Our view: We assume coverage of CAE with an Outperform rating and $40 price target. We believe current valuation does not adequately reflect: 1) CAE's organic revenue growth, which we expect will benefit from meaningful secular tailwinds; 2) its differentiated Civil service/product offering, which enjoys strong barriers to entry; and 3) the investment it made during the pandemic which we view as setting the stage for solid growth. Potential catalysts for the stock in our view are near-term reported revenue growth and margin expansion, which we believe will provide strong indication of CAE's long-term earnings power.
Key points:
Assuming coverage with a $40 PT and OP rating. We value CAE shares on a sum of the parts basis using a blended EV/EBITDA multiple of 13.1x on our FY25 EBITDA estimate of $1,218MM (+17% CAGR FY22-FY25), discounted back 1-yr. We use FY25 as the basis year as we view it as better representing normalized (i.e. post-pandemic) EBITDA. Our 14x Civil multiple is driven off compares to the Rail and Waste sectors, which trade in the 11x to 15x range, and our Defense multiple of 11x is derived using a 2x discount to its peers due to lower margins. We anticipate CAE’s valuation will be supported by the company's favourable industry fundamentals (including secular growth and high barriers to entry), strong mgmt team, high FCF conversion, and the expected recovery in both travel and defense procurement. Based on the 31% return to our price target, we assume coverage at OP.
• Secular tailwinds set the stage out to 2030. We believe secular tailwinds will support +13% revenue CAGR FY22-FY25. Key drivers of this growth are: i) a medium-term recovery in passenger travel to pre-pandemic levels (+35% growth to reach 2019 levels); ii) pilot training demand expected to grow at +5% CAGR out to 2029; and in the defense segment iii) increased spending by NATO members driven by Russia’s invasion of Ukraine.
• Barriers to entry position CAE favourably looking ahead. CAE is a leader in the civil aviation training market, with 30% market share. We believe this acts as a significant barrier to entry resulting in a secular growth trend and stable margins (RBC: +17% revenue CAGR and 410bps of margin improvement in Civil FY22-FY25).
• Investments made during the pandemic provide platform for growth. On the back of solid FCF generated during the pandemic, CAE was able to invest in growth and executed on a key restructuring initiative. We point to: i) nine acquisitions totaling ~$2B; ii) a meaningful restructuring program (~200bps of savings); and iii) a ramp up in growth capex in FY22 above pre-pandemic levels (~$220MM in FY22 vs. ~$200MM in FY20). We view these investments as setting the stage for a significant rebound in growth exiting the pandemic.