Description

CAE’s dominant near-monopoly status in third-party training / Full Flight Simulator (FFS) manufacturing makes it a high quality way to play the ongoing post-COVID air travel recovery / pent-up demand theme. It is a leading beneficiary of commercial air capacity recovery without worrying about other variables like loading factors, airfare, fuel, or labor cost. 

The business model incrementally benefits as airlines outsource more of their training work to third-party training facilities (market share gain angle) due to cost advantage (CAE believes it can save airlines 20% of cost). Today only 40% of training hours are outsourced to third-party independent training facilities but this number has been rising over the last 2 decades with the trend set to continue. The company’s disproportional exposure to Low-Cost Carriers (LCC) could accelerate its base earning power recovery given LCCs will likely take capacity market share post COVID and LCCs have higher tendency to outsource training. In addition, CAE is a large beneficiary of elevated global pilot retirement pace as “friction / pilot churn” is good for training demand. 

CAE also has a Defense business undergoing a margin improvement initiative under new leadership (ex-L3H veteran), that is currently integrating a double-digit-% EPS accretive military training acquisition. While this segment has been underperforming recently, its large international training exposure should allow it to benefit from improved military training demand post Russia-Ukraine conflict on a forward-going basis.

From a return perspective, I can see ~mid-30% upside over the next 12 months as various idiosyncratic levers boost training demand and lead to positive earning estimate revision before compounding at a more normalized low-teen rate after that; return can be further enhanced if air traffic recovery for CAE’s client base happens faster than expected and if multiple goes back to the historical high (bull case of up ~60% over the next 12 months).

Note: CAE is HQ’ed in Canada and reports in CAD. It has a CAD line that trades on the Toronto Stock Exchange but also a USD line that trades on NYSE. All “$” signs refer to CAD $ when talking about the business (revenues, profit, etc), except when talking about the stock price (I use the US line in the write-up)

Background / Company / Industry Description

What does CAE do? CAE sells flight simulator equipment and operates training network that services airlines, biz jet operators, and defense. The company has dominant position in flight simulation equipment and aerospace training market with a high market share. 

CAE enables pilot training by either 1) selling Full Flight Simulators (“FFS” / capital equipment) to airlines or 2) providing training services at its own training infrastructure, ultimately helping customers improve safety / accuracy in an industry that require high technical expertise with low tolerance for error 

The highly regulated end market gives CAE a tollbooth-like business, as pilots are required to train on a recurring basis (every 6 to 9 months), it is also more of an early cycle business within aerospace as training demand is more tied to “flying hours / capacity” rather than loading factor (you need two pilots regardless of how packed a flight is)

I would rate the market structure as attractive, where CAE has market share leadership across the board

• FFS equipment: CAE consistently commands 70%+ share in commercial aero FFS, 80% share in CY2019 (rest provided by L3H/OEMs/Thales)

• Commercial aero training services: owns ~75% of the non-airline (where training is done in-house) / non-OEM (Boeing and Airbus offer training services too) third-party independent training market

• Business jet training services: ~50% mkt share (duopoly with FlightSafety / BRK portfolio company)

Corporate history: the company started from a defense simulation root, and gradually expanded into dominant commercial aero simulator manufacturing before morphing into a services company in the last decade

• Founded in 1947, entered into defense simulator business with Royal Canadian Air Force in 1952 

• CAE grew to be a global exporter in 1980s as 85% of production was exported across the globe

• Became the leader in flight / system simulation by 1990s – across full-flight simulators (FFS) and visual / computer-based system

• Started to aggressively build the global training network to focus on providing services post 2000 

• Became global leader in civil aviation training by 2010s with 10k+ employees and 160 sites/ training locations in over 35 countries today

• Gained credibility with customer base due to expertise and innovation in simulators over many decades – then it used that to strategically enter into higher margin training biz

Pictures: here is a commercial jet FFS on the lift, and a helicopter FFS on the right. The picture at the bottom shows CAE’s Training Center at London Gatwick (with a dedicated wing for easyJet)