CAE Inc (TSX: CAE) is a global company focused on delivering training for the civil aviation, defence, security, and healthcare markets. It sells multiple types of simulators and synthetic exercises to the customers, which serve as alternatives for live-training experiences. 

Key highlights

• Improved financials: The company reported year over year growth in the second quarter was driven by the strengthening of the Civil training business, the continued ramp up of structural cost saving initiatives, and the integration of the L3 Harris Military Training business in its Defense results. CAE’s revenue increased 16% to CAD 814.9 million and transformed its net loss to net profit at CAD 17.2 million.

Source: Company Filing

• Secured free cash flows: Given the negative environment, the company's financials improved, indicating increased operational efficiencies. The company generated CAD 19.4 million in free cash flow for the quarter, but this was down on a year-over-year basis due to a decrease in cash provided by operating activities, which included payments of approximately CAD 52 million in the quarter for acquisition costs associated with the L3H MT acquisition. Despite this, the company generated free cash flows, which is a big benefit.

• New acquisition update: The company recently announced the purchase of Sabre's AirCentre airline operations, which provides flight and crew management and optimization solutions, for USD 392.5 million. The company's customer base in the digitally enabled flight and crew operations areas is likely to grow as a result of the above. In the 2019 calendar year (pre-pandemic), AirCentre generated roughly USD150 million in revenue and nearly USD55 million in EBITDA.
  

• Healthy Order intake: In Q2 2022, the company posted 30% rise in its order intake to CAD 871.4 million, compared to CAD 667.8 million in the previous corresponding period. The Defense book-to-sales ratio stands at 1.02x for the quarter and 0.90 for the last 12 months, while the Defense backlog, at the end of Q2 2022 stood at CAD 4,564.7 million, while the consolidated backlog stood at CAD 8.827.9 million, respectively.

Financial overview of Q2 2022

Source: Company Filing

• In Q2 FY22 company posted revenue of CAD 814.9 million, climbed from CAD 704.7 million in the previous corresponding period (pcp). The surge was primarily driven by strong momentum from the Defense and Security segment.
• Gross profit was posted at CAD 227.6 million, jumped from CAD 191.0 million in Q2FY21, due to higher revenue, partially offset by higher cost of sales.
• The group’s operating income stood at CAD 39.2 million, as compared to CAD 28.2 million in Q2FY21. The quarter witnessed an increase in selling, general and administrative expenses coupled with higher research & development expense.
• The quarter turned profitable and reported a net income of CAD 17.2 million, as compared to a net loss of CAD 6 million in the previous corresponding period (pcp).
  

Risks associated with investment

The bulk of the group's sales comes from the aviation sector and owing to continued lower activities due to travel constraints, most training projects have been suspended. If the current trend continues, the company's cash flows, and revenue would suffer. 

Valuation Methodology (Illustrative): EV to EBITDA

Stock recommendation

CAE showed its mettle and resiliency by effectively confronting the uncertainties of COVID-19 while also taking resources to radically improve the Company for the future. The company continue to play offence during this period of disruption, as evidenced by its recent announcement of the proposed acquisition of Sabre's AirCentre business, which marks its ninth accretive acquisition since the pandemic began. As business conditions continue to improve further, the company look to extend this posture as it relates to both organic and inorganic growth investment. Moreover, the group witnessed improved order backlog and free cash flows, even in this depressed environment, is a big positive. Therefore, based on the above rationale and valuation, we recommend a "Buy" rating at the closing price of CAD 32.75 as on December 22, 2021. We have considered TransDigm Group Inc, Textron Inc, Mercury Systems Inc. etc. as the peer group for the comparison.

*Depending upon the risk tolerance, investors may consider unwinding their positions in a respective stock once the estimated target price is reached. 

Technical Analysis Summary

One-Year Technical Price Chart (as on December 22, 2021). Source: REFINITIV, Analysis by Kalkine Group

*The reference data in this report has been partly sourced from REFINITIV.

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