Many investors looking to take advantage of beaten down Canadian stocks are looking to the oil and gas, and airline sectors.
The key question that’s confusing a lot of investors right now is will these stocks recover, or have the underlying businesses been materially impacted?
One stock in question is CAE Inc (TSE:CAE). The company is exposed to the airline sector, but not in the way you’d typically expect.
The stock is still trading well below its pre-pandemic highs. Are Canadians missing a golden opportunity to grab a discounted stock in a beaten down sector? Lets have a look.
What does CAE Inc (TSE:CAE) do?
CAE Inc is a global company focused on delivering training for the civil aviation, defense, security, and healthcare markets.
The company also develops and sells simulators for companies to train employees as an alternative to live training.
The company truly is a global enterprise, with operations in over 35 countries. The company has over 10,000 employees and 160 training sites.
The company has stated on an annual basis, it trains over 220,000 airline pilots, business aviation pilots, maintenance technicians, and cabin crew.
Is CAE Inc a strong contrarian play?
As you can tell, CAE offers a unique business model when it comes to the aviation industry.
Instead of supplying passengers with the traditional point A to point B travel, it provides the means for other companies to do so via training, and even the leasing of personnel.
The company also has exposure to the defense and healthcare sectors.
Although the company has without question been materially impacted by COVID-19, I view the setbacks faced by CAE to be temporary.
Prior to COVID-19, this was an extremely well run company. A Canadian Dividend Aristocrat and a high level of operational efficiency, prior to cutting the dividend due to the COVID pandemic, it had consistently raised dividends by double digits since 2010.
But, the impacts of COVID-19 on the company were definitely harsh.
How badly was CAE impacted by the pandemic?
If we look to year over year results, comparing the second quarter of 2021 to the second quarter of 2020, it was clear the impact of the global pandemic was taking its toll on CAE.
Revenue of $704 million was down 21% from the year prior and operating profits collapsed, coming in at $28.2 million which is a decrease of 77%.
CAE states that not only did aviation training and leasing revenue crumble, defense contracts were delayed or halted due to travel restrictions and an urgency for governments to get the pandemic under control. Its healthcare segment was impacted severely as well, as hospitals put training on the back burner and instead focused on saving lives.
However, there are definitely strong signs this company isn’t in as bad of shape as many think, and we can look to the company’s bottom line. Earnings per share in the most recent quarter came in at a loss of $0.02.
This is a significant decrease from the $0.28 per share in posted in 2020, but if we look to a company like Air Canada, who posted a diluted loss per share of $12.50 through the first 9 months of 2020, we can see the situation could be much worse.
The company also posted a book to bill ratio of 0.95, compared to 1.11 the year prior. If you’re unsure of what book to bill ratio is, it essentially signals the overall demand for a company’s product.
A number higher than 1 indicates there is more demand for your product than there is supply. Less than one, means that the demand for the company’s product is less than what is available.
However, considering the current circumstances in the aviation industry, I’d view a book to bill ratio of 0.95 to be a positive.
CAE Inc will recover, but this is an investment that will require patience
We can expect CAE Inc to stay at depressed price levels for the duration of the pandemic. That much is obvious. It still trades 17% below its pre-pandemic highs and will likely continue to do so moving forward.
Once the pandemic is over, we also have to consider the fact that airline companies that are in rough financial shape, like Air Canada, may reduce capital expenditures to reduce debt and get themselves back on track. As a result, we could see CAE’s aviation revenues severely impacted for the short to mid term.
However, the company should be able to stay afloat due to the fact that defense and healthcare spending should return to normal relatively quickly after the COVID-19 pandemic subsides. In fact, the company could end up benefiting significantly in the healthcare department as there were clear holes in the system that will no doubt be plugged by governments after this is all over.
There will come a time when CAE returns to normal, and continues to be a strong option for Canadian investors as both a growth and income investment. However, don’t expect this company to turn it around in the next few years.
Considering its expected struggles moving forward, I’d venture to say that this stock has recovered a little too fast, too soon. It’s currently trading at 44 times forward earnings and 3.2 times sales, which is an 87% and 45% premium respectively to what it has typically traded at over the last half decade.
This is a contrarian investment in the airline sector that is likely going to take many years to pay off, and if you’re an investor with a short time horizon or a lack of patience, it may end up frustrating you moving forward. And not to mention, this stock is bound to subject investors to significantly volatility based on pandemic related news moving forward. We recently covered one stock to avoid in particular, Laurentian Bank of Canada (TSX:LB). Is CAE as much of a no-go? We will leave that for you to decide.
If you’re buying CAE today, you’d better be doing so with a 5+ year timeline in mind.