Introduction & Investment thesis
In this article, I am diving into another aviation-related company, CAE Inc. (NYSE:CAE). As a Canadian aerospace company, CAE remains highly correlated to the aviation industry due to its core business model that’s based on training pilots. While this has brought considerable negativity towards CAE’s stock price, currently trading at half 52-week value, CAE should benefit from a pick-up in commercial training activity as airlines add more capacity next year. The process would require patience and does remain uncertain, but CAE has been able to streamline its costs, adjust its capital commitments and focus its capabilities on a promising healthcare segment. Investors looking to potentially ride a recovery curve in the aviation equity market over the mid/long term should favor CAE, which is more likely to navigate the crisis than a typical airline. The company is listed both on the NYSE and TSX, but I will be using the latter listing as a reference point for this article.
CAE Stock Candlestick chart – Source: Bloomberg
Context makes it difficult to predict any short-term gains
Travel restrictions continue to be a major concern with lockdowns and second-wave COVID-19 curves making it difficult to consider an investment at this stage. In Canada, passenger numbers were down 90% year over year in July. That makes CAE’s earnings recovery difficult to anticipate, especially that civil training solutions account for 60% of total revenues. Business aviation included in the earnings mix is also trending down. According to a WINGX Advance report, global business aviation movements were down 12% year on year in September. In essence, this is more positive than trends witnessed in commercial aviation, but further signs of activity pickup are needed in my opinion. A reduction in passenger demand ultimately leads to deferrals in pilots’ training and CAE faced a number of temporary deferrals from airlines. As such, lower simulator orders compared to previous years should be a “given”.
CAE at glance – Source: Investor Presentation
Going forward, client-specific risks and the impairments entailed are also worth watching. CAE has built a large base of customers over the years that could face precarious debt situations during this pandemic. In fact, many of those airlines are already restructuring or filing for bankruptcy (LatAm and Avianca). Looking at the company’s supplementary information, CAE has a large base of customer worldwide from low-cost to established franchises which limits the impact of single-name risk to some extent.
Weakening demand partially mitigated by diversification
CAE’s strength compared to typical airlines stems from the fact that it drives 40% of its revenue base from Defense/Security and Healthcare. According to CAE’s 2020 financial report, over “90% of the sites that provide services in Defense and Security have remained open”. CAE is well positioned in a number of large defense programs and booked $1.2 billion of order intake during the year with $4.1 billion Defense backlog (annual report). This emphasizes the company’s diversification strength, a key investment criterion in a context of pandemic. Speaking of mitigants, the Healthcare segment also represents an opportunity. Out of its core business, CAE has positioned itself to make contributions in response to COVID-19. In April, the company concluded an agreement with the government to manufacture 10,000 ventilators for intensive care. While training needs might be less of a focus this year, the healthcare crisis could become a good measure of diversification going forward.
CAE full fiscal year 2020 results – Source: Newswire
Resilient financial profile and proactive management
As a result of the pandemic, CAE has restructured its operations with estimated cost savings of $50 million for the next fiscal year. This included digitalization and the optimization of the company’s asset base. Compared to Q4 revenue of $977 million, the annual cost savings are not marginal and will contribute to the bottom-line results for next year.
In my opinion, the company’s results are showing strong signs of resilience given that the utilization rate for simulators is way under capacity. In fact, training center utilization is on average 77% under capacity for the quarter while revenue declined only 33% versus the prior year. As evidenced with positive operating cash flow of $36.9 million in the most recent quarter, CAE is able to generate positive cash flow even at low capacity.
CAE exhibits robust liquidity buffers backed by $363.3 million in cash as at June 30, 2020 and more than $2.2 billion in current asset base. These buffers, combined with the restructuring measures, reduced capital commitments and cash generation from lower-capacity training centers, make CAE a relatively solid pick in the aviation space.
Concluding thoughts and valuation
CAE’s profile looks more appealing than most airlines if you have appetite for the industry. First, because training activity should recover faster than general demand, backed in part by the business jet segment. Secondly, defense and healthcare exposure are supported by signs of order activity and innovative measures – a mark of management flexibility in this context. Finally, CAE has taken adequate measures to manage costs and bolster liquidity. Naturally, your investment remains conditional upon the outlook for vaccine deployment, COVID-19 statistics and their implications for travel restrictions. But if you have faith in these developments, CAE is set to recover well in the future.
Equity Relative Valuation P/E vs comps – Source: Bloomberg
CAE trades at 50% its 52-week value and is down more than 35% year on year. At 2.5x book value, the valuation looks high but manageable by peer standards as aeronautic-based companies trade at large premiums due to their technological footprint. The relatively high P/E must be contrasted with the current earnings stream and peak reached in June. Overall, CAE is an interesting stock to watch if you’re monitoring aviation trends and anticipate a recovery.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.