Bombardier : The risk-yield tradeoff on the issuer does not appear to be sufficient

2016 was a good year for Bombardier, as reflected in a higher price for the 2021 BBDBCN bonds which currently offer a four-year yield of about 4.1%. In our latest report of 7 April 2016, we maintained our Neutral recommendation on the issuer, given the yield offered (8.5% at the time) while liquidity was under control and good news about new CSeries orders and Canada's support were still expected. Currently, considering the year-on-year performance of the 2021 BBDBCN bonds (+17 pts, i.e. -460bp spread, vs. -200bp for the JPM Single-B index), and while we are not necessarily expecting a positive newsflow in the coming months, we recommend taking advantage of the current levels to take profits on the issuer. The risk-yield tradeoff on the 2021 BBDBCN bond does not appear to be sufficient, while the group is set to burn through at least another $ 750m in FCF this year (and certainly much more over the first nine months) and given the still high execution risks related to the transformation plan. - - >Support factors - - Bombardier is a world leader in rail transportation (backlog of $ 30bn) and business aircraft (backlog of $ 15bn).- Quebec's confirmed support (investment of $ 2.5bn) and, more recently support from Canada which has contributed around $ 372m to help the CSeries and Global 7000 development. - Alain Bellemare, who took over at the helm of the company since two years, crafted a transformation plan to ensure profitable growth in each division. Important measures were taken (lower production rates, halting the Learjet 85 programme, 14,000 job cuts), whereas CSeries is currently operating. The group aims to return by 2020 to a margin of 8% to 10% in the business aircraft division (vs. 4.4% in 2015 and 6.4% in 2016) and of about 8% in Transport (vs. 5.6% in 2015 and 7.4% in 2016), and be profitable again in commercial aircraft (vs. -$ 417m in 2016). Bombardier is looking to generate within the next three years annual revenue of over $ 25bn (vs. $ 16.3bn in 2016), with profitability of about 7% to 8% (vs. around 3% currently). - Sound liquidity management and good access to the bond market. As FCF generation is unlikely to be positive before 2019, the group anticipated its financing requirements by securing $ 2.5bn investments from Quebec and by refinancing its 2018 bonds ($ 1.4bn) from end-2016. Points to watch - - Execution risk associated with the Transformation plan, especially in connection with the CSeries. In the commercial aircraft segment, Bombardier is a challenger, vying with smaller Boeing (A2/A) and Airbus (A2/A+). To date, the group’s orderbook covers only the production programme out to 2020, leaving little leeway for FCF forecasts in the event of order postponements or cancellations, knowing that several orders do not seem to be fully secured. - Longer term, should CSeries fail to penetrate the market, the group may have to develop a new programme, which could delay the deleveraging process.- Bombardier is unlikely to return to positive FCF before 2019 and its credit ratios are expected to remain tense for at least another two years. - We believe the decision to reduce available outstanding RCF following last year’s negotiations reflects a more cautious attitude on the part of banks towards the group’s aerospace segment. - Brazil filed a complaint with the World Trade Organisation (WTO) against Canada over governmental aid to CSeries development. The appeal proceedings could take several years.- When CDPQ’s investment in Bombardier Transport was completed, Moody’s downgraded its bonds rating to B3, i.e. one notch below the issuer’s rating, to reflect structural subordination of these securities to CDPQ’s investment in Bombardier Transport (i.e mandatory convertible bond of $ 1.5bn).