CAE INC. $14 (Toronto symbol CAE; Conservative Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 261.4 million; Market cap: $3.7 billion; Price-to-sales ratio: 1.7; Dividend yield: 1.7%; TSINetwork Rating: Average; www.cae.com) began operating in 1947 as Canadian Aviation Electronics Ltd. It originally made ground-communication equipment and antennas for the Royal Canadian Air Force.
In 1952, the company began making flight simulators for air force pilots. It’s now the world’s leading maker of flight simulators for commercial and military aircraft. CAE made about half of the commercial aircraft simulators in use today and has 16% of the military simulator market.
Sales of simulators to airlines tend to move up and down with the economy. To steady its revenue, CAE began training pilots in 2001. It now trains over 100,000 pilots and crew members a year at 50 schools worldwide.
The company gets 55% of its revenue by selling simulators and training to commercial airlines. Another 40% comes from providing simulators and training to militaries, mainly in the U.S. and Europe.
New markets have big potential
CAE gets the remaining 5% of its revenue from products it has developed for other industries. For example, it now makes simulators for specialized mining equipment, including underground trucks, loaders and drills. It has also developed simulators and mannequins to train paramedics, nurses and medical students.
The company’s revenue fell 8.2%, from $1.7 billion in 2009 to $1.5 billion in 2010 (fiscal years end March 31), as airlines cut spending on simulators and training during the recession. However, revenue rebounded to $1.6 billion in 2011 and rose to $2.1 billion in 2013.
The lower sales during the recession cut CAE’s earnings by 16.5%, from $0.79 a share (or a total of $200.5 million) in 2009 to $0.66 (or $168.6 million) in 2010. Total earnings rose to $169.8 million in 2011, but per-share profits were unchanged at $0.66. Earnings then rose to $0.74 a share (or $190.7 million) in 2013.
In the three months ended September 30, 2013, CAE’s earnings fell 9.7%, to $38.3 million from $42.4 million a year earlier. Per-share earnings fell 11.8%, to $0.15 from $0.17. Revenue fell 3.8%, to $487.5 million from $506.5 million.
The drop is due to stronger competition in Europe and South America. As a result, CAE is relocating about 20 of its flight simulators to pilot schools where demand is greater. That has pushed up its costs, but should lift its earnings.
CAE spends around 10% of its revenue on research, which helps it maintain its high market share and develop simulators for new planes like Bombardier’s CSeries jets. However, the company receives tax credits from the Canadian and Quebec governments. That’s why its net research costs were just 3.1% of its revenue, or $14.9 million, in the latest quarter. That’s up from 2.8% of revenue, or $14.3 million, a year earlier.
Large backlog cuts risk
The company ended the quarter with an order backlog of $3.9 billion, which is roughly equal to two years’ worth of revenue. Including orders received after September 30, 2013, CAE has sold 38 simulators in its 2014 fiscal year, and is on track to beat its full-year target of 40. It sold 35 simulators in fiscal 2013.
The outlook for CAE’s commercial businesses is bright. To replace retirees and meet rising air travel demand, airlines will need about 500,000 new pilots over the next 20 years, particularly in fast-growing regions like Asia and the Middle East.
CAE will also benefit from new U.S. Federal Aviation Administration rules that mandate using simulators to train pilots to handle emergencies like severe weather and engine stalls.
Governments continue to cut military spending as they cope with large budget deficits. However, demand for CAE’s military products should remain strong, because it costs about 90% less to train pilots on simulators than in real aircraft. Simulator training also extends the life of expensive military planes and helicopters.
Balance sheet supports growth
CAE strong balance sheet will let it continue to develop new simulators and make acquisitions. As of September 30, 2013, its long-term debt was $1.1 billion, or a manageable 30% of its market cap. It also held cash and investments of $286.9 million, or $1.10 a share.
The company’s earnings will probably dip to $0.67 a share in fiscal 2014. The stock trades at 20.9 times that figure. However, earnings should recover to $0.82 a share in 2015, and CAE trades at a more reasonable 17.1 times that forecast. CAE has increased its dividend each year since 2008. The current annual rate of $0.24 yields 1.7%.
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