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CSeries continues to influence Bombardier stock

March 10, 2014, Montreal - For several years, Bombardier Inc.’s shares have risen and fallen along with hopes that the plane maker’s C Series jet will, upon launch, transform the company into an earnings machine.


March 10, 2014
By The Globe and Mail

Right now is one of those falling times. Bombardier stock dropped more
than 10 per cent last month, setting a 52-week low, after an earnings
report that disappointed on multiple fronts. The Montreal-based company
acknowledged yet another delay in the C Series’ introduction, to the
second half of 2015. It also reported underwhelming profit margins and
issued disappointing guidance. Friday, it said it was freezing salaries
for 38,000 nonunion workers.

At Friday’s close of $3.60 the stock has now wiped out 2013 gains
that, at their high point, represented an 80-per-cent return for
investors in less than a year.

 

For those who believe in
Bombardier’s ability to make an airplane that will successfully compete
with giants Boeing and Embraer, the fading share price looks like an
opportunity. With every poor quarter Bombardier announces, however, its
turnaround moves further into the future – with the real possibility the
descent will continue in 2014.

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“What I’m telling my clients is if
you need immediate gratification this year, forget it,” says Brian
Langenberg, an independent analyst in Chicago with Langenberg & Co.
who has covered industrial stocks for two decades. “If you need to see
signs of progress this year that make you feel real warm and fuzzy about
the second half of 2015, please call me back around December, because I
assume this [pattern of earnings misses is] going to go on for a
while.”

 

“The only reason the stock should be interesting to an
investor right now is if they’re willing to be disciplined and
value-oriented and say, ‘You know, once they do get this freakin’ thing
in the air and it’s hauling people, it’s probably a $7 stock.’”

 

However,
the best-case scenario for when Bombardier gets the C Series in the air
now seems to be late 2015. The company’s recent results were so bad
that ratings agencies downgraded Bombardier’s debt and equity analysts
began to openly wonder whether the company can make it to launch with
the cash it has on hand.

 

Bombardier reported earnings before
interest and taxes, or EBIT, of $186-million (U.S.) for the fourth
quarter, versus a consensus of $295-million, says RBC Dominion
Securities Inc.’s Walter Spracklin. EBIT margins at its Aerospace and at
its Transportation division, where it makes rail cars, came in under 4
per cent, below expectations and well below management’s long-term goal
of 8 per cent.

 

Mr. Spracklin, who has a “sector perform” rating on
the shares, believes the company won’t need additional financing – if
it meets its new, reduced guidance for profit margins and capital
expenditures. The company has $7.2-billion in debt, with $1.7-billion of
it coming due in 2016. “Continued C Series program delays put
Bombardier in a much more difficult financing position as 2016
approaches,” he says.

 

Analyst Darryl Genovesi at UBS Securities
LLC, who has a “neutral” rating on the shares, says he believes there
will be at least one more delay in the C Series, and that Bombardier’s
“cash burn to come over the next few years is still underappreciated.”
He sees the company, which has $4.8-billion in cash, using $2-billion of
it from 2014 to 2016 to subsidize its operations and capital spending.
If the C Series has cost overruns akin to Boeing’s 787, however, he sees
an extra $3-billion to $4-billion in cash outflows on top of that.

 

Anthony
Scilipoti of Veritas Investment Research, who has a “sell” rating on
the shares, says that Bombardier’s missed and reduced guidance is
particularly surprising since much of its revenue comes from orders
placed well in the past, for future delivery. “It seems clear to us that
management has very little visibility into its contracts,” he says.

 

While
Bombardier’s stock price “may seem compelling,” Mr. Scilipoti says, its
debt levels and operational issues “will not support the cash flow
demands of its development programs. We expect Bombardier’s prospects to
get worse before they get better.”

 

There are some dissenting
voices. Nicholas Heymann of William Blair & Co. LLC has an
“outperform” rating and $6 (Canadian) target price on the stock. He
believes investors are in one of their periodic funks about the outlook
for Bombardier. Their fears about the company’s ability to finance the C
Series are overblown, he says, and he hopes the company will be able to
reassure investors of that at its Investor Day on March 20.

 

However,
to win back investor confidence, the company will have to demonstrate
tangible results in execution, C Series orders, and the certification of
its new aircraft, and that will take longer, he says.

 

“Exiting
positions in Bombardier may seem appealing, but fear and loss of
confidence have almost certainly (again) magnified perceived risk versus
strong potential,” he says. The share price hit lows after a failed
bond offering in November, 2012, but “three sequential quarters of
improved operating execution and enthusiasm for the C Series’ first
flight in September, 2013, lifted the shares over 80 per cent 10 months
later.”

 

Mr. Langenberg suggests patience is essential. “From a
long-term perspective, it’s a very attractive stock because it’s all
about the C Series … [Bombardier has] proven their ability to grow and
make airplanes people want to buy. It’s not like anybody says the C
Series is a plane that’s in trouble. They’re moving to a bigger weight
class, in a big way, and they’re having learning-curve issues.”

 

Investors
in Bombardier have learned a few things too, such as how optimism and
elation can give way to ennui and distress. The former feelings may
indeed return at some time in the future. For 2014, however, count on
the latter.