More training on the Boeing 737 could spur revenue for this flight simulator firm

This leading pilot-training operator and maker of flight simulators should benefit from the extra training pilots will need on Boeing Co.’s 737 Max planes in Canada, the U.S., the U.K. and other countries. That follows two crashes in the past five months.

The anticipated rise in demand, plus a key acquisition and a strong balance sheet, suggests the company has a bright future ahead.

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CAE INC., $29.57, Toronto symbol CAE, is a leading maker of flight simulators for commercial and military aircraft. It also operates pilot-training schools in over 35 countries and makes mannequins and other medical-simulators for training health professionals.

The company 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 It originally made ground-communication equipment and antennas for the Royal Canadian Air Force.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. CAE is now the world’s leading maker of simulators for both commercial (airline industry) and military aircraft. The company currently controls 70% of the global civilian flight simulator market as well as 35% of civilian pilot training.

CAE began instructing airline and military pilots in 2001 in order to cut its reliance on the sale of simulators to air carriers, which rise and fall with the overall economy. It now trains over 120,000 pilots each year at centres in 35 countries.

Selling simulators and training services to commercial airlines accounts for about 55% of total revenue. Another 40% comes from providing simulators and instruction for military clients, mainly in the U.S. and Europe.

The remaining 5% of CAE’s revenue comes from its health-care business, which makes simulators and mannequins for teaching paramedics, nurses and medical students. These devices help reduce medical errors and lower insurance costs.

The U.S. is the company’s biggest market, accounting for about 40% of its revenue. That’s followed by Europe (30%), Asia (18%), and the Middle East and other countries (5%). Canada supplies the remaining 7%.

And now the company stands to benefit from the grounding of Boeing Co.’s (New York symbol BA) 737 Max planes in Canada, the U.S., the U.K. and other countries following two crashes in the past five months. (Note—Boeing is a recommendation of Wall Street Stock Forecaster, our newsletter that focuses on U.S. stocks.)

As the 737 Max is a modified version of an earlier model (737-800), Boeing and airline operators decided that pilots only needed a couple of hours of supplemental instruction.

Boeing is now investigating the cause of the two crashes, which may be related to the software that controls the autopilot and other functions. Once the aircraft maker corrects those problems, it’s likely that government aviation regulators will demand 737 Max pilots receive more extensive training.

Blue Chip Stocks: Revenues and earnings are down but the future looks good

In its fiscal 2019 third quarter, ended December 31, 2018, CAE’s revenue declined 1.1%, to $816.3 million from $828.2 million a year earlier.

That drop was mainly due to a 15.2% revenue decline at its civilian aviation operations. As a result of a five-week strike in the summer of 2018, CAE delivered fewer simulators in the quarter compared to a year earlier. However, the company has now accelerated production and expects to sell about 70 simulators for all of fiscal 2019. That’s up from 50 in fiscal 2018.

As well, sales of medical-simulation products in the quarter slipped 0.7%. However, sales to military clients jumped 27.1%. That’s mainly due to CAE’s July 2018 acquisition of Alpha-Omega Change Engineering Inc. for $33.5 million. That firm provides aircrew training services to U.S. defence and intelligence agencies.

Earnings in the quarter fell 46.0%, to $77.6 million from $143.8 million. Due to fewer shares outstanding, per-share earnings declined at the slightly slower pace of 45.3%, to $0.29 from $0.53.

If you exclude costs to integrate new businesses, changes to the U.S. tax code and other unusual items, earnings per share in the quarter fell 23.7%, to $0.29 from $0.38.

The company spent $31.1 million (or 3.8% of its revenue) on research in the latest quarter. That’s up 4.4% from $29.8 million (3.6% of revenue) a year earlier.

Meanwhile, CAE continues to make acquisitions. In March 2019, it completed its acquisition of the Business Aircraft Training business of Bombardier Inc. (Toronto symbols BBD.A and BBD.B). It operates 12 flight simulators that train pilots to fly Bombardier’s business jets. Those simulators are already located in CAE-operated facilities in Montreal and Dallas.

The company paid $645 million U.S. for those operations. It will also pay Bombardier an additional $155 million U.S. in royalty payments over the next 20 years.

CAE can easily afford this purchase. It ended the quarter with cash of $361.7 million and long-term debt of $1.12 billion, or a moderate 15% of its market cap.

The company’s order backlog is also strong. As of December 31, 2018, it totaled $8.96 billion, or 3.0 times CAE’s annual revenue.

Projected earnings will probably rise from $1.21 a share in fiscal 2019 to $1.47 in 2020. The stock trades at 19.0 times the 2020 estimate. That’s a reasonable multiple in light of the company’s dominance in the flight simulator market as well as rising demand for new pilots. Moreover, CAE gets around 60% of its revenue from recurring training contracts.

CAE last raised its quarterly dividend with September 2018 payment. Investors now receive $0.10 a share, up 11.1% from $0.09. The new annual rate of $0.40 yields 1.4%.

CAE’s dividend has grown an average of 14.9% annually over the last 5 years.

Recommendation in The Successful Investor: CAE is a buy.


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