$ (3,034)$ 1,910$

FCFF 5,286$ 5,580$ 7,967$ 2,374$ 4,253$

(averages)

Total Expenses as a % of Sales (excluding Interest Exp.) 93.0% 92% 92% 91% 92% 97%

Capex as a % of Sales 2.1% 2.4% 2.1% 2.5% 1.7% 1.7%

Working Captial 13,588$ 12,327$ 8,536$ 5,177$ 2,392$

Working Captial as a % of Sales 12.4% 15.7% 15.1% 12.4% 8.1% 3.5%

CAGR of Revenue 6.1%

Boeing Historical EBIT & FCFF Calculation (Summarized)

Boeing ValuationDollars in millions

Revenues: 1 2 3 4 5 6

Total revenues 90,954$ 100,277$ 116,083$ 141,100$ 180,083$ 215,029$

Less: Total Expenses 84,587$ 93,258$ 107,957$ 131,223$ 167,477$ 199,977$

EBIT 6,367$ 7,019$ 8,126$ 9,877$ 12,606$ 15,052$

Add: Depreciation 2,128$ 2,346$ 2,716$ 3,302$ 4,214$ 5,032$

Less: Investment in Capital 1,910$ 2,106$ 2,438$ 2,963$ 3,782$ 4,516$

Less: Investments in Working Captial (2,310)$ 1,156$ 1,960$ 3,102$ 4,834$ 4,333$

FCFF 8,895$ 6,104$ 6,444$ 7,114$ 8,204$ 11,235$

Present Value 8,273$ 5,280$ 5,185$ 5,323$ 5,709$

PV of FCFF (Year 1 - 5): 29,769$

PV of Horizon Value: 172,974$

Value of the Firm: 202,744$

3

Appendix 5: Airbus EBIT & FCFF

Appendix 6: Airbus Valuation

In millions (Euro) €

Revenues: 2013 2012 2011 2010 2009

Revenues 59,256$ 56,480$ 49,128$ 45,752$ 42,822$

Cost of sales (50,895)$ (48,582)$ (42,285)$ (39,528)$ (38,383)$

Gross Profit 8,361$ 7,898$ 6,843$ 6,224$ 4,439$

EBIT 2,607 2,089 1,613 1,187 (380)

Add: Depreciation and amortization 1,968$ 2,053$ 1,884$ 1,582$ 1,826$

Less: Investment in Capital 2,949$ 3,270$ 2,197$ 2,250$ 1,853$

Less: Investment in WC 2,164$ 76$ (1,386)$ (2,819)$ (2,423)$

FCFF ($538) $796 $2,686 $3,338 $2,016

(averages)

Total Expenses as a % of Sales 96.7% 96% 96% 97% 97% 101%

Capex as a % of Sales 4.9% 5% 6% 4% 5% 4%

Working Captial as a % of Sales -2.2% 4% 0% -3% -6% -6%

CAGR of Revenue 6.7%

Airbus Historical EBIT & FCFF Calculation (Summarized)

Airbus ValuationEuros in millions

Revenues: 1 2 3 4 5 6

Total revenues € 62,219 € 68,596 € 79,409 € 96,522 € 123,189 € 147,094

Less: Total Expenses € 60,166 € 66,333 € 76,788 € 93,626 € 119,493 € 141,210

EBIT € 2,053 € 2,264 € 2,620 € 2,896 € 3,696 € 5,884

Add: Depreciation € 2,282 € 2,516 € 2,913 € 3,540 € 4,519 € 5,395

Less: Investment in Capital € 3,049 € 3,361 € 3,891 € 4,730 € 6,036 € 5,884

Less: Investments in Working Captial (€ 3,884) (€ 1,580) (€ 1,375) (€ 1,575) € 2,502 € 3,108

FCFF € 5,170 € 2,999 € 3,018 € 3,281 (€ 324) € 2,288

NPV € 4,807 € 2,593 € 2,426 € 2,452 (€ 225)

PV of FCFF (Year 1 - 5): € 12,053

PV of Horizon Value: € 34,942

Value of the Firm: € 46,995

Exchange Rate as of 12/31/2013 1.37

Value of the Firm in USD: 64,590$

4

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