Summary
- CAE Inc. is facing strong headwinds this year, and thus the stock has plunged 46% in the last 12 months.
- However, these headwinds are likely to abate in the upcoming years.
- CAE is trading at only 11.0 times its expected earnings in fiscal 2026.
CAE Inc. ( CAE ) has plunged 46% in the last 12 months due to strong headwinds, namely business deceleration in the defense segment, 40-year high inflation, and the risk of an imminent recession. The downtrend of the stock is so strong that it is likely to persist in the short run. On the other hand, thanks to its reliable long-term growth trajectory, CAE has become remarkably attractive, and thus it could nearly double over the next three years.
The reasons behind the plunge of CAE stock
First of all, CAE has plunged due to a deceleration in its defense business. As this segment generates 44% of total revenue, it is undoubtedly important for the overall performance. In the most recent quarter, CAE grew its total revenue 24% over the prior year's quarter, but its adjusted earnings per share plunged from $0.15 to $0.06, thus missing the analysts' consensus by $0.11. The disappointing performance resulted from slower-than-expected growth in the defense segment and some charges in this segment. Due to the deceleration in this division, management lowered its guidance for growth of annual operating income from ~35% to ~25%. The stock plunged 17% on the news.
The disappointment of the market over the short-term performance is justified, as analysts were expecting a stronger recovery from the pandemic. However, management stated that it expects the headwinds in this segment to gradually abate in the upcoming quarters. In addition, CAE received orders of $1.05 billion in the latest quarter, with a book-to-bill ratio of 1.12, and thus it grew its backlog 26% over the prior year's quarter, to an all-time high of $10.0 billion. As this amount is nearly 4 times the annual revenues of CAE, it undoubtedly bodes well for the future growth prospects of the company.
Moreover, CAE is in a sustainable, long-term growth trajectory. It benefits from a strong cyclical tailwind, namely the recovery of the aviation industry from the pandemic, and a secular tailwind, namely the retirement of a great number of pilots in the upcoming years. The new pilots, who will replace the old ones, will need extended training courses. It is also important to note that CAE recently reaffirmed its 3-year guidance for average annual growth of earnings per share of about 25%. To cut a long story short, CAE is facing some short-term headwinds, but its growth prospects remain promising.
The other major reason behind the plunge of CAE is the increasing risk of an upcoming recession. Due to the surge of inflation to a 40-year-high, the Fed is aggressively raising interest rates in an effort to cool the economy. Consequently, the risk of an imminent recession has significantly increased. The aviation industry is infamous for its vulnerability to recessions.
However, CAE is much more resilient to recessions than airline stocks. CAE is the global leader in training for the civil aviation and defense aviation, with more than 150 training sites in several countries. The company trains more than 120,000 crew members and numerous healthcare professionals every year. The superior resilience of CAE when compared to airlines was evident in 2020. Due to the collapse of air traffic, all the airlines incurred excessive losses in that year and received financial aid from the government to survive. On the contrary, CAE remained marginally profitable in that year, with earnings per share of $0.10 .
If a recession shows up, it will almost certainly be milder than the fierce recession caused by the lockdowns in 2020 and hence CAE is likely to endure such a downturn without any problem. Moreover, as experience has shown, every recession has been succeeded by an economic recovery, and hence CAE will return to its long-term growth trajectory after the recession subsides.
Inflation - Valuation
The surge of inflation to a 40-year high has greatly increased the cost basis of many companies this year. CAE seems to be a bright exception, as the effect of inflation on its margins seems to be limited so far.
On the other hand, CAE is not immune to the impact of inflation on the valuation of growth stocks. High inflation reduces the present value of future cash flows, and thus it exerts pressure on the price-to-earnings ratios of growth stocks. The impact of inflation on the valuation of CAE is prominent.
CAE is currently trading at a price-to-earnings ratio of 23.3 . However, it is critical to realize that the company is in the very early phases of its recovery from the pandemic. Analysts agree with the guidance of management for approximate growth of earnings per share of 25% per year over the next three years. They thus expect CAE to achieve earnings per share of $1.41 in three years.
This means that CAE is currently trading at only 11.0 times its expected earnings in fiscal 2026, which ends in March 2026. This is an exceptionally cheap valuation level for CAE. To be sure, the stock has traded at an average price-to-earnings ratio of 20.2 over the last decade. Moreover, inflation will almost certainly revert towards its normal level of 2% in the upcoming years, thanks to the aggressive stance of the Fed, which has prioritized restoring inflation to 2% at the expense of short-term economic growth. Whenever inflation reverts to its normal levels, the valuation of CAE will probably return to its historical average. Therefore, as CAE is trading at 11.0 times its expected earnings in 2026 and its 10-year average price-to-earnings ratio is 20.2, the stock can nearly double over the next three years.
Risks
As mentioned above, CAE is exceptionally cheap from a historical perspective, particularly given its reliable growth trajectory. A potential risk for the stock is the adverse scenario of a prolonged recession. Such a downturn will hurt the aviation industry, and thus it will probably cause the business performance of CAE to decelerate. However, the average recession has lasted 15 months since 1900. In addition, the Fed has become so active in the last two decades that it is not likely to allow a recession to last much longer than that. Whenever a recession has occurred, a strong recovery has ensued. This rule is likely to remain in place, and hence CAE is not likely to be hurt by a recession in the long run.
Another risk is the scenario of persistently high inflation for years. In such a case, the valuation of CAE is likely to remain suppressed for years. However, as mentioned above, the Fed has prioritized restoring inflation to 2%, even at the expense of short-term economic growth. Therefore, this is a highly unlikely scenario. Investors who can maintain a long-term perspective and ignore the temporary pressure on the stock price of CAE are likely to be highly rewarded in the long run.
Final thoughts
CAE is facing strong headwinds right now, and thus its stock has plunged this year. However, all these headwinds are likely to abate in the upcoming years. Therefore, the plunge of the stock has presented a great opportunity to purchase the dominant player in aviation training at a cheap valuation level. On the other hand, due to the negative market sentiment and the strong downtrend of the stock, which is likely to persist in the short run, only the investors who can maintain a long-term perspective and ignore short-term volatility should consider purchasing the stock. A great entry point would probably be around the technical support of $14, which is 10% lower than the current stock price.
For further details see:
CAE Inc. Could Nearly Double Over The Next 3 Years