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Morningstar | Bombardier Tries to Soothe the Market at Its Investor Day

Bombardier’s stock has dropped nearly 50% over the past three months due to weak cash flows for 2018 and 2019. At its investor day, management sought to alleviate concerns by confirming its 2020 targets, and it showed normalized cash flow metrics in an attempt to demonstrate that it remains on track. For all the focus on transportation's working capital, we think most of the risk sits in the business aircraft now due to the Global 7500 ramp. And debt maturities in 2020 and 2021 mean management doesn't have much room for error. We continue to forecast management hitting most of its 2020 targets in our base case, but we did reduce cash flows slightly for Bombardier, which knocked 5 cents off our fair value, which now stands at CAD 4.

Management outlined 2019 guidance--$18 billion of revenue, $1.2 billion of operating profit, and break-even cash flow--in more detail. Bombardier targets 2019 revenue growth in transportation (9%) and business aircraft (25%) but flat year-over-year revenue in aerostructures and commercial aircraft (controlling for A220 deconsolidation). The Global 7500 ramp will drive business aircraft growth, and Bombardier sees 150-155 deliveries, including 15-20 Global 7500s. Consolidated operating margins are pegged at just above 6.5%, with the two largest businesses, transportation and business aircraft, targeting 9% and 7.5%, respectively. If we exclude commercial aircraft, our model indicates that 2019 operating margins would be roughly 100 basis points higher than our forecast for 2019.

For 2020, we project revenue of $19.9 billion combined with 7.7% operating margins, which are both slightly below management targets. Our free cash flow in 2020 stands at $800 million (excluding A220 investments) compared with the targeted range of $750 million to $1 billion. More important than our 2020 projections are our normalized assumptions for Bombardier, which envision 8.9% operating margins and $610 million of free cash flow, starting in 2022.

The 140 basis points of margin expansion we anticipate from 2020 to 2022 is driven by the commercial aircraft and business aircraft units. In the former, we anticipate a turnaround within the CRJ business coupled with the A220 becoming profitable. Since Bombardier uses equity accounting for the A220, this program alone will add around 30 basis points to consolidated operating margins in 2022. In the business aircraft unit, we forecast 160 basis points of margin expansion from 2019 to 2022 thanks primarily to the Global 7500 program moving down the learning curve. Interestingly, management gave a range for Global 7500 deliveries in 2020 for the first time, putting this figure at 35-40 aircraft. This represents a doubling of aircraft deliveries year over year. We don’t bake in any margin expansion at the transportation or aerostructures businesses between 2020 and 2022. In fact, for aerostructures, we anticipate a slight contraction in margins from 2020 to 2022 in order to reflect what we think are normalized levels of profitability.

Although its call option is valid starting February of next year, we're not anticipating Bombardier buying back the CDPQ stake in transportation, which will likely cost around $2.5 billion, until end 2019 at the earliest. Before it exercises its right to purchase the CDPQ minority holding in transportation, we think management will want better visibility on 2019 cash flows, will refinance $850 million of 2020 debt maturities, and will want to close the sale of its Q400 turboprop and business aircraft activities, which should net about $900 million post-tax. About another $1.4 billion of debt maturities are out there for 2021 and this may also inform any transaction with CDPQ.

Lastly, despite all the focus on the working capital at transportation, we believe most of the working capital risk actually resides in business aircraft now. The ramp of the Global 7500 will weigh on inventories in 2019 and the doubling of production year over year in 2020--for the first time management gave a 2020 delivery range of 35-40 aircraft for the Global 7500--means skillful inventory and delivery management is required to avoid deteriorating cash flow. Management seems to have accounted for this risk in its 2019 cash flow guidance via contingencies but not necessarily in its 2020 cash flow target.