CAE INC. $15(Toronto symbol CAE; Conservative Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 265.3 million; Market cap: $4.0 billion; Price-to-sales ratio: 1.8; Dividend yield: 1.9%; TSINetwork Rating: Average; www.cae.com) is the world’s leading maker of flight simulators, which help teach airline and military pilots how to take off, land and handle a variety of emergency situations.
Since it started up in 1947, CAE has sold over 1,500 simulators to 140 airlines. It currently controls 70% of the global flight simulator market.
To cut its reliance on simulator sales, which tend to rise and fall with the overall economy, CAE began instructing pilots in 2001. It now operates around 50 pilot-training centres in over 25 countries. These facilities also train cabin crews and maintenance personnel.
CAE typically sells its customers a package of simulators and training services, making it harder for them to switch to competitors.
The company now gets 55% of its revenue by selling simulators and training to airlines. Another 40% comes from providing simulators and instruction for military clients, mainly in the U.S. and Europe.
The remaining 5% comes from its health care division, which makes simulators and mannequins for teaching paramedics, nurses and medical students. These devices help reduce medical errors and lower insurance costs. As a result, the global medical-simulator market is growing by 20% a year.
Strong recovery after recession
The company’s revenue rose 38.6%, from $1.5 billion in 2010 to $2.1 billion in 2014 (fiscal years end March 31). CAE saw improved simulator demand after the recession and benefited from timely acquisitions. For example, in 2012 it paid $281.9 million for Oxford Aviation Academy, which operates flight schools in the U.K., the U.S., Europe and Asia.
Earnings gained 25.0%, from $0.56 a share (or a total of $144.5 million) in 2010 to $0.70 a share (or $180.3 million) in 2012. Costs to integrate Oxford and improve profits at its military businesses cut CAE’s 2013 earnings to $0.53 a share (or $137.7 million). Earnings rebounded to $0.73 a share (or $190.0 million) in 2014.
The company spends about $150 million a year to develop new products, like simulators for unmanned aircraft (or drones).
To help with these initiatives, CAE receives tax credits from the Canadian and Quebec governments. Excluding these credits, it spent $68.4 million (or 3.2% of its revenue) on research in 2014, up 13.8% from $60.1 million in 2013. CAE also stands to gain as the cost of computer chips and graphic displays continues to decline.
The company recently received orders for eight flight simulators and related equipment. In all, these deals are worth $120 million. CAE has now sold 31 simulators in fiscal 2015 and is on track to beat last year’s record of 48.
New threats should spur military sales
Sales to military clients could suffer as governments cut defence spending as they cope with large budget deficits.
However, the rise of ISIS will likely spur military spending in the next few years, especially now that the Republican Party controls the U.S. Congress. In addition, Chinese military moves should encourage many allies of the U.S. to increase their defence spending.
What’s more, simulator training costs less than training pilots in real aircraft. That’s why the U.S. Navy expects simulators to account for 50% of its training programs on certain aircraft by 2020. That’s still below the average for commercial pilots, who get two-thirds of their training on simulators.
CAE’s strong balance sheet will let it keep developing new simulators and making acquisitions. As of September 30, 2014, its long-term debt was $1.2 billion, or a manageable 30% of its market cap. It also held cash and investments of $277.8 million, or $1.05 a share.
Low Canadian dollar a plus
The company’s earnings should improve to $0.83 a share in 2015, and the stock trades at 18.1 times that estimate.
CAE gets 90% of its revenue from customers outside of Canada, so the lower Canadian dollar will help lift its fiscal 2016 earnings to $0.97 a share. The stock trades at a more reasonable 15.5 times that forecast.
The company has also increased its dividend each year since 2008. The current annual rate of $0.28 a share yields 1.9%.
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