Bombardier comment November 30, 2017

There are some things to like about Bombardier as a company. It makes great and exciting products. (Top of the line business jets, great commercial jets including the new C Series, fast trains and subway cars). The company employs many thousands of people and contributes greatly to the economy of Canada and some other countries and helps meet the transportation needs of the world.

I’d love to be able to say the stock is a good investment. Unfortunately, I can’t say that. It actually has a book value of NEGATIVE $2.71 per share. Now, that is a red flag but not necessarily a deal breaker at all. For example, Dollarama is so profitable that it is now financed entirely with debt and has a negative book value per share. But Bombardier is barely bringing in enough EBITDA to just pay its interest costs. Adjusted EBITDA of $689 million through Q3 2017 and finance (interest) expenses of $507 million. The company shows an adjusted¬† EBIT coverage ratio of 1.1. Normally anything under about 2.0 is considered unhealthy, I believe.

With these weak numbers it seems to me that a debt restructuring could occur. That would involve wiping out the common and preferred shares. Maybe the government would never let that happen and maybe pending improvements in profits and cash flows mean it will never happen. But maybe it could happen. I think governments would be want to protect jobs. But why should they want to protect equity investors?

The company has at times talked about wanting to achieve an EBIT margin of around 8.0%. From rough calculations it appears to me that close to half of that would go to interest costs leaving pre-tax earnings at 4% of revenue (and this is just an aspiration, what they HOPE to do). It just looks inadequate to me.

Based on its numbers I would have to continue to rate the shares as a Sell. And even the preferred shares I am now thinking should be rated a Sell given the weak balance sheet. But I am not very much inclined to update the reports and update the rating on these shares. Instead, I am inclinded to remove these investments from our list. The common shares (A and B) trade at low prices and any improvement in outlook could send the shares higher. This makes it very hard to predict which direction the shares will move in the next year. Maybe I am giving up on Bombardier just when things are looking better. But there is just nothing in the numbers that would give me much faith.

I have also long been bothered by what looks to me like poor disclosure. Over the years their reports hardly mention government assistance. How can that be? When they announce a new plane order it is always at “list price”. It turns out list prices seem to be grossly exaggerated compared to the actual prices. How is that honest reporting? Then they seem to deny that the C Series plane order from Delta Airlines was “dumping”. But they booked an “Onerous Contract” charge on that sale. (I had never before heard of a company making a sale and then immediately booking a huge loss on the sale). In my view, the company has not been honest with even itself for years.

Consider Bombardier’s Debt:

They just successfully raised one billion dollars of seven year debt at 7.5%. That is actually impressive, I suppose. But I find it strange that $600 million of this will be used to pay off lower interest 4.75% debt due 2019. Why pay off 4.75% debt with 7.5% borrowing? I think they have done this before and it may be they don’t want the risk of being UNABLE to raise debt in 2019.

What of these 7.5% bonds though? Are they worth the risk? Bombardier has a a credit rating of B minus from Standard and Poors which means “faces major uncertainties” but it is above the CCC rating which means “currently vulnerable”.

I don’t think I would risk buying these bonds. 7.5% is a very good return if it comes to pass and the bonds mature as scheduled in seven years. But I think it comes with a non-zero risk that this company could be forced to restructure at some point. (In which case¬† these bonds would likely take a permanent loss.) I think I would prefer a more certain 4 or 5% to this potentially risky 7.5%.

Here is something interesting from Bombardier’s latest report:

In Q3 they delivered 16 commercial planes (7 Q400, 4CRJ regional jets and 5 of the new CS300, the 150 seaters). Revenue was $525 million so $33 million per plane (and that assumes none of the revenue came from spares or anything other than plane deliverys). And they delivered 31 business jets (4 Learjets, 18 Challenger jets, and 9 Global jets). Revenue for business jets was $1095 million. So this appears to be $35 million per plane. I am shocked to see that business jets sell for more than commercial jets even with 5 150 seaters in the commercial figure. Commercial jets are being sold at a loss. Hopefully, Air Canada and Delta and Swiss Air and the others will send nice thank you cards to Bombardier for selling them planes below cost.