Summary
- CAE continues to see strong billings and operating margin improvement in multiple segments of the business.
- Civil aviation is leading the way with a return to capacity in training centers and solid flight simulator sales.
- Valuation is very reasonable with solid expected growth in coming years and significant debt reduction.
CAE ( CAE ) ( CAE:CA) is a strong mid cap industrial company headquartered in Canada, with expertise in training and flight simulation. CAE recently reported its second straight quarter of strong results, with investors moving back into the name as it continues to execute. After a significant lull in demand after the pandemic, countries are now ramping up their training programs with increased demand for flights. After a weak Q1 result that sent the stock falling, CAE has put up strong results the past 2 quarters and the stock has outperformed greatly the past 6 months. Below you can see that revenue bottomed out in early 2021 with many of the other airline and flight related stocks, but has since rebounded strongly. While the return of flights has been slower than many expected, revenue and margins for this sector continue to improve in the coming years. This makes CAE a strong industrial choice, with tailwinds like China reopening and strong defense spending potential among Western countries propelling them into 2023. At 2.3x book value, the stock trades at a reasonable valuation when you look at its superior growth profile compared to peers.
Three differentiated segments
CAE has 3 segments that have varying results and industry drivers behind them. Civil aviation, defense and healthcare all are unique but require significant training tools. CAE released strong Fiscal Q3 results on the 14th of February with continued improvement in backlog boding well for 2023. Backlog is over 2 years' worth of sales with a record $10.8 billion dollar backlog. Some of this revenue will take some time to materialize, as part shortages and supply chain issues continue to persist especially for electronic components. Book (new orders) to revenue ratio continues to be strong with a 1.22x this quarter after 1.30 last quarter for the entire business. Revenue follows backlog over time, with $1020.3 million in the quarter a bit below expectations but up significantly over last year.
20% growth in revenue is far above peers at this point in the business cycle, and it led to an increase of operating income of 43% on an adjusted basis to $160.6m. Operating margins continue to improve up to an adjusted 15.7% of revenue from 13.3% a year ago, and 12.6% last quarter. Larger operating margin adjustments relate to acquisition expenses and should roll off on the coming year. This quarter's margin was on the high end due to sales mix, but operating margins should trend to this mid teen % consistently over coming years.
Results for the Civil segment continue to be strong led by long term agreements on training and continued success in selling flight simulators. Airlines are continuing to rebound from the pandemic as they outsource operational support and crew management needs to CAE. The reopening of China should increase global air travel and help the industry return to 2019 levels over the next few years. They sold 14 full flight simulators and operating income was above 20% at 20.6% for the period. This is a strong number, with China yet to ramp back up to its normal 6 to 8 simulators purchased per year. Utilization of het training centers that CAE provides is at 73% with a ton of long term upside, as 40% of 2019 pilots will be retiring and replaced by 2029. The company continues to grow its worldwide total simulator fleet which is up to 323 globally.
The defense segment is seeing improving results with the synergies from its acquisition of assets from L3Harris ( LHX ). The assets included AMI, a design and manufacturer for military simulators and Doss aviation. Doss provides the initial flight training to the US Air Force. These are important relationships to cultivate and helps increase their technology footprint in their core competency of flight simulation and professional training. CAE paid a reasonable 13.5x 2020 Ebitda for assets which have a $500m revenue run rate per year. These were 2020 numbers which were depressed, showing a smart management decision to acquire during a time of sector weakness. Synergies will be $40m once fully integrated - a solid % of total revenue from the pickup. Defense quarterly bookings were 1.05x revenue, but for the past 12 months a very solid 1.25 times showing a ramp coming throughout 2023 for revenue here. The company also has a huge backlog of $7.3 Billion in bids awaiting decision - showing a large potential of growth in the coming quarters with an already robust backlog.
CAE investor presentation (CAE 2022 investor presentation)
CAE is involved in bids for many $100m program and several over $1 Billion - providing some big potential contracts in the coming years. Total backlog is up over 13% in the past year with revenue lumpy but still up 6% y/y. Some fear regarding the United States military budget is unfounded, as the continued war in Ukraine should be supportive of small military budget increases.
Long term CAE expects double digit growth of revenue and profitability metrics here, with next quarter to be even stronger than this one called out by management. The recent F-35 contract signed by Canada for 88 fighters should mean incremental training revenue in the years 2026-2032 as CAE is a major player in training in Canada as well. The market continues to underestimate risks with regards to Russia and the ongoing Ukraine war. Budget cuts are unlikely with the current political climate, and European countries are likely to face internal pressure to increase defense budgets. CAE sees the defense spending cycle in the early stages of a new upswing, with new contracts more profitable than older ones as well.
The health segment is quite small but results have also improved here in Q4 with a positive EBITDA in the quarter. The segment provides assets to hospitals, universities and other healthcare related organizations. The Covid-19 pandemic has acted as a tailwind here with increased use of training simulators for hospital applications. This is a growth market with the advanced patient simulators continuing to grow in acceptance, with revenue in Q4 up 57% over Q3. This is from a low base, and profitability is low at 7.5% EBITDA margin with room to grow in the future. Globally this a $1.7 billion dollar market where CAE has expertise but it isn't a main focus for the company considering its relative size. This market has a 12% CAGR and CAE should be able to outgrow this market over time.
Negatives
The downsides of CAE as a long term investment are few but not insignificant when you compare them to their peers. First, CAE has a very significant debt load for a company of its size. Net debt for CAE stands at $3.07 Billion with an adjusted EBITDA to debt of 3.74x. While this is below the extreme range of 5+, it is still quite a high debt burden and means significant interest payments to support prior acquisitions CAE has made. Interest rates have a negative impact on income as a result of some variable debt, with a $48.8m interest payment in Q3 2022. This is up from $34.5m a year ago and shows the drag interest rate increases will continue to have. It also means that in a potential recession, income could possibly go negative whereas its bigger peers have a much bigger margin of safety.
Also concerning peers, CAE is one of the few defense names that does not pay a dividend. This is because of the acquisitive nature of the company and that high debt load plus a focus on growing earnings. Acquisitions are off the table for now, with shareholder returns likely to come after de-leveraging. CEO Mark Parent noted "You see – we're focused on deleveraging right now. We don't see any gaps in our portfolio." Look for them to buy back shares once Debt is down to a more manageable level of 3.0x EBITDA.
Buy Rated
CAE continues to work towards 20% operating income growth per year over the next 3 years and should start 2023 on a strong note. Defense is the segment with the most question marks medium term, however a $5.1 Billion backlog means good visibility for the next 2 years for CAE. Civil will continue to drive improving results and operating margins, allowing CAE to reduce the debt load and increase profits. Aviation is coming back with a vengeance and training new pilots is a desperate need globally where CAE shines. While buybacks and dividends are not on the table yet, in 6-8 quarters once debt has been reduced it is likely to be another catalyst for shares to go higher. Those looking for long term growth in an area with significant defensive characteristics, and don't mind not having a dividend payout have an excellent option with CAE.
For further details see:
CAE: Top Industrial Pick With Intriguing Valuation