BOMBARDIER INC -CL B BBD W
June 12, 2014 - 2:49pm EST by
Novana
2014 2015
Price: 3.80 EPS $0.33 $0.37
Shares Out. (in M): 174 P/E 9.6x 8.8x
Market Cap (in $M): 6,163 P/FCF nm nm
Net Debt (in $M): 3,513 EBIT 102 1,186
TEV ($): 9,671 TEV/EBIT 9.7x 8.9x

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  • Aerospace
  • Transportation
  • Sum Of The Parts (SOTP)
  • Deleveraging
  • Canada
 

Description

Please see below link to access version with charts and financials
https://app.box.com/Bombardier
 

Summary Investment thesis

For long term investors who can bear short term volatility, Bombardier (“BBD”) represents a compelling long opportunity. BBD shares are currently depressed because of a number of overhangs / fears / misconceptions which will go away in the next 12-24 months, namely:

  • Excessive leverage – BBD’s current leverage is high at 2.7x Net Debt / EBITDA and over 5x Gross Debt / EBITDA
  • Low (negative in fact) cash generation – share price dropped 7% after Q1 results because cash burn was higher than expected
  • Low margins – in particular, in its aerospace division, BBD has the lowest margins in the sector
  • Program delays – BBD is in the midst of the development of three large aerospace programs, some of which were hit by delays
  • Perfect storm on its main development program (CSeries) – during May and June 2014, the company suffered a number of blows to this program (order cancellations, expected orders not materialising, test engine accident)
  • Weakness  in its business aviation segment
  • Sub-par margins in its trains division

On top of these overhangs depressing the stock, the market also fails to recognise the substantial upside embedded in BBD’s aerospace business and to a lesser extent in the Train division, due to typical short termism. In particular, the market fails to appreciate the following:

  • Steep top line acceleration from 2015-16 onwards due to the introduction of new business and commercial aviation programs
  • Cyclical recovery in the business aviation segment where we expect orders (and deliveries) to pick up considerably after 4/5 years of inventory draw down post-recession
  • Margin recovery in the train division as loss making contracts are rolling off in 2014-15

The margin of safety here is wide. Bombardier trades on current 2014E 10x earnings where aerospace comps trade on mid to high teens and train comps trade on mid to low teens. In our base case scenario we believe there is c. 150% upside over 3 years, or a compounded annual return in the mid 30%.

Also, this is a stock very much out of favour, under the radar screen that didn’t participate in the recent market and aerospace rally. Large US brokers (GS, ML, JPM) are all negative on BBD with a SELL recommendation. The scope for re-rating in the stock is substantial.

(All figures in the below sections will be in USD unless otherwise stated except for the share price, which is in CAD).

Brief business description and recent developments

BBD was founded as a snowmobile manufacturer in Montreal in 1942 and grew through a number of acquisitions to become a leading rolling stock (trains) manufacturer and Aerospace OEM. As of FYE 2013, the balance of revenues was equally split between trains and aerospace. Going forward, the aerospace division is expected to grow much faster. Margins in aerospace are currently depressed (little over 4% in 2013) so the majority of profit comes from the train division. In terms of cash flow, the train division is very cash generative with cash conversion of c. 100% over time (FCF over EBIT) while the aerospace division is currently consuming large amounts of capital.

The aerospace division has really 3 components to it: a commercial division focused on regional jets, a business division (business jets) and a service division. The 3 segments have very different characteristics. The commercial division follows the traditional long cycles of the aerospace industry (like Airbus and Boeing) where backlog tends to cover many years of production and margins tend to be more resilient. The business division on the other hand is much more susceptible to the business cycle and backlogs typically don’t go over a year. The service division is much more stable.

The train division is stable and is expected to grow in line with GDP. Its main division, Rolling Stock, drives demand for the other 2 divisions, Services and System & Signalling:

Share price in BBD stagnated since market selloff in 2008-09 and didn’t recover like most other aerospace OEMs for a number of reasons:

  • Whilst the commercial aviation cycle picked up quickly after the recession in 2010, the business aviation cycle was in a state of significant oversupply from 2010 onwards. Corporate and rich individuals around the globe found themselves with too much inventory of business jets. Between 2010 and 2014 the industry witnessed a steady retirement of older jets and draw down in parked jets. Such conditions caused new orders to plummet. Bombardier historically benefitted from its leading position in business jets and suffered both volume collapse and margin compression given the difficult market environment
  • Whilst the commercial aviation and the regional jet market picked up, Bombardier didn’t quite benefit from it because it started losing market share to Embraer on its CRJ jets and to ATR on its turboprops Q400. Again, lower volumes there affected financials
  • In 2008, Bombardier announced that it would start its first large commercial aviation program, the CSeries, aimed at the 100-149 seats market, which would put it in direct competition with Airbus and Boeing. Such programs require many years (6-7) of investments before any return can be made. BBD is at the very cusp of this investment phase, not only on its CSeries but on 2 other programs concurrently. The research and development which includes investments in tooling on these 3 programs caused massive cash outflows in the last 4 years that led to increase in leverage. The market didn’t like this
  • Furthermore, it appears that following the recession, in order to fill the pipeline, Bombardier bid very aggressively on a number of large train projects at low, and sometimes negative, margins. This caused overall decreased in EBIT margins in train segment from 7% in 2011 to less than 6% in 2013. The market projects these low margins going forward

Furthermore, in recent months, Bombardier was hit by a number of negative events that caused share price to fall further:

  • Q1 results released on May 1st 2014 were in line with expectations but showed worse cash burn than expected. Share price fell 6% on the day
  • On May 15th, Air Canada had results and its CEO announced intentions not to place an order with Bombardier on its CSeries, something that was widely expected. Share price fell 7% on the day
  • On May 21st, Republic Airways Holding, a regional jet operator in the US, announced that the previous order for 40 CSeries planes from Bombardier will not be cancelled at this point in time but the planes will no longer fit in RJET’s business plan
  • On May 30th the company announced an accident on its test plane regarding an engine. All test flights were suspended
  • On June 10th, the company announced that engines tests restarted but the test planes are still on the ground and that the CSeries won’t appear at the Farnborough show in July as somewhat expected by the market

This (rather incredibly unlucky) set of events spooked the already nervy investors about possibly further delays on this program, which is currently expected to come into service in H2 2015.

We believe that most of the fears and misunderstanding above described will go away in the next 12-24 months and at the same time, the company will exhibit tremendous acceleration in top line, margins and cash generation. Details below.

Understanding long cycle programs

Everyone that ever invested in aerospace should know that new programs are long, costly and prone to unexpected surprises. The CSeries for Bombardier is no different. The problem with Bombardier though was that it stretched itself too thin, both financially and operationally by developing 3 new planes contemporarily. This is something that in hindsight was a major mistake as all large OEMs are careful when developing a new aircraft not to stretch itself too thinly. For example, Boeing had many years between the B787 and the B777. Equally, Airbus allowed a number of years between the A380 and the A350.

Bombardier’s 3 large programs are the following:

  1. CSeries – single aisle small commercial jet for 100-149 passengers. It’s a revolutionary plane in many respects, with new technologies including a new Pratt & Whitney Turbofan engine. Total development cost of the program: in excess of $4bn (just as indication of its size, the Boeing 777 development cost was c. $6bn). EIS (Entry in Service) expected in H2 2015
  2. Learjet 85 – this is the largest in the Learjet class, which is a light business jet. Development cost is c. $1bn, EIS at the end of 2014 / beginning 2015
  3. Global 7000/8000 – these are large corporate jets with the highest performances in the industry in terms of range and speed, competing with Gulfstream. Development cost is c. $2bn, EIS in 2016

Those 3 programs combined represent a cumulative investment in development, research and tooling of approximately $7bn. What is important to realise here is that for many years, BBD sees only the cash outflow with no returns from it. Once the deliveries will begin, there will be no more tooling associated with these programs and, on the contrary, the programs will start generating cash. In other words, even assuming zero cash generation from these new programs, the aerospace division is currently cash generative, even if it doesn’t appear so. From 2016-17 onwards, it will be very cash generative.

We think investor short termism is the reason why the market worries about current cash burn. In reality, we are at the very end of this long and large investment programmes. In our numbers, by the end of next year (2015), BBD would have increased its net debt position by $4.5bn between 2010 and 2015 but would have spent over $6.3bn in program tooling over the same period. From 2016 onwards, those programs will turn from use of cash to sources of cash. This long term dynamic is misunderstood by the market and is part of the reason why the opportunity exists today:

Aerospace division

The main value driver for BBD future appreciation is the Aerospace Division where we expect top line to grow by c. 75% between 2013 and 2018 and EBIT to double. In forecasting top line, we took a bottom up approach, estimating deliveries per type of aircraft multiplying them by an estimated price which is based on the list price plus a constant discount to list price as typical in Aerospace. The actual price paid by airlines is always a secret. In order to estimate aircraft deliveries, we took management estimates of market growth and market share in each market and cross checked these with OEM’s and competitors assumptions and consulted a number of industry executives to triple check these. On top of this, we took a haircut on all of the above to add a layer of conservatism in our numbers. See below our summary revenue breakdown estimates for 2018 for the division:

Commercial

In commercial, there are basically 3 segments:

  1. Regional aircrafts (60-99 seats) – this is comprised by the CRJ family. In the past, it used to have a market leading position but lost market share to Embraer. We estimate that in 2013 this family of aircraft contributed $700m in turnover and it will fall to c. $340m by 2018. This is in stark contrast with company estimates as it believes it will continue to retain c. 30% market share in this segment. We think our assumption is particularly draconian in light of recent large orders for the CRJ900 Next Gen (Delta and American ordered a combined 70)
  2. Turboprops (20-60 seats) – this is comprised by the Q400. In the past, the Q400 dominated the turboprop category but in recent years, they lost market share to ATR. Our industry calls suggest that ATR gained market share in developing markets as it’s cheaper than the Q400 but significantly less performant. The Q400 is a phenomenal aircraft as much cheaper than a jet of similar dimensions and yet almost just as fast. As developed market airlines will need to replace their older turboprops, we think BBD will gain a large share of the market for its new refreshed Q400 NextGen. We estimate than in 2013 revenues were c. $530m from the Q400 and that they will grow to c. $800m in 2018
  3. CSeries (100-150 seats) – the crown jewel of BBD Aerospace. We spent quite some time discussing this program with potential customers and industry experts and came away with a rather constructive view of this plane. To cut the story short, this is the first commercial plane designed specifically for 100 to 150 passengers in 30 years or so (we may have to go back to the MD-80 or even further back to the DC-9). Interestingly enough, if one looks at the passenger distribution by number of passenger per departure, the 100-130 passengers is the most regular category in the US. Still, it’s not served well at all by the industry. Some OEMs try to stretch planes that were originally designed for smaller configuration (Embraer) and others try to shrink larger planes into smaller configuration (Boeing and Airbus). The net result is that the C-Series is, on paper, a much more efficient aircraft, also thanks to its Turbofan engine from Pratt & Whitney. Bombardier announced that it will have 300 firm orders by the time it enters into service in H2 2015. The order book today stands at 203. The market doesn’t believe BBD will get to 300, we do but we don’t believe it’s absolutely crucial to get there before EIS. Whilst orders came in possibly at slower pace than expected, it is important to note that since the CSeries launched, its competitors (A319 Neo, B737 Max) received significantly less orders than Bombardier. From market share perspective, they gained much more than 50%, it’s just that the market wasn’t there yet. As the programme goes through certification, we think more orders will flow in. The company expects a market of c. 6,900 deliveries over the next 20 years (or 345 per year on average) and capture 50% market share (implying c. 170-175 annual deliveries). In our model we estimated 2018 deliveries of 90, about 40-50% below company implied estimates. We have also done comparative analysis of the CSeries against its peers and it’s by far the most cost competitive aircraft in its range

 

The commercial aerospace division should therefore accelerate top line from $1.2bn in 2013 to over $5bn in 2018. In terms of margins, we will look at Aerospace margins on a consolidated basis as the company does not break down margins by business / commercial / other divisions. See summary assumptions below. Please note that under “market assumptions”, we used other OEMs estimates:

 

Business jets

Bombardier produces 3 families of aircrafts that correspond to 3 sub-segments in the market: light, medium and ultra-long range distance. The lighter segment has the lowest barriers to entry, it’s the most competitive and it’s has been hit the hardest during recession. Consequently, the light segment is the one most cyclically depressed, following by the medium segment and finally the high-end segment where demand and supply is back in balance today. Since there is a substantial element of fixed costs in this business, any cyclical recovery would have a very positive effect on margins as they are currently significantly depressed.

Just to put things in perspective, in 2009 the company delivered 70 Learjet, in 2013 only 29. The families of aircrafts are the following:

  1. Learjet family – light business jets. It operates in a highly competitive market, competing with Cessna, Embraer, Gulfstream and Hawker Beechcraft. We assume that the new Learjet 85 (which according to the company should contribute over $1bn in revenues) will be somewhat successful but that overall, Learjet will be losing market share. The company assumed it will retain 20-25% market share, we assumed c. 13%
  2. Challenger family – medium business jets. The market is competitive but Bombardier is doing a decent job at defending its market share. Key competitors are Embraer, Dassault and Gulfstream. The company delivered its first Challenger 350 this year. The company expects to capture 30-35% market share going forward, we assumed only c. 26%
  3. Global family – large jets. This is actually a healthy market where at the very top end; it’s a near duopoly between Bombardier and Gulfstream. Conversations with industry experts confirmed that the new Global 7000/8000 will be the top of the range in the industry and will set a new standard when it will enter the market in 2016. The company expects to capture 35-40% market share. We assumed only 32% in our model.

 

The Business aerospace division is therefore expected to grow c. 7% annually to 2018 which is c. 20% below where the company is implicitly guiding:

 

Summary Aerospace assumptions

The final bit which we haven’t explicitly modelled is the growth in maintenance and other services revenues. We have conservatively assumed 6% CAGR to 2018 which we think it’s very reasonable considering that manufacturing sales will be growing at 14% CAGR. Summing it all up, we get total revenues of over $16bn in 2018 from $9bn in 2013. We have basically assumed $7bn in incremental sales which is below the low end of company guidance of $8-12bn increase in sales over the period. Below, we show a bridge from 2013 to 2018 by “mature” vs “new” programs:

In terms of margins, the company current generate a cyclical low of 4% EBIT margin. Last year, the company provided an indicative 8% EBIT margin target for 2014 that included a 2% dilutive effect from the CSeries. This target has been withdrawn and 2014 guidance stands at 5% EBIT margin with no dilutive effect from the CSeries as it comes into service in 2015. However, long term, we believe the company will be able to achieve 8% margin before dilutive effect from CSeries. This will be driven mainly by a sharp recovery in business aerospace margins as cyclically depressed volumes will pick up. Whilst very hard to estimate now, we assume that in 2018 there will still be 150bps of margin dilution from CSeries so we set EBIT margin 2018 at 6.5%. To put things in perspective, adjusted EBIT margin in 2008 (FYE Jan 2009, they then changed financial year end) was 9% so 6.5% target is certainly not an aggressive assumption.

Train division

The segment operates three divisions: Rolling Stock, Services and Signalling & Systems.

It is a market leader worldwide with large competitors being Siemens and Alstom. This segment is exposed to a number of secular tailwinds including urbanisation in developing countries, move towards clean energy and congestion reduction, liberalisation of public transport plus the normal replacement cycle. Bombardier is also exposed to the Chinese market where it operates a JV and offers high speed train solutions. Segment EBIT is currently below 6% but the long term target is 8%. A new CEO was appointed in 2013 from Boeing with the clear mandate to restructure the business, extract efficiencies and lift margins. We believe he will be successful in doing so. In our model, we assumed annual top line growth of 3% (against company target of 5%) and modest margin expansion annually to reach the stated target of 8% in 2018.

A word on cash flow

Much of the fear in the market is caused by Bombardier high leverage (c. 5x debt). This is very much mitigated by the large cash balance (c. $3bn) and access to debt facilities that ensures Bombardier has plenty of liquidity to finish its development programme without liquidity concerns. We note how CAPEX in aerospace peaked at $2.2bn in 2013 but it expected to decline already in 2014 to c. $1.75bn and then decrease until 2016 when it will drop below $1bn. At the same time, cash from operations will accelerate throughout the period so we are at the very nadir of cash generation in BBD corporate history.

Please note that in our cash flow analysis we factored increased usage of cash to service interest payment as a large portion of debt associated with development programs was actually capitalised. In 2013 for example, only $150m of interest was recorded in the P&L when the total actual interest cost was $359m.

It is noteworthy that the company regularly pays a decent dividend (2.6% dividend yield).

Summary financials and expected returns

Below we show summary financials and valuation metrics. On our numbers, Bombardier trades at c. 5x P/E 2018:

Looking at comparable companies in both aviation and trains, we get to an average comps multiple of 15x forward P/E:

Even applying a 20% discount to Bombardier, we would get to a forward P/E fair multiple of 12x. Applying such multiple to our estimated 2018E EPS of $0.69, we would get a fair share price of c. $9 in 2017, 3 years from now, or c. 150% upside. At $9 in 2017 Bombardier would still trade at 30% discount to peers on EV / EBITDA basis:

Alternatively, looking at SOTP valuation we get to very similar results. The key assumption here is what value to attribute to all future programs that are being developed. We assumed a 1x book value valuation for those. Even under this scenario we would get to 150% upside:

No matter how we look at this, the upside and the margin of safety appear to be very large.

Risks

In a way, a lot of what could have gone wrong already did go wrong in the last 2 months: customer cancellations, cash burn and even an accident during the program! We think that most of the risks are already more than priced in the stock but we would be remiss not to mention the following risks:

  • Further delays to CSeries EIS past H2 2015
  • Further customer cancellations
  • Economic turndown delaying recovery in business jets
  • Lower margin than anticipated on new programs and higher margin dilution than expected
  • Liquidity crunch (but we think liquidity is sufficient even in worst case scenario)
  • Corporate Governance – the family Bombardier controls the Board. The CEO is the son in law of Mr. Bombardier and his motives may not be align with shareholders best interest
I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

  • Quarterly results showing improvement in cash generation and margin recovery in train business
  • Confirmation of Entry In Service of CSeries for H2 2015
  • Large orders announcement, especially for CSeries
  • Time
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    Description

    Please see below link to access version with charts and financials
    https://app.box.com/Bombardier
     

    Summary Investment thesis

    For long term investors who can bear short term volatility, Bombardier (“BBD”) represents a compelling long opportunity. BBD shares are currently depressed because of a number of overhangs / fears / misconceptions which will go away in the next 12-24 months, namely:

    • Excessive leverage – BBD’s current leverage is high at 2.7x Net Debt / EBITDA and over 5x Gross Debt / EBITDA
    • Low (negative in fact) cash generation – share price dropped 7% after Q1 results because cash burn was higher than expected
    • Low margins – in particular, in its aerospace division, BBD has the lowest margins in the sector
    • Program delays – BBD is in the midst of the development of three large aerospace programs, some of which were hit by delays
    • Perfect storm on its main development program (CSeries) – during May and June 2014, the company suffered a number of blows to this program (order cancellations, expected orders not materialising, test engine accident)
    • Weakness  in its business aviation segment
    • Sub-par margins in its trains division

    On top of these overhangs depressing the stock, the market also fails to recognise the substantial upside embedded in BBD’s aerospace business and to a lesser extent in the Train division, due to typical short termism. In particular, the market fails to appreciate the following:

    • Steep top line acceleration from 2015-16 onwards due to the introduction of new business and commercial aviation programs
    • Cyclical recovery in the business aviation segment where we expect orders (and deliveries) to pick up considerably after 4/5 years of inventory draw down post-recession
    • Margin recovery in the train division as loss making contracts are rolling off in 2014-15

    The margin of safety here is wide. Bombardier trades on current 2014E 10x earnings where aerospace comps trade on mid to high teens and train comps trade on mid to low teens. In our base case scenario we believe there is c. 150% upside over 3 years, or a compounded annual return in the mid 30%.

    Also, this is a stock very much out of favour, under the radar screen that didn’t participate in the recent market and aerospace rally. Large US brokers (GS, ML, JPM) are all negative on BBD with a SELL recommendation. The scope for re-rating in the stock is substantial.

    (All figures in the below sections will be in USD unless otherwise stated except for the share price, which is in CAD).

    Brief business description and recent developments

    BBD was founded as a snowmobile manufacturer in Montreal in 1942 and grew through a number of acquisitions to become a leading rolling stock (trains) manufacturer and Aerospace OEM. As of FYE 2013, the balance of revenues was equally split between trains and aerospace. Going forward, the aerospace division is expected to grow much faster. Margins in aerospace are currently depressed (little over 4% in 2013) so the majority of profit comes from the train division. In terms of cash flow, the train division is very cash generative with cash conversion of c. 100% over time (FCF over EBIT) while the aerospace division is currently consuming large amounts of capital.

    The aerospace division has really 3 components to it: a commercial division focused on regional jets, a business division (business jets) and a service division. The 3 segments have very different characteristics. The commercial division follows the traditional long cycles of the aerospace industry (like Airbus and Boeing) where backlog tends to cover many years of production and margins tend to be more resilient. The business division on the other hand is much more susceptible to the business cycle and backlogs typically don’t go over a year. The service division is much more stable.

    The train division is stable and is expected to grow in line with GDP. Its main division, Rolling Stock, drives demand for the other 2 divisions, Services and System & Signalling:

    Share price in BBD stagnated since market selloff in 2008-09 and didn’t recover like most other aerospace OEMs for a number of reasons:

    • Whilst the commercial aviation cycle picked up quickly after the recession in 2010, the business aviation cycle was in a state of significant oversupply from 2010 onwards. Corporate and rich individuals around the globe found themselves with too much inventory of business jets. Between 2010 and 2014 the industry witnessed a steady retirement of older jets and draw down in parked jets. Such conditions caused new orders to plummet. Bombardier historically benefitted from its leading position in business jets and suffered both volume collapse and margin compression given the difficult market environment
    • Whilst the commercial aviation and the regional jet market picked up, Bombardier didn’t quite benefit from it because it started losing market share to Embraer on its CRJ jets and to ATR on its turboprops Q400. Again, lower volumes there affected financials
    • In 2008, Bombardier announced that it would start its first large commercial aviation program, the CSeries, aimed at the 100-149 seats market, which would put it in direct competition with Airbus and Boeing. Such programs require many years (6-7) of investments before any return can be made. BBD is at the very cusp of this investment phase, not only on its CSeries but on 2 other programs concurrently. The research and development which includes investments in tooling on these 3 programs caused massive cash outflows in the last 4 years that led to increase in leverage. The market didn’t like this
    • Furthermore, it appears that following the recession, in order to fill the pipeline, Bombardier bid very aggressively on a number of large train projects at low, and sometimes negative, margins. This caused overall decreased in EBIT margins in train segment from 7% in 2011 to less than 6% in 2013. The market projects these low margins going forward

    Furthermore, in recent months, Bombardier was hit by a number of negative events that caused share price to fall further:

    • Q1 results released on May 1st 2014 were in line with expectations but showed worse cash burn than expected. Share price fell 6% on the day
    • On May 15th, Air Canada had results and its CEO announced intentions not to place an order with Bombardier on its CSeries, something that was widely expected. Share price fell 7% on the day
    • On May 21st, Republic Airways Holding, a regional jet operator in the US, announced that the previous order for 40 CSeries planes from Bombardier will not be cancelled at this point in time but the planes will no longer fit in RJET’s business plan
    • On May 30th the company announced an accident on its test plane regarding an engine. All test flights were suspended
    • On June 10th, the company announced that engines tests restarted but the test planes are still on the ground and that the CSeries won’t appear at the Farnborough show in July as somewhat expected by the market

    This (rather incredibly unlucky) set of events spooked the already nervy investors about possibly further delays on this program, which is currently expected to come into service in H2 2015.

    We believe that most of the fears and misunderstanding above described will go away in the next 12-24 months and at the same time, the company will exhibit tremendous acceleration in top line, margins and cash generation. Details below.

    Understanding long cycle programs

    Everyone that ever invested in aerospace should know that new programs are long, costly and prone to unexpected surprises. The CSeries for Bombardier is no different. The problem with Bombardier though was that it stretched itself too thin, both financially and operationally by developing 3 new planes contemporarily. This is something that in hindsight was a major mistake as all large OEMs are careful when developing a new aircraft not to stretch itself too thinly. For example, Boeing had many years between the B787 and the B777. Equally, Airbus allowed a number of years between the A380 and the A350.

    Bombardier’s 3 large programs are the following:

    1. CSeries – single aisle small commercial jet for 100-149 passengers. It’s a revolutionary plane in many respects, with new technologies including a new Pratt & Whitney Turbofan engine. Total development cost of the program: in excess of $4bn (just as indication of its size, the Boeing 777 development cost was c. $6bn). EIS (Entry in Service) expected in H2 2015
    2. Learjet 85 – this is the largest in the Learjet class, which is a light business jet. Development cost is c. $1bn, EIS at the end of 2014 / beginning 2015
    3. Global 7000/8000 – these are large corporate jets with the highest performances in the industry in terms of range and speed, competing with Gulfstream. Development cost is c. $2bn, EIS in 2016

    Those 3 programs combined represent a cumulative investment in development, research and tooling of approximately $7bn. What is important to realise here is that for many years, BBD sees only the cash outflow with no returns from it. Once the deliveries will begin, there will be no more tooling associated with these programs and, on the contrary, the programs will start generating cash. In other words, even assuming zero cash generation from these new programs, the aerospace division is currently cash generative, even if it doesn’t appear so. From 2016-17 onwards, it will be very cash generative.

    We think investor short termism is the reason why the market worries about current cash burn. In reality, we are at the very end of this long and large investment programmes. In our numbers, by the end of next year (2015), BBD would have increased its net debt position by $4.5bn between 2010 and 2015 but would have spent over $6.3bn in program tooling over the same period. From 2016 onwards, those programs will turn from use of cash to sources of cash. This long term dynamic is misunderstood by the market and is part of the reason why the opportunity exists today:

    Aerospace division

    The main value driver for BBD future appreciation is the Aerospace Division where we expect top line to grow by c. 75% between 2013 and 2018 and EBIT to double. In forecasting top line, we took a bottom up approach, estimating deliveries per type of aircraft multiplying them by an estimated price which is based on the list price plus a constant discount to list price as typical in Aerospace. The actual price paid by airlines is always a secret. In order to estimate aircraft deliveries, we took management estimates of market growth and market share in each market and cross checked these with OEM’s and competitors assumptions and consulted a number of industry executives to triple check these. On top of this, we took a haircut on all of the above to add a layer of conservatism in our numbers. See below our summary revenue breakdown estimates for 2018 for the division:

    Commercial

    In commercial, there are basically 3 segments:

    1. Regional aircrafts (60-99 seats) – this is comprised by the CRJ family. In the past, it used to have a market leading position but lost market share to Embraer. We estimate that in 2013 this family of aircraft contributed $700m in turnover and it will fall to c. $340m by 2018. This is in stark contrast with company estimates as it believes it will continue to retain c. 30% market share in this segment. We think our assumption is particularly draconian in light of recent large orders for the CRJ900 Next Gen (Delta and American ordered a combined 70)
    2. Turboprops (20-60 seats) – this is comprised by the Q400. In the past, the Q400 dominated the turboprop category but in recent years, they lost market share to ATR. Our industry calls suggest that ATR gained market share in developing markets as it’s cheaper than the Q400 but significantly less performant. The Q400 is a phenomenal aircraft as much cheaper than a jet of similar dimensions and yet almost just as fast. As developed market airlines will need to replace their older turboprops, we think BBD will gain a large share of the market for its new refreshed Q400 NextGen. We estimate than in 2013 revenues were c. $530m from the Q400 and that they will grow to c. $800m in 2018
    3. CSeries (100-150 seats) – the crown jewel of BBD Aerospace. We spent quite some time discussing this program with potential customers and industry experts and came away with a rather constructive view of this plane. To cut the story short, this is the first commercial plane designed specifically for 100 to 150 passengers in 30 years or so (we may have to go back to the MD-80 or even further back to the DC-9). Interestingly enough, if one looks at the passenger distribution by number of passenger per departure, the 100-130 passengers is the most regular category in the US. Still, it’s not served well at all by the industry. Some OEMs try to stretch planes that were originally designed for smaller configuration (Embraer) and others try to shrink larger planes into smaller configuration (Boeing and Airbus). The net result is that the C-Series is, on paper, a much more efficient aircraft, also thanks to its Turbofan engine from Pratt & Whitney. Bombardier announced that it will have 300 firm orders by the time it enters into service in H2 2015. The order book today stands at 203. The market doesn’t believe BBD will get to 300, we do but we don’t believe it’s absolutely crucial to get there before EIS. Whilst orders came in possibly at slower pace than expected, it is important to note that since the CSeries launched, its competitors (A319 Neo, B737 Max) received significantly less orders than Bombardier. From market share perspective, they gained much more than 50%, it’s just that the market wasn’t there yet. As the programme goes through certification, we think more orders will flow in. The company expects a market of c. 6,900 deliveries over the next 20 years (or 345 per year on average) and capture 50% market share (implying c. 170-175 annual deliveries). In our model we estimated 2018 deliveries of 90, about 40-50% below company implied estimates. We have also done comparative analysis of the CSeries against its peers and it’s by far the most cost competitive aircraft in its range

     

    The commercial aerospace division should therefore accelerate top line from $1.2bn in 2013 to over $5bn in 2018. In terms of margins, we will look at Aerospace margins on a consolidated basis as the company does not break down margins by business / commercial / other divisions. See summary assumptions below. Please note that under “market assumptions”, we used other OEMs estimates:

     

    Business jets

    Bombardier produces 3 families of aircrafts that correspond to 3 sub-segments in the market: light, medium and ultra-long range distance. The lighter segment has the lowest barriers to entry, it’s the most competitive and it’s has been hit the hardest during recession. Consequently, the light segment is the one most cyclically depressed, following by the medium segment and finally the high-end segment where demand and supply is back in balance today. Since there is a substantial element of fixed costs in this business, any cyclical recovery would have a very positive effect on margins as they are currently significantly depressed.

    Just to put things in perspective, in 2009 the company delivered 70 Learjet, in 2013 only 29. The families of aircrafts are the following:

    1. Learjet family – light business jets. It operates in a highly competitive market, competing with Cessna, Embraer, Gulfstream and Hawker Beechcraft. We assume that the new Learjet 85 (which according to the company should contribute over $1bn in revenues) will be somewhat successful but that overall, Learjet will be losing market share. The company assumed it will retain 20-25% market share, we assumed c. 13%
    2. Challenger family – medium business jets. The market is competitive but Bombardier is doing a decent job at defending its market share. Key competitors are Embraer, Dassault and Gulfstream. The company delivered its first Challenger 350 this year. The company expects to capture 30-35% market share going forward, we assumed only c. 26%
    3. Global family – large jets. This is actually a healthy market where at the very top end; it’s a near duopoly between Bombardier and Gulfstream. Conversations with industry experts confirmed that the new Global 7000/8000 will be the top of the range in the industry and will set a new standard when it will enter the market in 2016. The company expects to capture 35-40% market share. We assumed only 32% in our model.

     

    The Business aerospace division is therefore expected to grow c. 7% annually to 2018 which is c. 20% below where the company is implicitly guiding:

     

    Summary Aerospace assumptions

    The final bit which we haven’t explicitly modelled is the growth in maintenance and other services revenues. We have conservatively assumed 6% CAGR to 2018 which we think it’s very reasonable considering that manufacturing sales will be growing at 14% CAGR. Summing it all up, we get total revenues of over $16bn in 2018 from $9bn in 2013. We have basically assumed $7bn in incremental sales which is below the low end of company guidance of $8-12bn increase in sales over the period. Below, we show a bridge from 2013 to 2018 by “mature” vs “new” programs:

    In terms of margins, the company current generate a cyclical low of 4% EBIT margin. Last year, the company provided an indicative 8% EBIT margin target for 2014 that included a 2% dilutive effect from the CSeries. This target has been withdrawn and 2014 guidance stands at 5% EBIT margin with no dilutive effect from the CSeries as it comes into service in 2015. However, long term, we believe the company will be able to achieve 8% margin before dilutive effect from CSeries. This will be driven mainly by a sharp recovery in business aerospace margins as cyclically depressed volumes will pick up. Whilst very hard to estimate now, we assume that in 2018 there will still be 150bps of margin dilution from CSeries so we set EBIT margin 2018 at 6.5%. To put things in perspective, adjusted EBIT margin in 2008 (FYE Jan 2009, they then changed financial year end) was 9% so 6.5% target is certainly not an aggressive assumption.

    Train division

    The segment operates three divisions: Rolling Stock, Services and Signalling & Systems.

    It is a market leader worldwide with large competitors being Siemens and Alstom. This segment is exposed to a number of secular tailwinds including urbanisation in developing countries, move towards clean energy and congestion reduction, liberalisation of public transport plus the normal replacement cycle. Bombardier is also exposed to the Chinese market where it operates a JV and offers high speed train solutions. Segment EBIT is currently below 6% but the long term target is 8%. A new CEO was appointed in 2013 from Boeing with the clear mandate to restructure the business, extract efficiencies and lift margins. We believe he will be successful in doing so. In our model, we assumed annual top line growth of 3% (against company target of 5%) and modest margin expansion annually to reach the stated target of 8% in 2018.

    A word on cash flow

    Much of the fear in the market is caused by Bombardier high leverage (c. 5x debt). This is very much mitigated by the large cash balance (c. $3bn) and access to debt facilities that ensures Bombardier has plenty of liquidity to finish its development programme without liquidity concerns. We note how CAPEX in aerospace peaked at $2.2bn in 2013 but it expected to decline already in 2014 to c. $1.75bn and then decrease until 2016 when it will drop below $1bn. At the same time, cash from operations will accelerate throughout the period so we are at the very nadir of cash generation in BBD corporate history.

    Please note that in our cash flow analysis we factored increased usage of cash to service interest payment as a large portion of debt associated with development programs was actually capitalised. In 2013 for example, only $150m of interest was recorded in the P&L when the total actual interest cost was $359m.

    It is noteworthy that the company regularly pays a decent dividend (2.6% dividend yield).

    Summary financials and expected returns

    Below we show summary financials and valuation metrics. On our numbers, Bombardier trades at c. 5x P/E 2018:

    Looking at comparable companies in both aviation and trains, we get to an average comps multiple of 15x forward P/E:

    Even applying a 20% discount to Bombardier, we would get to a forward P/E fair multiple of 12x. Applying such multiple to our estimated 2018E EPS of $0.69, we would get a fair share price of c. $9 in 2017, 3 years from now, or c. 150% upside. At $9 in 2017 Bombardier would still trade at 30% discount to peers on EV / EBITDA basis:

    Alternatively, looking at SOTP valuation we get to very similar results. The key assumption here is what value to attribute to all future programs that are being developed. We assumed a 1x book value valuation for those. Even under this scenario we would get to 150% upside:

    No matter how we look at this, the upside and the margin of safety appear to be very large.

    Risks

    In a way, a lot of what could have gone wrong already did go wrong in the last 2 months: customer cancellations, cash burn and even an accident during the program! We think that most of the risks are already more than priced in the stock but we would be remiss not to mention the following risks:

    • Further delays to CSeries EIS past H2 2015
    • Further customer cancellations
    • Economic turndown delaying recovery in business jets
    • Lower margin than anticipated on new programs and higher margin dilution than expected
    • Liquidity crunch (but we think liquidity is sufficient even in worst case scenario)
    • Corporate Governance – the family Bombardier controls the Board. The CEO is the son in law of Mr. Bombardier and his motives may not be align with shareholders best interest
    I do not hold a position of employment, directorship, or consultancy with the issuer.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    • Quarterly results showing improvement in cash generation and margin recovery in train business
    • Confirmation of Entry In Service of CSeries for H2 2015
    • Large orders announcement, especially for CSeries
    • Time

    Messages


    SubjectRE: Questions
    Entry06/13/2014 05:43 AM
    MemberNovana
    Lars,
    good questions.
     
    1) C-Series VS BA / Airbis re-engined. I will summarise at best our understanding here. This is based on data provided by BBD, competitors, analysts as well as independent consultants. We have here in front of our eyes and independent AirInsight 70 pages report on the C-Series which we can't distribute, where a number of comparative stats are presented and analysed. In the summary below please take figures with grain of salt. There are so many variables here (which aircraft: C-Series100 or 300 Vs A320 / 319? What cost are you looking at, just fuel or total including maintenance? Cost per passenger or per trip? What distance?) so I will give you a very basic "average" number.
    Pre re-engineering of BA/Airbus, CSeries had c. 15% cost advantage. The re-engineering brought this down to maybe 7-8%. The other 7-8% comes from the fact that the CSeries uses advanced materials and was specially designed for this size. On top of this, you need to add the transition cost / training costs for an airlines to train pilots. That would add another 1-1.5% depending on how big your airline is. So, the net benefit of having a CSeries today is maybe 6-7% and you also have better delivery schedule. Is this enough to move airlines? Yes. Airlines will move for very little. Financing is cheap and 6-7% additional margin when your EBIT is 5% means a lot. Having said that, the erosion of cost benefit will have an impact to BBD. We have assumed peak deliveries of 90 planes a year, Vs BBD assumption of 175 and our checks with consultants suggsting 120. The reason we are lower is because smaller airlines that have an established Airbus or Boeing fleet will no longer switch to C-Series because not worth the hassle of transition for just a few planes. We think that only the large airlines like Lufthansa that will need large number of smaller aircrafts will go for the C-series. So the re-engineering by BA / AIR is certainly negative but more than reflected in our assumptions and very much reflected in BBD share price.
     

    SubjectRE: RE: Questions
    Entry06/13/2014 08:16 AM
    MemberNovana
    Regarding the second question - cash costs on C-Series. This is a very tricky one. The company doesn't give any indication whatsoever. We tried to get to a reasonable estimate of the above through a number of assumptions. In order to estimate these, we had to assume:
    * a "normalised" EBIT margin for the program once mature
    * how long would it take to get there in terms of aircrafts produded
    * a "reasonable" learning curve to get there
    * any other factors affecting cash flows
     
    For "normalised" EBIT margin, we assumed that once mature, this program will generate contribution margins to BBD of 13%. This is pretty reasonable for a mature large OEM program. The A320 and B737 are more profitable that this and are competing in an arguably fiercer market than the 100-150 seats. Also, in discussions with the company, the company indicated that when they started investing in this program, they were looking for double digit IRR on the investment and double digit margins. If we do a quick and dirty calculation of the IRR on the C-Series assuming it lasts 25 years and when mature will exhibit EBIT margin of 13% (in 2020) which then increases some 20bps per year until 2041, we get an IRR of 13% per tax, which is probably at the low end of what BBD would have liked to achieve. we therefore think that a "mature" 13% EBIT margin makes sense here. Note that on our assumptions of only 90 deliveries per year, we get to a pre-tax IRR of just 5%.
    As per how long it will take to get there, we have assumed it gets there in 2020 because we assumed that the first 300 aircrafts will be below "normal" profitability. This is our assumption and could of course be off but we got there considering the following. Looking at other developing projects that are accounted under block accounting (for example Spirit Aerosystms accounts this way), the first block represents the number of aircrafts where cumulative cash flow and profit is zero and after the first block, margins are recognised normally. It gives you an indication of how many aicrafts you need to produce before you get to normal margins. For Spirit for example, the block accounting on the 787 is for 500 aicrafts, for the A350 is 400 and for the Gulfstream 280 is 250. Now, here we are talking about supplying an OEM, not the OEM's learning curve itself, but it is indicative. The more complex the program, the more aicrafts you need before you get to normal margins. Very roughly speaking, the C-Series is less complex than the A350 but more complex than the G280, so between 250 and 400 aircrafts. We assumed 300. Incidentally, this is the number BBD wanted to have as firm orders before production, probably becaused it wanted to make sure that first phase of "below normal" margin production will be fully covered. We think it's actually a pretty conservative assumption. Under our assumptions, the company will deliver 300 aircrafts before 2020.
    The next assumption needed is the learning curve on the first 300 aircrafts. We have no idea, we used the standard aerospace assumption of 85% but happy to change it.
    Finally, we had to assume the selling price for each C-Series plane. Again, no idea because we don't know what is the discount to list price. We assumed an average realised price of c. $45m per plane.
    Armed with these assumptions we could calculate margin dilution in 2018 from the CSeries (1.50%) and the cumulative cash drain until 2018 from the CSeries (from 2019 it will be cash generative). We ended up with c. $1.6bn.
    The final element we have zero visibility on is working capital management. In large new programs, the OEMs insist on some sort of pre-delivery payments in order to manage the difficult learning curve. Assuming that on average c. 20% of the final purchase price is paid in advance 12 months before delivery, the company will generage c. $800 in positive working capital during the period.
    Net-net, we think that cumulative cash drain from the C-Series early production to 2018 will be c. $800mm which is very manageable given BBD ample liquidity.

    SubjectC-Series Program
    Entry06/13/2014 10:48 AM
    Membergosens
    Hi - have been considering taking a look....definitely seems like a time arbitrage opportunity on the surface.
     
    What value do you believe the market is currently putting on the C-Series vs. the other various businesses?  Basically, other than large cash outflows going away, do you have to ascribe a large positive value to this program (i.e. is the PV of the C-Series program from day 1 of commerical production onwards positive?) in order  to see significant upside to BBD equity?  
     
    The value of a commerical aerospace program is highly levered to 1)  learning curve and 2)  annual production rate.
     
    Your assertion that cash flow requirements will come down as soon as pre-production/tooling is complete is correct.  But, the actual value of this program will very highly dependent on the learning curve that BBD follows.  So while the negative cash outflows from R&D/tooling/etc. may decrease, a large number of early aircraft produced will also come at negative cash margins.  So while the cash requirements over the next 2 years may decrease, the C-Series is still likely to be a use of cash vs. a source of cash.
     
    Presumabley profitability will increase as more planes are produced and BBD reduces unit costs, but break-even is likely a few years out.  And if orders are not there, then BBD will not benefit from higher outer year production rates where presumabley each plane is producing positive cash margins. 
     
    Also, if you assume 0 value from here to the C-Series and a subdued bizjet recovery, what is the implication for BBD equity?  Basically, where do you see downside from here?  Given the financial leverage, I suspect the downside here is a zero (probably not actually the case since in Canada BBD may be "too big to fail"....but that is not positive for equity).
     
    Interested in your thoughts on all of this.
     
     

    SubjectRE: C-Series Program
    Entry06/13/2014 11:21 AM
    MemberNovana
    Gosens,
    you will see most of the answers to your cash burn / learning curve questions in my earlier response to Lars.
     
    In our opinion, the market is assigning zero value to the C-Series. Under our assumptions, the current NPV of the C-Series program is c. $1.8bn (8% discount rate) which is clearly well below what the company believes to be as they spent to date c. $3.3bn, which would mean that the C-Series would earn a substantially negative return on invested capital.
     
    If you apply market multiples to the rest of the business (which would be fair in light of the fact that the rest of the business is derisked), you would get in our numbers a fair value of close to $6.5-7.0 today and that includes the $1.8bn we attribute to the C-Series, or $1.1 per share. Assigning a zero to the C-Series would yield a SOTP price of c. $5.50. Please note that in getting there we excluded the tooling investments required to finish the program from our Net Debt figures.
     
    These numbers are based on "normal" market recovery. You asked about what happens in subdued market recovery. We assumed current business jet excluding new launches (L85, Global 7000/8000) to grow c. 1% a year to 2018. We think this assumptions already captures a "subdued" market recovery, further downside would be limited in our opinion.
     
    Regarding potential downside, we really struggle to see a zero here. You have over $3bn in cash and the train business should generate in excess of $600m of cash a year which is more than enough to pay taxes and interest. Absent liquidity crunch how do you get to zero? Even assuming you stop today and throw in the Ocean the C-Series, you still get upside from here!

    SubjectRE: RE: RE: RE: Questions
    Entry06/13/2014 11:32 AM
    MemberNovana
    No views on the former (it would obviosuly be nice, but necessary?) and no idea on the latter (note that the $45m is a bogus number as the CSeries 100 should be less and the 300 more, I just threw in a weighted average). These things are very hard to find out, it's amazing how the airline industry is able to keep poor transparency in pricing in the market

    SubjectRE: RE: C-Series Program
    Entry06/13/2014 12:04 PM
    Membergosens
    One other question - I seem to recall that BBD has a liability in the form of repurchase agreements with its cutomers i.e. it must repurchase some aircrafts.  Do you know the details/size of this liability and do you include it in your valuation?

    SubjectRE: RE: RE: C-Series Program
    Entry06/13/2014 12:22 PM
    MemberNovana
    Quoting from annual report: "the Corporation may provide a guarantee for the residual value of aircraft at an agreed-upon date,generally at the expiry date of related financing and lease arrangements. The arrangements generally include operating restrictions such as maximum usage and minimum maintenance requirements. The guarantee provides for a contractually limited payment to the guaranteed party, which is typically a percentage of the first loss from a guaranteed value. In most circumstances, a claim under such guarantees may be made only upon resale of the underlying aircraft to a third party"
    As of 31/12/2013 the liability was $1.8bn but only $924m in hte next 5 years. Basically, if you assume the residual value of aicrafts under residual value guarantees is zero, then you'd have a $924m cash outflow in next 5 years. In reality, the current market value is likely to be far in excess of residual value guarantee, especially now as cycle is turning.

     
     

    SubjectRE: RE: RE: RE: C-Series Program
    Entry06/13/2014 01:25 PM
    Memberjso1123
    Thanks for the write-up.  I think the key analysis here is a per-unit cost analysis on C-Series showing unit ramp, $/unit tooling amortization (i.e. how much will end up being capitalized and over what # of units will they amortize it), $/unit cash cost with implied learning curve and how that compares to other aerospace programs to make sure it is reasonable.  The biggest challenge w/this one is not knowing how much money they are going to lose on the program given that everyone is valuing this on earnings.  
     
    For example, they are assuming ~25 C-Series units in year 1 and they are saying expect a 200bp margin dilution in aerospace from C-Series losses.  If we assume $10b in aerospace revenue (current rate plus ~$1b from C-Series @ $45mm ASP x 25 units) that implies $200mm in EBIT losses from C-Series / 25 units = $8mm/airplane in losses. 
     
    But my understanding is they are amortizing the $4.5b in development costs over a large block of units...if we assume 750 units that works out to be $6mm/unit in amortization.
     
    So this implies cash cost losses of $2mm/unit on the initial production.  That just seems way too low compared to what other new programs have generated.  

    Again these are high level #s and I haven't done the real work but I think this would be the most important analysis behind how to value the stock given it all gets down to earnings as the C-Series ramps.
     
    Thanks for any thoughts
     

    SubjectRE: RE: RE: RE: RE: C-Series Program
    Entry06/18/2014 04:31 AM
    MemberNovana
    I guess the point of the write up was to illustrate the wide margin of safety in the stock even with particularly bearish assumptions on the C-Series. I will not argue your math, I'm just showing how taking numbers much worse than yours, you still get to significant upside here.
     
    In getting to $1.8bn current NPV for the C-Series, I have assumed the following. Interested to hear your views on whether we have been too optimistic here:
    * Run rate production rate of 90 aircrafts (Vs 175 stated by the company)
    * Average realised price of $45m (for 100/300 averaged)
    * Learning curve 85%
    * 1st plane cash costs of $145m, so $100m in losses. Pls note that first 5 planes are test planes so already built and behind us (more or less, not entirely true but for the sake of simplicity let's assume so)
    * 0 deliveries in 2015
    * 30 deliveries in 2016 at average loss of $30m per plane
    * 60 deliveries in 2017 at average loss of $11m per plane
    * 90 deliveries in 2018 at $1m loss per plane
    * Cumulative cash burn on first planes of $1.6bn mitigated by $800m in customer advances, so net cash burn to 2018 of $800m on C-Series
    * Normalised contribution margin of 13% (assuming maintenance CAPEX = D&A, so cash margins). Note that this is not an EBIT / EBITDA figure; from a P&L perspective it's probably closer to EBITA. Assuming as you say $6m in unit amortisation per plan, it'd actually imply EBIT of close to 0%!
     
    Under these assumptions we see SOTP fair price today at around $6.50. Again, the point here is to illustrate that we don't need to assume $2m/unit cash cost losses to create value from the C-Series here. The reason the opportunity exists today is that nobody knows exactly the learning curve, cash losses on first planes etc., not even the company truly knows that. The point is that we can run a very conservative scenario and still see massive upside. You can then go wild if you wish by building bullyish assumptions.

    SubjectRE: Other liabilities
    Entry06/18/2014 04:38 AM
    MemberNovana
    This is a very fair point. We have included in our cash flow estimates continued Defined Benefit contributions but haven't capitalised them on balance sheet. The P/E reported is therefore correct whilst on EV / EBITDA you'd have to adjust for this.
    As a side note, a 100-110bps rise in l.t. interest rate assumption would bring down the net deficit to zero.

    SubjectWho's driving this?
    Entry06/18/2014 07:57 AM
    Memberjgalt
    I just read your write-up and there's no mention of management tenure or quality. It sounds like this company has disappointed in so many ways -- execution mistakes or bad luck, lower margin than peers, etc. 
     
    What has changed on the management side and if nothing has changed, why do you expect better execution going forward?

    SubjectRE: RE: RE: RE: RE: RE: C-Series Program
    Entry06/18/2014 09:00 AM
    Memberjso1123
    Thanks for the detail Novana.  I think ASP is correct @ $45mm.  Issue is if your  #s are right then there is a major negative downgrade to earnings vs. mgmt guidance (i.e. in 2016 you have $900mm in C-Series cash losses plus say $5mm/plane intangible amort = ~$1b in EBIT hit.  Management has guided to $200mm in losses (200bp).  If that materializes my gut is you'll have a better shot to buy the stock much cheaper.
    thanks for sharing the thoughts
     

    SubjectRE: Who's driving this?
    Entry06/18/2014 09:01 AM
    MemberNovana
    In 2013 Lutz Bertling was appointed new CEO of train division (his title is "President and COO"). He's a German coming from Airbus with solid reputation. This is the most underperforming of the 2 segments. It gives us confidence the segment will hit 8% in medium term with progressive margin improvement. In Aerospace, it's hard to assess - they have been hit like everyone else on business jets slowdown and on C-Series it's early days, 1 year delay compared to delays on A380 / A350 / B787 is not outrageous. Our checks on aerospace management suggest they are good engineers but not as aggressive / commercially savvy as John Leahy (Airbus COO) for example, but they are technically qualified. The 8% EBIT margin target for 2014 then abandoned did dent their credibility and they want to avoid another disappointment at all costs so our guess is that future guidance bar will be set pretty low.

    SubjectRE: RE: RE: RE: RE: RE: RE: C-Series Program
    Entry06/18/2014 09:09 AM
    MemberNovana
    jso1123,
    I see your point but take Airbus. Nobody cares about 1 year margin dilution impact on A-350. People worry a lot about cash burn but they look at Airbus margins ex A-350. At least, that's how people should look at it. The company will give "Adjusted EPS" guidance ex C-Series and this is what analysts will look at.
     
    Again, I understand our numbers are very low, we are making the case that even on very low numbers, way below company forecasts, we create positive value for the C-Series from here onwards and leaves the share price ridiculously mispriced

    SubjectRE: shareholders
    Entry07/25/2014 10:37 AM
    MemberNovana
    This is a question that would require a very long answer but I'd say there are 3 reasons for value destruction in last decade
    1. Cyclical  - the business was impacted by 2 shocks to the airline industry that significantly affected their aerospace segment ('01-'02 and '08'09 recession). We are starting to see only now some volume recovery there
    2. Investment cycle - in last 4 years they embarked in massive investment programme that inevitably added some fixed costs to business and took a lot of management attention and focus. Our thesis is that 2015 is the turning point from that point of view
    3. Corporate culture - They basically have the lowest margins in the industry and yet a very high reputation in the market for their products, especially in Aerospace. Bombardier has a culture of engineering excellence which in the past was not bombined with commercial acumen. Our bet is that this is about to change but none of this is priced in the stock. Some of signs that this change was the appointment of new CEO in train division (a German from Airbus) and recently announced large scale restructuring of aerospace division which is a big deal in Canada. As mentioned in the write-up, not too dissimilar from EADS 2 years ago
    We believe the investments will work very well with items 1 and 2 above resolved (and we are very confident there) and point 3 above would be further upside, but we feel things are really changing there.

    SubjectRE: RE: RE: shareholders
    Entry07/28/2014 06:21 AM
    MemberNovana
    Just to put things in perspective, I estimate that the 1,800 cut to the workforce alone should enhance 2015 Aerospace margins by c. 140bps. Assume the following:
    • Average employee cost of $78k in 2013 (76,400 employees and $5,961m in wages)
    • Estimate Aerospace revenues of $10bn in 2015

    And you get 140bps of self help on estimated EBIT margin base of 5%. We actually assume only 50bps of margin expansion in 2015 from 2014 but it shows the scope for margin upgrades in this business.


    SubjectRE: Testing schedule & Braathens news
    Entry09/04/2014 12:01 PM
    MemberNovana
    Lars,
    sorry for the delay in getting back to you. I wouldn't read too much into Braathens decision to move delivery time. It happens to be the first delivery so there are lots of news around this but operators change the delivery schedule all the time. Braathens is small operator and for them is a big deal, not so much for Bombardier. Company is talking to both customers with already a firm order and to new ones to offer that slot.

    SubjectRE: RE: Testing schedule & Braathens news
    Entry09/04/2014 12:27 PM
    MemberNovana
    Nails,
    I fail to envisage a realistic scenario where the company would go into serious financial distress. They currently have $3.9bn of available liquidity ($2.5bn in cash and $1.4bn) and the company is expected to generated c. $1bn in FCF in H2 2014, so they should have almost $5bn in liquidity at year end.
    By the end of the year, the company will have invested c. $4bn in tooling on C-Series on a total expected to c. $4.5bn, so there is going to be little (c. $500m) incremental CAPEX to go out on the C-Series. Even assuming this doubles, its an additional $500m. To assume $1-2bn in extra costs would seem a bit excessive but the company would still have plenty of cash to cover it.
    In terms of cash burn once in production (2016 onwards), the company indicatively expects some 200bps of margins dilution in 2016-17, or $200m per year on $10bn of aerospace sales, or cumulative $400m. Expecting 30 deliveries in 2016 and 60 in 2017, that implies c. $4-4.5m of negative margin per plane. From a cash flow perspective, it should look much better due to a) customers pre-delivery payments and, b) amortisation of tooling. All this is to say that according to the company, total cash burn expected on C-Series from 2016 onwards should be well below $400m, so again, with $5bn in available liquidity, financial distress doesn't see a realistic scenario even if the company is very wrong about its negative margins assumptions. Don't forget that in the meantime, the Transport division is generating cash.
    Regarding long term growth, please see tables in write up where I show how my estimates in 2018 are c. 20% below the company implied guidance for Business aviation and about half for Commercial aviation. Lots of margin of safety.

    SubjectMacquarie order
    Entry09/29/2014 07:27 AM
    MemberNovana
    Bombardier and Macquarie AirFinance Sign Purchase Agreement for up to 50 CSeries Aircraft.
     
    I think this announcement will build commercial momentum for next 12 months. Many skeptics doubted BBD ability to reach 300 firm orders on C-Series by EIS as targeted by management. With Macquarie order we are at 243 firm orders and 320 LOIs. BBD needs to convert just 1 in 6 LOI in the next 12 months to reach 300 orders by EIS. I think in the end the orders at EIS will be a lot higher than the targeted 300. As results from flying tests come back, I expect renewed interested for the C-Series. Next positive newsflow will come from the announcement of the first operator to take the C-Series.
     
    Ironically, the lack of announcement on an inevitable delay on C-Series is holding the stock back. Nobody on the street expects a delivery by H2 2015, most analyst (and us) expect first delivery in H1 2016. Nobody wants to be invested in Bombardier before the likely announcement of a delay. I actually wouldn't be surprised the stock to pop higher on that news.
     

    SubjectRe: Macquarie order
    Entry01/16/2015 11:57 AM
    MemberMJS27

    thoughts?


    SubjectAnyone following this one closely?
    Entry04/10/2015 03:43 PM
    Memberjso1123

    Does any one have a read on the CEO and what if anything he can do here?  

    C Series market opportunity seems to be getting worse (note Ilyushin cancellation warning today).  However assuming they get the certification done by year-end (putting the development R&D/capex behind them) how much of a drag is that platform going forward?  

    On the business jet side, their franchise is one of the best alongside Gulfstream, yet they do 5% op margins (albeit prob burdened with C Series bleed) while Gulfstream does 20%. 

    Also rumored today they are going to split the company and sell or IPO the train business.  

     

     


    SubjectRe: Anyone following this one closely?
    Entry04/14/2015 02:27 PM
    MemberNovana

    Apologies for the delay in replying and for the performance of the stock. 

    To put things mildly, the thesis hasn't played out as expected. All major downside risks materialised. In the last 6 months c. $2.7bn of capitalisation were burned which is probably fair considering that cash burn over 2014 and 2015 will turn out to be c. $2bn worse than expected:

    2014 - In the 10 weeks or so between Q3 results and the profit warning for Q4, the company managed to lower cash generation estimates by c. $1bn - no wonder the CFO got fired last week by the new CEO. The 3 key drivers of cash burn above expectations where a) delays in transportation deliveries affecting payments, b) lower pre delivery payments in business jets and c) higher than expected number of trade-ins affecting inventory

    2015 - Cash generation in 2015 will turn out to be almost $1bn worst than expected. The main reason is higher than expected CAPEX on C-Series. CAPEX will end up being c. $2bn in aerospace in 2015 Vs c. $1.4bn originally forecasted. In transportation, FCF will trail EBIT again due to tail end of production and delivery issues that affected 2014

    Because of the above, the company raised $3.1bn and changed management. It's very hard to tell whether we have touched the bottom operationally but the liquidity risk is off the table with the capital raise and the cancellation of the dividend. We can now focus on valuation:

    Transportation - the company is still under-earning due to legacy project management issues. EBIT in 2015 will be c. $550m, well below the 8% long term target. Applying peers (Alstom) multiple to what we believe is depressed margins, we get c. $7bn in EV

    Business Jets - the division will do $500-550m in EBIT in 2015, or c. 7%. Note this is cyclically depressed at a time where inventory levels in the industry are low and orders are about to pick up. Furthermore, in 2017 the Global 7000/8000 should add incremental revenue at higher than average margins. Finally and most importantly - FX tailwinds. Whilst Airbus is up 50% this year mostly on fx, the market seems to forget that Bombardier has over $3bn in Canadian dollar denominated costs linked to business jet production and c. £350m in GBP costs. Bombardier hedges 75% for the next 15 months and 50% for the following 6 months, which basically means that in 2017 they are completly unhedged. We calculate a net tailwind compared to 2015 of over $300m in EBIT. Assuming some organic margin expansion due to operating leverage, better mix from Global 7000/8000 and FX tailwind, it wouldn't be far fetched to see $900m in EBIT in 2017. Applying a very modest 10x EBIT to 2017E estimates, that gives you over $9bn in EV

    C-Series - for simplicity, we assume it's a zero when it clearly isn't. We are 6-9 months away from certification and less than 1 year from EIS. We also assume zero value to the rest of the commercial aviation business ($2.7bn in revenues in 2014)

    Net Debt - We estimate c. $5bn at the end of 2015 not including pension liabilities which may or may not be included.

    Fair equity value excl. pension liabilities: $7bn +$7bn - $5bn = $9bn. This is c. 2x current market cap today.

    This is very high-level but illustrates the upside in a base case scenario. The downside from here is limited given that the biggest risk (liquidity crunch) is off the table. Focus from now on will be on new CEO execution and it could well prove to be a bumpy road in short term.


    SubjectRe: Re: Anyone following this one closely?
    Entry04/14/2015 08:52 PM
    Memberjso1123

    Novana - thanks for the update.  To me this gets down to two questions:  1) While we all recognize the C Series has been a very bad investment ~$5b white elephant, is there a case that it has negative NPV post-EIS?  2) Do you have any sense what the new CEO is going to do here (if anything given the family still controls the company)?  There feels like a lot of opportunity for an operator to take out costs and fix chronic performance issues.  Have you had a chance to meet with him?  

    Thanks 

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