Latest from Scotiabank Scotiabank has put out a research piece on transportation/aviation. It is a lengthy report so I am providing some of the initial section and then the section on Bombardier.
I find it interesting when looking at the BBD section. The valuations are all built on 2024 and forward. I think the low price we are seeing is based on the 2023 and prior actual results. Basically, once the market starts to believe the predictions for 2024 forward will materialize, this stock should shoot through the room, just like Scotiabank is predicting.
2024 Playbook - Load Up on Freight for Volume Rebound, Trim Aviation Exposure with Exceptions
OUR TAKE: Mixed. We review our top ideas for 2024 based on the risk/reward and assuming a soft landing, while keeping in mind the uncertainties this year, such as macro, central bank policies, government elections, and global conflicts. In general, we have tempered our 2024 expectations to below consensus due to uncertainties, while trimming our multiples in a few cases, although our target prices have mostly increased due to valuation roll-forward to 2025E. Our stock ratings are largely intact, but we are upgrading TFII to SO from SP (more bullish vs. Street) and downgrading CAE to SP from SO (out of consensus), based on idiosyncratic factors. This year, we are switching our relative sector preference to freight from aviation, albeit with some exceptions, as we expect a restocking-driven freight volume rebound and a consumer-driven slower-yet-positive aviation growth, particularly in 2H. As we highlighted in our Focus On 2024 report, our top picks are CJT in a soft-landing scenario and CP in a hard-landing scenario. In today’s report, we are adding to our top soft-landing ideas: AC, BBD and MTL based on valuations, and MDA and TFII based on catalysts. In addition to CAE, we have an out-of-consensus view on SP-rated AND and CHR.
KEY POINTS
Stocks best positioned for growth in 2024. We expect y/y growth in fundamental KPIs to rebound or accelerate for the freight sector but decelerate for our aviation coverage as the former recovers and the latter approaches normalization, particularly in 2H. TFII tops the universe with our estimated 20% EPS growth, driven by recent M&A, U.S. LTL turnaround, slight organic recovery, and recent buybacks. A potentially large M&A and/or more buybacks would point to incremental upside. Rails also look positioned for double-digit EPS growth, with CP at 14.5% and CNR at 10%, in our estimation. Rail traffic appears to have troughed in Q2/23 and pricing remains above inflation, while CP is ramping up KCS synergies and CNR is deploying a lot of capital on buybacks. For other freight carriers, we expect relatively moderate earnings growth, although AND and MTL could accelerate growth through M&A, while CJT should deliver significant FCF growth from fleet-related capex reduction. Within our aviation coverage, MDA could impress again with continued solid double-digit growth as backlog converts into revenue, while BBD could nearly double FCF on production growth, margin expansion and capex reduction. Many other aviation names should also deliver strong earnings growth, including even CAE if it can manage to turn around defense segment margins. However, AC could be one of the few exceptions with a potential EBITDA/FCF decline due to tough comps, margin headwinds (pilot contract, airport fees and regulation) and capex increase. With respect to 2024 outlook, we are relatively more cautious for AC, BBD, CJT, HRX and TFII (>5% delta vs. consensus).
Catalysts on the horizon. While earnings outlook might change based on how uncertainties unfold this year, we see potential catalysts for several names. Although MDA gained 80% last year, it could still outperform particularly if the Telesat contract drives faster-than-expected growth or more mega contracts are won. TFII is a notable long-term outperformer, but it could unlock more value by spinning off its TL division (likely 2024 or 2025), following the DSKE acquisition (Q2/24). Further, large M&A could be a catalyst for TFII as well as MTL and EIF. Similarly, CJT has notably outperformed since Oct. 2023, but it could create further value by monetizing more assets (e.g., B757s) and repurchasing more shares. CP is not cheap, but it could win more contracts while integrating KCS amid ongoing nearshoring trends. It could also resume dividend growth after nearly four years as well as buybacks heading into 2025 as the leverage ratio normalizes. For AC, most negatives appear priced in so potential guidance beat, clarity on pilot contract and any capex offsets could serve as catalysts. For BBD, FCF remains the key sentiment catalyst as it deleverages toward investment grade. CAE could reinstate dividend after nearly four years, following the healthcare divestiture (Q1/24), although investors are more focused on defense margins. CHR could potentially close its delayed Fund III later this year, which has been weighing on investor sentiment.
Undemanding valuations, some unjustifiably low. Most of our covered stocks are trading at a discount to their peers as well as to their historical averages (pre-pandemic). However, a few names, such as our top picks AC, BBD and MTL, are trading at or near their historical troughs. On the flip side, select stocks like CNR, CP, TFII and TRZ are trading through their historical highs. Generally speaking, we expect the undervalued stocks to re-rate higher as investors gain more visibility and confidence on the companies’ earnings outlook and as central banks potentially start normalizing policy rates. A re-rating toward “historical averages” would result in a significant upside torque (>40%) particularly in AC, BBD and MTL, which underscores our bullish views on these stocks. In addition to attractive valuations, BBD and MTL are growth stories along with double-digit FCF yields. Although stocks with premium valuations face a multiple contraction risk, we still expect some of them to outperform due to their idiosyncratic factors. In particular, we are attracted to CP’s industry-leading long-term EPS CAGR (potentially mid-teens), driven by self-help organic growth initiatives, KCS synergies and resumption of buybacks, which warrant a premium valuation on shorter-term fundamentals, in our view. Similarly, we think TFII deserves a premium multiple vs. history because the company has become structurally more resilient with an increased exposure to the U.S. LTL market (high entry barriers and more concentrated) and an exit from the U.S. TL dry van market (low entry barriers and more fragmented). Further, it remains quite acquisitive and could even spin off the TL segment to unlock more value for shareholders. Our other top picks, CJT and MDA, are trading below their historical averages, which makes FCF/EBITDA growth and growth rate/FCF inflection, respectively, more important stock drivers. While CAE is trading at its historical average, we continue to believe that the market is not ascribing much value to the defense business due to low margin visibility perhaps.
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Bombardier Inc. (BBD.B-T) – Sector Outperform, Target increases to $90 from $85 BBD is one of our top picks this year. We believe the stock’s significant discount to history and peers is reflecting investors’ key concerns about the bizjet cycle (flying activity, book:bill ratio and pre-owned inventory), the company’s potentially looming product reinvestment cycle, and the return of material FCF seasonality quarter over quarter. In addition, we think some traditional investors remain on the sidelines due to BBD’s rocky past when the company had a more stretched balance sheet while struggling with underperforming assets like CSeries and train division (sold over the years heading into the pandemic). We understand the cycle concern, however, the bizjet industry is not as sensitive to macro as commercial aviation, while BBD is no longer in the relatively more macro-sensitive segment (smaller bizjets). Further, OEMs have built a solid backlog over the past three years, production rates are constrained by industry supply chain issues (e.g., engine suppliers), pricing remains firm, and order cancellation risk is much lower in this cycle due to more stringent penalty terms. In addition, BBD has significantly grown its resilient, higher-margin aftermarket services business, while also expanding into other growth avenues (defense and certified pre-owned). Industry pre-owned inventory is still quite low at ~6% vs. ~10% pre-pandemic and historically normal range of 11%-14%. Book:bill ratio remains relatively healthy at ~1.0x despite rising production rates as fleet operators in particular are driving order activity. BBD’s leverage ratio has significantly improved to 4x from nearly 8x in 2021 and remains on track to hit management’s 2025 target of 2.0x-2.5x, which could take the company closer to investment grade rating. Even with our reasonable estimates and highly conservative valuation multiple, our BBD target price implies the highest potential return in our coverage universe.
Highly attractive valuation. We raised our target price to $90 from $85 on rolling forward valuation to 2025E from average 2024E-2025E, while trimming our EV/EBITDA multiple by 0.5x to 6.5x and largely maintaining our forecasts. Our target multiple is significantly below BBD’s pre-pandemic average of 10x to reflect macro/long-term capex risks and the pure-play nature of the business. The stock is currently trading at 6.2x/4.8x on our 2024E/2025E vs. the closest comps (GD/TXT) at 11x/10x and its pre-pandemic trough of 6.0x.
Estimate changes. We have largely kept our 2024-2025 EBITDA and FCF estimates intact, while slightly increasing our delivery outlook to align with management’s 2025 target. We are also introducing our 2026 estimates, which reflect our increased capex assumption of US$600M vs. US$300M in 2025E. We expect FCF to nearly double in 2024 and more than triple by 2025 from 2023, before normalizing to US$600M in 2026. Our annual FCF forecasts are quite conservative vs. consensus, while our 2025 estimates are more conservative than guidance.
- Q4 preview. BBD is likely to report in February. We largely maintain our estimates of US$653M FCF (~4x y/y), US$2.8B revenue (+7% y/y), US$384M EBITDA (+9% y/y), and US$213M EBIT (+1% y/y), assuming 57 deliveries (+8 y/y) and 0.8x book:bill ratio (vs. 1.0x YTD). Our estimates are slightly more conservative than consensus. For the full-year 2023, we are above management’s targeted minimums of FCF (>US$250M), deliveries (>138), revenue (>US$7.6B), EBITDA (>$1.125B), and EBIT (>US$695M).
- 2024 outlook. BBD will likely provide detailed guidance as usual. We have modestly increased our delivery (145), revenue (US$8.2B), EBITDA (US$1.3B) and EBIT (US$872M) estimates as we are gaining more confidence in BBD’s 2025 production target on the back of recent order disclosures, while maintaining our FCF estimate (US$450M). Our estimates are more conservative than consensus, particularly FCF (Street US$577M). Assuming a book:bill ratio of ~1.0x, we expect earnings growth, modest interest cost savings, lack of RVG payments, and capex reduction to drive significant FCF growth. We continue to assume US$300M capex, down from US$352M in 2023E as the new Toronto assembly plant has likely commissioned. We expect the leverage ratio to further improve to 2.9x from 3.5x in 2023E.
Notable corporate updates. (1) BBD announced a firm order from an undisclosed customer for 12 Challenger 3500 jets, with deliveries set to begin in 2H/25. (2) During the quarter, the company raised US$750M debt priced at 8.75% (fixed) with a 2030 maturity. The proceeds were used to redeem all remaining 2025 debt (US$380M; 7.50% rate) and US$360M of 2026/2027 debt maturities (7.125% and 7.875% rates).
| Exhibit 17 - BBD Q4 Expectations – SGBM vs. Street |
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| Source: Company reports; FactSet; Visible Alpha; Scotiabank GBM estimates. |
| Exhibit 18 - BBD Revised Estimates |
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| Source: Scotiabank GBM estimates. |
| Exhibit 19 - Bombardier Inc. – Financial Estimate Summary |
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| Source: Company reports; Scotiabank GBM estimates. |