- Many investors want to invest in the recovery of the airline industry.
- However, airlines are carrying excessive amounts of debt, and some of them are likely to go out of business.
- As a result, airline stocks are highly risky.
- CAE is offering similar upside potential to airlines but with much lower risk.
The airline industry has been severely hurt by the pandemic, which has caused a collapse in the global air traffic. This downturn is only temporary, as people will return to their normal flying habits the latest in a few years from now. It is thus natural that many investors want to invest in the recovery of the airline industry. However, airline stocks are highly risky, as they carry excessive amounts of debt, and some of them may go bankrupt. In this article, I will analyze why CAE (NYSE:CAE) is an ideal way to invest in the recovery of the airline industry.
CAE is the global leader in training for the civil aviation and defense aviation. It is the dominant player in the industry, with over 160 sites and training locations in more than 35 countries. Every year, it trains more than 120,000 civil and defense crew members and thousands of healthcare professionals worldwide.
A great advantage for CAE is the fact that it operates in strictly regulated industries, with mandatory and recurring training requirements. Airlines and business aircraft operators sign multi-year contracts with CAE and are obliged to follow these contracts in order to remain compliant with regulations.
While CAE is the global leader in its business, it still has ample room to grow. It has a market share below 33% in the civil market and a market share of 7% in the defense market. Even better, the company benefits from the secular growth that characterizes air traffic. IATA expects the global air traffic to grow by 4.2% per year until 2027. The forecast was issued before the pandemic, but the ongoing disruption is only temporary, while the long-term growth trajectory remains intact.
Although the stocks of airlines have bounced lately, they are still approximately 50% off their peaks posted early this year. As a result, many investors may be tempted to invest in these stocks with a long-term perspective. After all, there are numerous vaccine studies underway, and an effective vaccine for coronavirus is likely to come to the markets early next year. Such a development will put the pandemic under control, and people will gradually return to their normal flying habits.
However, airlines wasted excessive amounts on meaningless share repurchases in recent years, and thus, they all carry huge debt loads right now. In addition, due to the depressed air traffic, they are all burning cash at a fast pace this year. As experience has proved in all the previous recessions, some airlines will inevitably go out of business in the ongoing downturn, particularly if the downturn lasts longer than currently anticipated. Of course, the survivors will emerge stronger, thanks to the consolidation of the industry, but it is undoubtedly risky to try to predict which airlines will go out of business and which will emerge stronger.
Thanks to its solid business model, CAE is a much safer investment than airline stocks. On the one hand, the company will inevitably see its revenues slump this year due to the closure of some training center operations that were caused by the pandemic and the cost-cutting measures of airlines. On the other hand, a portion of the revenues of CAE is recurring. In civil aviation, pilots are required to pass training courses on a regular basis, usually every six to nine months, in order to maintain their certifications and remain active.
CAE also benefits from an impressive backlog. Its backlog currently stands at $9.5 billion. This amount is worth revenues of approximately 2.5 years and more than twice the current market cap of the stock. It is thus excessive and provides a strong buffer to the results of the company during the ongoing downturn. Thanks to the solid business model that results from the recurring nature of a portion of its revenues, CAE is expected to remain profitable this and next year and earn $0.29 and $0.65 per share, respectively. This is a striking difference from all the major airlines, which are expected to post hefty losses this year.
Moreover, as soon as the pandemic subsides and people return to their normal flying behavior, the stock of CAE is likely to return to the level it was in February, just before the outbreak of coronavirus worldwide, around $30. If this materializes, the stock will offer an approximate 67% return from its current price of $18. Overall, the stock is offering exciting upside potential with limited risk.
The aviation industry is going through a fierce downturn due to the collapse in the air traffic that has resulted from the pandemic. However, the pandemic is likely to subside the latest from next year, and the air traffic is likely to return to normal levels in a few years. As a result, CAE is likely to return towards its level before the outbreak of coronavirus and thus highly reward investors. CAE is offering exciting upside potential with limited risk, as it has remained profitable during the ongoing downturn thanks to its resilient business model. It thus has a much better risk/reward profile than airline stocks, which carry excessive risk due to their debt pile and operating losses.
This article was written by
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