We search for companies in which change can alter the future for the better. That can mean a change in management. It can mean a change in management's attitude toward running the business, say by recognizing that 120 percent of the earnings come from 80 percent of the assets, so they should do something about that other 20 percent at some point. It can mean a new business opportunity that has yet to take off. It can mean a change in the dynamic of a company's cash flow and how it's to be used.
If we perform our analysis correctly, the value added we bring is an earlier and better understanding of the companies in our portfolio than other investors might have. If the companies then begin to improve, their earnings should increase and they're likely to earn a higher price/earnings multiple.
The above is quoted from Dennis Delafield, who founded Delaield Fund. Bombardier (BDRBF) matches with what Dennis views as operating turnaround. It has a new business, the CSeries program, ready to take off within 12-24 months. By assessing the attractive value of BDRBF relative to its peers and appreciating the dominant business positions of several divisions within BDRBF, investors can foresee the earnings improvement when the CSeries program can be successfully implemented. As the valuation of BDRBF can rise to 12x P/E multiple, there can be 75% upside potential.
As a cautious note, BDRBF is a risky investment despite the fact that most bad news have already been reflected in today's stock price. It will only be suitable for those investors with high risk tolerance.
Source: Company Fact Sheet
The above gives a good overview of the BDRBF businesses. In fact, the rolling stock business is among the top 3 rolling stock manufacturers as the research conducted by Frost & Sullivan shows below:
Source: Frost & Sullivan
Other than the rolling stock business, BDRBF also has a 32% market share in its aircraft business based on units delivered measurement as shown in the chart below.
Source: Company Presentation
With these solid businesses as a backup to support further innovation, BDRBF initiated a multi-billion CSeries program, which is designed for the 100- to 149-seat commercial aircraft market. This ambitious program was originally anticipated to be finished by 2012. Then, due to some unspecified suppliers issues, the program was postponed to 2014.
Unfortunately, there was an incident on May 29, 2014 at BDRBF's assembly plant at Mirabel, Quebec, when an engine made by Pratt & Whitney, a United Technologies (NYSE:UTX) unit, suffered an uncontained failure during ground trials. This created an uncertain for the prospects of CSeries Jet and caused BDRBF not to show up in an important aircraft event, Farnborough Air Show. This incident is definitely a valid concern for a pause for BDRBF investors. However, Pierre Beaudoin, the CEO of BDRBF, publicly announced that substantial progress has been made and weeks from now CSeries Jet would be expected back in flight. In fact, similar to the hiccup in the Boeing airplane, such large CSeries program has prone to some unexpected delay, and this is the business nature suitable only for high risk tolerant investors. Despite the setback in the completion of the CSeries program, the consensus view is that BDRBF should be able to deliver at the latest in the 2H of 2015.
Recently, there is a new positive development to restructure the BDRBF Aerospace into three independently operated segments: Business Aircraft, Commercial Aircraft and a new Aerostructures & Engineering Services. This initiative is expected to improve operation as resources can be allocated to segments with better return on capital.
As shown below, the order backlog of BDRBF has risen from $42.8 billion in 2010 to $69.7 billion in 2013. This shows the consistent demand for the products of BDRBF.
Source: Company Fact Sheet
In addition, in regards to the Bombardier Aerospace business, its backlog increased by 21% CAGR from $17 billion in 2009 to $37 billion in 2013. Nevertheless, the backlog of Bombardier Rail Transportation business is more stable between $31.5 billion and $32.4 billion from 2011 to 2013.
Pierre Beaudoin has been the CEO of BDRBF since 2008. His leadership to lead BDRBF goes through the worst economical downturn in 2008 is worth mentioning. Plus, his ambition to launch one of the largest multi-billion CSeries program shows his drive to bring BDRBF to the higher level.
Although the family Bombardier controls the Board, and Pierre Beaudoin is the son in law of Mr. Bombardier, there might be skepticism whether Pierre Beaudoin and the Bombardier family interest is aligned with sharedholders. I will also consider such risk when investing in BDRBF.
With leading position in the rail transportation as well as in the business aircraft, BDRBF should at least demand a valuation comparable to its peers. However, due to the lingering concern on the CSeries program, the share price of BDRBF is currently depressed. But with a long term view looking into 2015-2016, once the CSeries program can show traction and begin to deliver on its energy saving allegation, BDRBF will demand at least 12x PE multiple. (the peer comparison table below shows peers trading around 14x PE). As the consensus expectation of $0.49 EPS in 2015, BDRBF can be valued at $6, providing an upside potential of 75%.
One of the important valuation matrix is Return on Equity "ROE." The current ROE of BDRBF is 23.3%, and it is trending upward with the trendline indicating that ROE can potentially reach about 40%. The high ROE helps to show the high quality of BDRBF businesses.
Source: Yahoo Finance
For both the P/S and forward P/E multiples, BDRBF compares favorably against its peers. As sales is expected to grow to $20.5 billion in 2015, which is the highest for the past decade, the P/S ratio will become more and more attractive to its prospective investors.
In fact, the entry of barrier to the aircraft maunfacturing business is very high due to the large initiation investment and business know-how.
First, BDRBF is still in the investment phrase of implementing its CSeries program. With the uncertainty of the program delay, the current negative cash flow might extend into the future. In addition, the aerospace industry is prone to long and costly business cycle. Prospective investors should consider this long cycle business risk when investing in BDRBF. Second, the business aviation segment has still been in depressed level since the economic slowdown in 2008. However, the good news is that the inventory draw down since 2008 might give a positive outlook when the demand re-emerge in the near future. Third, recession or economic downturn will adversely affect the demand for aircrafts and thus delay the recover in the business jets.
The Bottom Line
It is a great value to invest in BDRBF for high risk tolerant investors. BDRBF has leading positions in both business aircraft and rolling stock business. The potential of the ambitious CSeries program will become a catalyst to propel the stock price higher when investors start to realize the return on this great investment. In its current depressed stock price, there is not much expectation built into the stock. The strong backlog, together with the low P/S valuation, will help to act as a floor to support the share price. With an industry with high barrier to entry, I am positive that the $3.5-4.5 billion investment in the CSeries program will eventually bear fruit for its patient investors. As the pendulum has swung too far to the pessimistic state, risk-tolerant investors should start to load up on BDRBF with favorable risk/reward profile and a 75% upside potential.
Note: The quote comes from the book "The Art of Value Investing: How the World's Best Investors Beat the Market."
Disclosure: I am not a securities broker/dealer or an investment adviser. You are responsible for your own investment decisions. All information contained should be independently verified with the companies mentioned, and readers should always conduct their own research and due diligence and consider obtaining professional advice before making any investment decision.