- Solid execution by the new management team on its five-year turnaround plan since this was implemented in 2015.
- Success of partnership with Airbus could create up to US$2.5b of value.
- Bombardier Transportation remains a key driver—industry fundamentals continue to be strong, translating into solid booking activity and margin improvement.
Bombardier is a leading global manufacturer of both planes (47% of 2017 revenues) and trains (53%). Its Aerospace division manufactures business jets (Learjet, Challenger and Global) and commercial aircraft (C Series, Q400 and CRJ), while the Transportation division covers the full spectrum of rail solutions, including rail vehicles, propulsion and controls, bogies, transportation systems, rail control solutions and maintenance services. The company has 66,000 employees globally.
In October 2017, Bombardier announced an agreement with Airbus whereby the latter will provide procurement, sales and marketing, and customer support expertise in exchange for a 50.01% interest in the C Series Aircraft Limited Partnership (CSALP). With this partnership, Bombardier management expects to double the value of the C Series program, driven by significant production cost savings. This should also translate into higher market share and additional deliveries. The partnership with Airbus is expected to close later in 2Q18—a key milestone for ensuring the program's success.
Looking at the business aircraft segment, the Global 7000 program has now flown more than 1,800 hours, and management reiterated its guidance of entry into service in the back half of 2018. This remains a key driver for achieving 2018 guidance, given the Global family generates the highest margin in Bombardier's aircraft portfolio. Industry fundamentals are also pointing in the right direction, with business jet utilization up in the US and Europe, and with pre-owned inventory now at its lowest level since 2007.
We continue to be pleased with the performance of Bombardier Transportation, driven by strong industry fundamentals (book-to-bill ratio of 1.0x in 1Q18), its solid backlog (US$35.7b) and stellar operational results (EBIT margin of 8.2% in 1Q18 vs 6.1% two years ago). Management is currently targeting an EBIT margin of 9.0%+ in 2020—which is achievable, in our view. Moving forward, Bombardier will have the opportunity to buy back Caisse de dépôt et placement du Québec's interest in the division as early as February 2019. This remains one of our preferred cash deployment opportunities as operational and financial control of Bombardier Transportation would be a key lever for value creation, in our view.
While debt levels are still elevated, management has set a clear path toward free cash flow (FCF) generation, consistently beating FCF expectations. Based on management expectations, FCF should break even in 2018 before returning to positive territory thereafter.
Our target price of C$4.75 is derived from an average of four valuation methods. The shares remain attractive, trading at an EV/EBITDA multiple of 8.5x based on our estimates for 2018, below the 9.4x average for peers. We continue to believe there is sizeable upside potential in the longer term (we estimate ~C$6.50/share), assuming the company meets its 2020 objectives.
- Acquisition of CESA and Beaver provides an excellent platform for growth and should strengthen Héroux's reputation.
- Bidding pipeline remains strong and Héroux is working to fill its excess capacity.
- Solid free cash flow generation should strengthen the balance sheet for further M&A opportunities.
- Key components in place for a C$32 stock in 2–3 years, in our view.
Héroux-Devtek is the third-largest manufacturer of landing gear in the world. Following the sale of its aerostructure and industrial products divisions to Precision Castparts in 2012, the company focused exclusively on landing gear. On October 2, 2017, Héroux announced the acquisition of CESA, a leading European provider of landing gear and actuation systems. The company now employs more than 1,300 people in 13 facilities around the world. On February 28, 2018, it announced the acquisition of Beaver Aerospace, a vertically integrated manufacturer of custom ball screws, and hydraulic and mechanical actuators.
We believe the recent acquisitions provide an excellent platform for Héroux to grow with Airbus (~50% of CESA's revenue), while also strengthening its exposure to the defence market (~67% of Beaver's revenue). Following the closing of the two transactions, Héroux's revenue mix will remain well-balanced, with 53% of revenues for fiscal year 2018 (FY18) coming from Military and 47% from Commercial. In terms of product mix, 42% of total revenues will be derived from proprietary products and 38% from aftermarket products, which tend to be recurring in nature and more profitable in the long term. Overall, we believe these acquisitions represent an excellent strategic decision for Héroux.
The outlook for commercial aerospace remains solid, with IATA calling for robust growth of 6.0% in the passenger market in 2018, slightly below the very strong performance of 7.5% in 2017. In addition, Boeing and Airbus continue to increase their production rates on narrow-body aircraft, with both now having more than eight years of production in their backlog. Moreover, the bidding pipeline remains impressive, as management is working with several OEMs on additional opportunities such as Boeing's middle-of-the-market option.
On the military side, business is gradually recovering across the globe. The US government is expected to grow its military funding by 9% year-over-year to US$639b in 2018, while the Canadian government is expected to increase its funding over the next 10 years to C$32.7b in 2026–27 from C$18.9b in 2016–17. In addition, Héroux is ramping up key programs (Saab Gripen, F-35, CH-53K and Embraer KC-390) and will continue to benefit from two maintenance, repair and operations contracts (CH-47 and C-130), which should fuel growth in its military segment in the medium term.
We continue to like the company's solid growth opportunities (B-777/777X program and new cross-selling opportunities with CESA and Beaver) and solid free cash flow profile (yield of ~7% based on our FY19 numbers). Furthermore, we believe Héroux has the key ingredients in place (growth opportunities, solid management team and strong balance sheet) to become a C$32 stock in the longer term, assuming C$695m in revenues and an EBITDA margin of 17% by FY21, and an 11x EV/EBITDA multiple.
Our C$19 target price is based on an average of three valuation methods: (1) 19x P/E multiple, (2) 10.0x EV/EBITDA multiple, and (3) a discounted cash flow value of C$21.09.
|Company||Ticker||Price ($)||Market cap ($m)||Ratingfootnote 1||Target price ($)||Dividend yield (%)||Total expected return (%)||Sector|
|Manulife Financial Corporation||MFC||24.86||49,301||Buy-AAR||28.00||3.5%||16%||Life Insurance|
|Alimentation Couche-Tard Inc.||ATD.B||53.85||30,455||Buy-AAR||74.00||0.7%||38%||Consumer Staples|
|Sun Life Financial Inc.||SLF||55.22||33,661||Buy-AAR||58.00||3.4%||8%||Life Insurance|
|TELUS Corporation||T||45.63||27,154||Buy-AR||52.00||4.6%||19%||Telecom, Media & Tech|
|Algonquin Power & Utilities Corp||AQN||12.47||5,852||Buy-AR||15.75||5.3%||32%||Power & Utilities|
|Uni-Select Inc.||UNS||19.91||842||Top Pick–AR||33.00||1.9%||68%||Consumer Discretionary|
|Transat A.T. Inc.||TRZ||8.49||331||Buy-AR||18.00||–||112%||Transportation & Aerospace|
- Target price change: UNS to $33 (from $34).
- AR: Average Risk, AAR: Above-average Risk
Source: Desjardins Capital Markets, Bloomberg, FactSet