In the search for value, it pays to focus on stocks that have performed poorly yet have catalysts for a long-awaited upward move.

That approach led me to aircraft maker Boeing (NYSE: BA) last autumn. 

The company’s stock had been trading nearly 40% below its pre-crisis peak, even as many other Dow components had already moved back up to levels seen back in early 2008.

My suggestion that Boeing could be the best rebound stock in the Dow was on the mark, as shares have risen 66% since then, compared with a roughly 15% rise in the Dow Jones Industrial Average and the S&P 500 index.

	Copyright 2013 © Boeing
	Boeing appeared poised to deliver roughly 120 Dreamliners (787s) a year by mid-decade. Arment thinks that figure now looks conservative, predicting the company will crank out 160 by 2016.

The “bottom-fishing” angle for Boeing has likely played out — but that doesn’t mean it’s time for profit-taking. In fact, Sterne Agee analyst Peter Arment sees an additional 40% upside ahead.

In general, I tend to steer clear of analysts‘ price targets as they are often based on near-sighted assumptions and typically fail to reflect multi-year growth drivers and challenges. But in this case, Arment backs up his $164 price target with a very cogent analysis, worth reflecting here.

First, let’s get the bad news out of the way. Boeing is a leading defense contractor, and the company’s revenues from Uncle Sam are expected to shrink, from $32.6 billion in 2012 to $26.5 billion by 2016. Operating profits in this segment are also expected to fall roughly $500 million, to $2.5 billion by then.

But it’s the commercial aircraft segment that keeps getting stronger. As I noted in my look at the company a year ago, Boeing appeared poised to deliver roughly 120 Dreamliners (787s) a year by mid-decade. Arment thinks that figure now looks conservative, predicting the company will crank out 160 of the high-margin fuel-efficient planes by 2016.

In addition, the analyst notes that Boeing has been building a strong order book for its 737-MAX, an upgrade to the 50-year-old workhorse, which is expected to enter production in 2017. Boeing already has more than 1,500 orders in hand for the plane, thanks to simulations that show the 737-MAX burns less fuel than comparable Airbus offerings.

“Outside the soft cargo market, global demand remains healthy and resilient given requirements to replace aging fleets, satisfy emerging growth regions, and add more fuel-efficient aircraft to existing fleets,” Arment predicts.

By 2018, he thinks Boeing will be producing 800 planes annually. That’s up from 500 in 2011 and 600 in 2012. And that kind of growth will have a direct impact on profit margins and free cash flow.

Source: Sterne Agee

Arment thinks Boeing’s operating margins won’t surge until later in the decade when both the 787 and 737-MAX are being produced in high volumes. The gain of roughly 4 percentage points in operating margins from 2016 until 2020 isn’t merely a guess. We know how much it costs for Boeing to make a plane, and we know the average selling price of these planes, so barring a major economic slowdown, Boeing should be able to meet these targets.#-ad_banner-#

Rising margins in the commercial aircraft division should help fuel robust growth in free cash flow. Arment sees it rising from $4.9 billion this year to more than $10 billion annually by later this decade. And that spells greater shareholder returns.

In recent years, Boeing’s dividend has suffered from benign neglect rising from around $1.60 a share in 2008 to a current $1.94, which is a 4% compound annual growth rate. Boeing is lavishing more attention on buybacks, with a current plan calling for $1.5 billion to $2 billion in further buybacks underway. 

But as the share price rises higher, buybacks make less sense, so Boeing may look to more aggressively boost its dividend in coming years. Applying $5 billion of its annual free cash flow to its dividend would boost it to roughly $6.50 a share. 

So how does Arment arrive at his $164 price target? By applying a 12 times multiple to projected 2015 free cash flow. Frankly, that seems a bit aggressive, as most large-cap stocks rarely trade for more than eight or nine times forward free cash flow. Arment’s view: that target multiple is justified “given peak free cash flow generation is still two years later in 2017.” 

Here’s how you should look at it. You can either follow the lead of other analysts who will steadily bump up their price target with each passing year, until they too have $160 or $170 price targets a half decade from now. Or you could simply focus on Arment’s long-term view — and buy shares now before they begin inching their way higher.  

Risks to Consider: There’s a decent chance that the global economy will face a major slowdown at some point in coming years, which will push shares of Boeing temporarily out of favor.

Action To Take–> I love this kind of stock recommendation from a Wall Street firm. It shows a far-sighted view that gets away from quarterly earnings analysis, and is backed up with solid evidence. Few companies have such a tremendous backlog in hand as Boeing does, giving the company a leg up in terms of long-term predictability and visibility — which investors crave.

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