Trains temper Bombardier’s risk

Bombardier makes most of its money from its airplane operations. This is a highly cyclical industry, and the recession has hurt demand for new planes. That’s mainly why Bombardier’s shares are down over 50% from last June’s peak of around $9.

However, Bombardier’s passenger-railcar business, while not as profitable, adds stability. The long-term outlook for this division remains bright, particularly as more people move to cities and governments increase spending on public-transit systems.

BOMBARDIER INC. (Toronto symbols BBD.A $3.78 and
BBD.B $3.65, Aggressive Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 1.7 billion; Market cap: $6.4 billion; Price-to-sales ratio: 0.3; SI Rating: Extra Risk) is the world’s third-largest maker of commercial aircraft, after Boeing and Airbus. Bombardier’s aerospace division supplies about half of its revenue and two-thirds of its profits.

The remaining revenue and earnings come from Bombardier’s transportation division, which controls 22% of the global market. This makes Bombardier the world’s largest maker of passenger railcars and commuter trains. The company sells most of its trains under long-term contracts with large, well-financed customers, such as national railways and municipal transit authorities. This helps offset the cyclical nature of Bombardier’s aircraft business.

Bombardier’s revenue fell from $15.6 billion in 2005 (the company’s fiscal year ends January 31) to $14.8 billion in 2006, but rose to $19.7 billion in 2009 (all amounts except share price and market cap in U.S. dollars). It lost $0.08 a share (or a total of $122 million) in 2005. But thanks to a major restructuring of its railcar business, earnings jumped from $0.11 a share (or $192 million) in 2006 to $0.56 a share (or $1 billion) in 2009.

The recession has hurt demand for new aircraft. In the latest fiscal year, Bombardier delivered 349 planes, down from 361 the previous year. Orders for new planes fell more than 50%, to 367 from 698.

Despite the drop in deliveries, the aerospace division’s revenue rose 2.6% in fiscal 2009, to $10 billion from $9.7 billion the previous year. The gain was the result of higher selling prices for business jets, and increased revenue from repairing and maintaining aircraft. Its gross profit margin (its gross profits as a percentage of its revenue) rose to 9.0% from 5.8%. The division’s $23.5-billion order backlog is equal to 2.4 years of revenue.

Business jet sales set to fall

Bombardier expects sales of business jets, which provide 52% of the aerospace division’s revenue, to fall 25% this year. This is partly because of bad publicity over the use of private jets by companies that have received government bailouts. To cope, Bombardier plans to lay off 4,400 employees this year, or about 14% of the division’s workforce.

Bombardier expects to offset at least part of this drop with a 10% increase in commercial-jet production this year. The company is basing this on steady demand for its turbo-propelled planes, which seat 60 to 90 passengers. These planes have the roughly the same speed and range of similiar-sized jet aircraft, but use about 30% less fuel.

The company also has high hopes for its new CSeries regional jet, which will seat 100 to 150 passengers. The planes are 20% more fuel-efficient than similar aircraft in use today. They also pollute less and make less noise. So far, Bombardier has 50 firm orders for the CSeries. These are worth $2.9 billion, plus options for 50 more planes. Bombardier expects to begin deliveries in 2013.

The CSeries will put Bombardier into direct competition with Boeing and Airbus. However, as these companies focus on larger models, it’s unlikely that either will build a direct competitor to the CSeries, at least for several years.

Revenue jumped 25.2% at Bombardier’s transportation division in the latest fiscal year, to $9.8 billion from $7.8 billion in the prior year. Profit margins rose to 5.3% from 4.4%, putting the division on track to reach its goal of 6% margins this year. Its $24.7-billion order backlog is equal to 2.5 years of revenue.

Like the aerospace division, Bombardier’s transportation business is working on improving fuel efficiency. This should enhance the appeal of Bombardier’s trains, particularly among increasingly environmentally-conscious public agencies.

Long-term trends look promising

The long-term outlook for railcars is bright. Urban areas will be home to 60% of the world’s population by 2025, and this should spur cities to expand their public-transportation systems. As well, railcars generally last 30 years, and those in service today have an average age of 20 years.

Bombardier’s improving earnings over the past few years have strengthened its balance sheet. Its $4-billion long-term debt is still a somewhat high 73% of its market cap, but none of this matures until May 2012. The company also holds cash of $3.5 billion, or $2.00 a share.

The “B” have higher yield, lower p/e

Bombardier’s class “A” shares (10 votes per share) do not trade as much as its “B” shares (one vote per share). That’s because insiders own most of the “A” shares.

Right now, the “A” shares are trading at less than 1% more than the “B” shares. We generally recommend buying the “A” shares if you can get them for no more than 10% over the “B” shares. However, Bombardier pays “B” shareholders a priority dividend of $0.0015625 (Canadian) per year, in addition to the current $0.10. That gives the “B” shares a yield of 2.8%, compared to 2.7% for the “A” shares.

The “A” shares trade at 7.8 times the company’s estimated earnings of $0.41 U.S. a share this year (7.6 times for the “B” shares).

Bombardier is a buy. The “B” shares are the better choice.